Japan’s corporate debt, which is the debt level to the Gross Domestic Product (GDP) is at its peak since 1990. On the backdrop of this report from Capital Economics May 16, it is projected that defaults could surge, impacting heavily on small banks and regional financial institutions.
The Pandemic Effects
The corporate debt in Japan has been rising over the years, with highs of over 200% being sustained, but the swift downturn as a result of the coronavirus pandemic has contributed to negative consequences to multiple sectors of the economy, which are struggling. The latest financial stability report of the Bank of Japan suggested that companies in sectors such as food, service, accommodation, and transport are at high risk of defaulting. Worse still, the probability is expected to rise sharply over the coming years.
The Covid-19 pandemic single-handedly contributed to a 9% annualized rise on debt securities and loans from non-financial institutions in Q4 of 2020. Sources at Capital Economics further indicate that loans from banks incurred 0.3% losses on existing assets in the same period. And what economic analysts are worried about most is, to what extent are the firms in struggling sectors of the economy going to be able to repay the borrowed money?
Profit Margins for Japanese Banks in Focus
A comparative analysis on an international scale shows that Japanese banks have one of the lowest profit margins, as stipulated by the country’s lending regulations. This consequently implies that, by international standards, they have quite a limited ability to deal with the rising defaults on loans.
Marcel at Capital Economics notes that during the peak of the pandemic, most companies obtained loans that were government or publicly backed by lenders as credit guarantors. The concern going forward is what will befall such companies when such government-backed public transfers come to an end this fiscal year.
In context, the public transfers to struggling companies accumulated to Y14 trillion (about $123.5 billion) in the fiscal year that ended in March. And based on records from the Bank of Japan, this figure amounts to 3% of the Gross Domestic Product.
What Sectors Are Hit Most?
According to Capital Economics, Q4 of 2020 saw food and, transport and accommodation sectors slump by an annualized 15%. This represented a steeper drop compared to 5% as was recorded in other sectors. This means that despite the reprieve of the anticipated post-pandemic boom, the aforementioned sectors would remain in trouble, seeing as to how far the country (and the globe) is from achieving normalcy.
The overall implication is that struggling firms will resort to piling up more debt to survive the effects of the worst recession in decades. But with alarm bells being sounded on the increased probability of corporate defaulting, chances are firms will struggle to obtain funding and some will eventually fail to cope with the situation. However, Marcel points to this hypothetical scenario as long as businesses remain shut and sales stay low. In which case, firms might be able to paper over the cracks, but not for much longer.