Macq-ro insights：Japan’s debt-deleveraging marathon

Please refer to page 30 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures. GLOBAL Why this issue matters to investors 1) Debt structures are expected to cap global growth 2) Debt headwinds persist globally: Whilst the private sector in advanced economies has largely returned to health... 3) ...advanced economies’ public sectors and EM economies (both private and public sectors) have much more to do 4) The struggle to deleverage: Japan’s step-down in real GDP growth over the last 25 years has its parallel in our ‘long grinding cycle’ thesis for global real GDP growth to remain in a moderate 2.5-3.0% pa range Recommended reading includes: 1) 15 November 2016 Rights, Wrongs & Returns 2) 20 December 2016 The Global Macro Outlook: The outlook for US bond yields 3) 14 December 2016 The OECD LI: monthly advance #8 4) 26 August 2016 Timing the exit from unconventional monetary policies: The ECB & the BOJ 5) 11 August 2016 The Great Divergence: Inflation and Policy 6) 26 July2016 Financial Repression for decades 7) 18 July 2016 Fiscal winds of change Analyst(s) Peter Eadon-Clarke +81 3 3512 7850 peter.eadon-clarke@macquarie.com Nara Song +81 3 3512 7878 nara.song@macquarie.com 5 January 2017 Macquarie Capital Securities (Japan) Limited Macq-ro insights Japan’s debt-deleveraging marathon Debt structures are limiting growth: Japan has repeatedly challenged conventional wisdom over the last 35 years. All five macro experiments below provide important insights for investors globally, since they relate to the protracted process of private and public sector debt-deleveraging. Japan has led the way with five macro experiments 1) A private sector balance sheet recession, 1996-2006 Pages 2-3 2) A structural corporate sector savings-investment surplus 4-5 3) The legendary Japanese gross public debt to GDP ratio 6-10 4) The BOJ & radical monetary policy 11-15 5) Fiscal reconstruction via financial repression & the private sector’s response 16-24 Source: Macquarie Research, January 2017 Japan’s experience informs our global views. Macquarie’s global strategist, Viktor Shvets uses the schematic below to illustrate the unrelenting waves of debt deleveraging expected globally through 2020 and beyond. Whilst the private sector in advanced economies has largely returned to health, advanced economies’ public sectors and EM economies (both private and public sectors) have much more to do. The timelines of global debt-deleveraging Note: DM: Developed markets, advanced economies, EM: Emerging markets, EM economies Source: Federal Reserve, Macquarie Research, January 2017 Japan’s step-down in real GDP growth over the last 25 years has its parallel in our ‘long grinding cycle’ thesis for global growth to remain in a moderate 2.5-3.0% pa range. For the former, please see page 25 herein, and for the latter the 20 December 2016 The Global Macro outlook linked on the left, pages 63-69. We believe investors and policymakers still have much to learn from Japan’s struggle to deleverage. With the global recovery maturing, growth expectations need to be restrained. Debt structures are expected to cap global growth. Our 2016, 2017 and 2018 global real GDP growth forecasts are 2.6%, 3.0% and 2.9%, respectively. Macquarie Research Macq-ro insights 5 January 2017 2 Private sector balance sheet recessions Fig 1 presents the last 35 years of financial history in one chart. Led by the example of Japan, the rise and fall in the ratio of private non-financial credit/GDP has coincided with major financial events. Fig 1 Private non-financial credit as a % of GDP: significant peaks* Note: (*) 1) 1990 saw the start of Japan’s lost decade 2) 1995 was Mexico’s peso crisis 3) 1997 saw Thailand kick off the Asian crisis 4) 2008 was the USA’s subprime crisis 5) 2011 was the start of the Euro crisis that included Spain 6) China is included to put the relentless rise in its private non-financial credit/GDP ratio into context Source: The Economist, BIS, Macquarie Research, January 2017 The importance of debt: the BIS Financial cycle Claudio Borio in his December 2012 BIS working paper: The financial cycle and macroeconomics: What have we learnt? (http://www.bis.org/publ/work395.pdf) detailed the existence of financial cycles: “Arguably, the most parsimonious description of the financial cycle is in terms of credit and property prices (Drehmann et al (2012)). These variables tend to co-vary rather closely with each other, especially at low frequencies, confirming the importance of credit in the financing of construction and the purchase of property.” Like business cycles, financial cycles are not mechanistic, but do appear as patterns in the data. One problem is that whilst business cycles average 3-4 years, financial cycles average 16. Averages are just that, so let's say 16 years plus or minus 5. A lot depends on how policy responds in the business cycle downturns