Japan Discovers The Price Of Money Sovereign Debt Gets Complicated The Daily Brief 489

TITLE: gdLJtU_b-DY CHANNEL: Unknown DATE: ---TRANSCRIPT--- In today’s episode, we’ll break down two important stories. First, we’ll talk about Japan discovering the price of money, and then we’ll talk about the tower of sovereign debt getting more twisted. Welcome back to the Daily Brief by Zeroda, where we cut through the noise to help you understand what’s actually happening in the most important stories from business and markets. I’m your host, Axara. Today is Thursday, 18th June. Before we start the show, we’d like to tell you about a new podcast we just shot as part of our new initiative, Subtext. So, India’s EV adoption is now less dependent on the vehicles and more dependent on everything it plugs into like the charger, the connector, the software, the protocols that charging networks use to talk to one another and most importantly the aging Indian electricity grid beneath all of it. Now to make sense of all of this, we spoke to Zora Khan, founder and CEO of IPC, which designs and manufactures EV chargers for India’s leading two and three-wheeler OEMs to understand what it actually takes to build charging infrastructure at scale in India. The link to the podcast is in the description below. Coming to the first story, at the end of March 2025, Japanese households held more than half their financial assets in cash and bank deposits. Globally, this is an unusual way to hold one’s wealth, at least in advanced economies. In the United States, for instance, cash makes up just 11.5% of household financial assets. Meanwhile, over 40% of American wealth is held in equities. Japanese households, meanwhile, had invested just over 12% of their financial assets in equities. In fact, even Indian households hold less cash and more equity even though ours is a far less developed economy. So there is a reason for this. In most of the world, cash keeps bleeding its value noted down by inflation. Idle money loses its purchasing power and you can only protect the value of your wealth if you invest it in something productive. But Japan learned a different lesson from history. Its financial life was frozen in time. For decades, prices barely moved. wages barely increased. Your bank would barely pay any interest for the money you deposited with them. But that was all right. At least it kept its value. Nothing else could promise that. Now, most Japanese had lived through an apocalyptic collapse in their stock and property markets back in the 1980s, and their economy never recovered. If you invested in the Japanese stock markets in 1989, you wouldn’t see a single yen in returns until 25 years later in 2024. So in an economy like this rationally cash was the only safe option and as it remained stuck year after year that rational choice became culture and that era lasted for three decades. Holding cash for all those years came with no cost. And that fact shaped Japanese financial life. How households saved, what firms charged, how the government borrowed and what the yen meant for outsiders. And then with the chaos of recent years, inflation returned. And with that, interest rates finally returned as well. So what is the return of the price of money due to a country that had forgotten all about it? Nobody can tell you for sure. So Japan’s economic stuper was born out of a period of irrational excitement. In the late 1980s, Japanese stock and land prices had become a national mania. And when that bubble was eventually punctured, the floor fell off. Assets collapsed in price. Banks were held with mountains of bad debt. Firms stopped investing. An economy that once threatened the United States dominance lost all its buoyancy. The country suddenly found itself in a waking nightmare. The economy’s momentum had stalled to a point where people refused to invest even when money was practically free. Prices were falling to a point where opening a business no longer made sense. Whenever there was a flutter of optimism, disasters like the global financial crisis or the 2011 Tohoku earthquake broke its back again. Ordinary monetary policy lost its power. Now, Japan tried everything it could to get out of this bind. And by 1999, interest rates were zero. In the 2000s, it began quantitative easing, flooding banks with money by buying banks assets. In 2016, it even tried negative interest rates, effectively punishing people for keeping money idle. And then it began to control the rate on long-term government borrowing as well, buying 10-year bonds indiscriminately from the market. Nothing worked. A new normal had taken hold. So brutal was Japan’s bubble burst that companies fundamentally changed their character. Japan went into something the economist Richard Coup calls balance sheet recession. Businesses no longer behaved like profit-making machines, and for 10 straight years, all their cash went into paying off debts and cleaning up their balance sheets. Debt, meanwhile, became taboo. Companies would not borrow to expand their operations, even if you offered them that money for free. This is why even when interest rates hit zero, no investment followed. Now, this fueled a doom loop. As the economy teetered and investment stopped, jobs disappeared. The country went into an employment ice age. And those that kept their jobs had to take wage cuts. With things so desperate, people stopped spending, delaying purchases as much as they could. Companies had to slash prices to keep selling. And for long periods, Japan went into deflation. Like a snake devouring its own tail. The cycle fed itself. With chronically low demand, firms had no reason to invest in expansions. People’s wages as a result stayed still, pushing them out of the market. And that in turn kept prices low. And over time, this log jam hardened into expectation. People learned that wages and prices would both stay the same. In such an environment, a Japanese bank had little chance of finding yields at home. The only way to get any return was to lend for very long, 30, 40 years into the future or go abroad. Similarly, insurers saw their business model stall and they needed to grow their money to pay for future claims. But Japan lacked opportunities to do so. Now, the only serious demand for money came from the Japanese government, which could borrow staggering sums for very long periods at minuscule rates. By the end of fiscal 2024, outstanding Japanese government bonds total to 1,171.1 trillion yen, 2 and a half times the size of the country’s GDP. The average bond matured in nearly 10 years at an interest rate of just83%. And after years of quantitative easing, by 2024, nearly half those bonds were held by the Japanese central bank itself. But outside Japan, Japan’s frozen economy opened space for a new trade. A global investor could borrow yen from Japan and sell them in exchange for something else like dollars, rupees, pesos, whatever, and then invested in something that promised returns. Those returns were yours to keep. The only real risk was if the yen appreciated too much before you repaid that yen loan. But that happened every once in a while, sparking a panic through global markets. But as long as forex rates remain reasonably stable, this was free money. According to an August 2024 assessment, the scale of these carry trades was more than 40 trillion yen or over rupees 23 lakh cr. A lot of this money reached us as well, often hitting our markets as FBI inflows. Now, it’s hard to estimate how much because these trades are fundamentally opaque. But by some estimates, nearly a quarter of that money flowed into India. Japan imports nearly all its food and fuel. For decades, we lived in a stable globalized economy where such arrangements were routine. But in 2022, as Russian forces marched into Ukraine, both suddenly became expensive. Now, in the short term, this was a bad thing for Japanese households who suddenly found themselves poorer, but it created momentum in a cycle that had long been stalled. In the following years, Japanese workers succeeded in meaningfully increasing their wages, especially since workers were scarce in its aging population. In 2024, for instance, Japanese workers negotiated an average wage increase of 5.1%. And this was the highest increase they had seen in 33 years. In turn, this allowed the prices of goods and services to both appreciate. More importantly, at long last, people expected prices to rise and began ordering their affairs accordingly. So, with prices finally moving, the Bank of Japan started unwinding the many deflation fighting measures it had put in place over the years. In March 2024, it finally did away with negative interest rates, setting them at 0 to.1%. And it also called some of its market interventions. Then it actually let interest rates rise. In July 2024, rates were hiked to 0.25%. They hit.5% in January 2025 and 75% in December 2025. And then this year they breached the singledigit mark. For the first time since 1995, interest rates went up to 1%. Now sitting here in India, that number probably looks like nothing. But to a country that had learned to expect free money, it was a sea change. Finally, after decades, money had a real price. The old regime had finally ended. This new moment will transform all of the Japanese economy, just as the zero inflation regime did 30 years ago. So, consider banks. On one hand, their lending margins might finally recover. At the same time though, the value of their older bonds has fallen. So if the government is now issuing bonds that pay real interest, say at 1.5%, bonds they held from before with rates somewhere near.5% look unattractive. Those dropping values have sparked a meaningful decline in the capital base of many smaller banks. In time, their future incomes will improve, but the past has been marked down. Lifeurers saw the same dynamic. their assets have fallen in value and they’ve also turned cautious about buying super longdated government bonds as volatility has risen. Now for the last many decades, these were the borrowers the government had banked on to fuel its heavy borrowing. Slowly, that’s becoming more expensive. The government’s interest bills are growing rapidly and its interest on general bonds has gone from approximately 8 trillion yen in fiscal 2024 to over approximately 10 trillion yen in fiscal 2025 to over 13 trillion yen in fiscal 2026. In fiscal 2026 across instruments, it’s paying 31.3 trillion yen for debt servicing, a quarter of its budget. As old cheap bonds fade away over the next decade, this burden will keep increasing year on year. Of course, most of the government’s bonds are currently held by the Bank of Japan, but that has its costs. According to the BOJ’s own surveys, the median market participant considers the market terribly impaired. Now, with inflation finally back, the BOJ is stepping back with plans of unloading 350 to 370 trillion yen of bonds by March 2030. So, as the Japanese economy recovers to a semblance of normaly, something unusual has happened. Ordinarily, stock markets hate a rate hike. But in Japan, this was seen as a signal that the country would see higher nominal growth while cash, like in the rest of the world, would start losing value. This resulted in a surge of money hitting the Japanese stock markets with the Tokyo stock price index practically doubling in 3 years. And while there’s no recent data on the carry trade because the data is hard to collect, there are chances that it has shrunk meaningfully. And this might even be a tiny piece of our own FBI outflows. Together, this points to a momentous transition. Japan is shedding the vestigages of an old regime and learning to live within a new one. But this adjustment will come with friction. Japan has made many choices over three decades embedded in portfolios, pricing habits, balance sheets, and debt structures. This will all take years to unwind. The old world is dead. But who knows what the new one will look like. Coming to the second story. For most of modern financial history, a government’s balance sheet used to be very simple. They had fewer types of creditors, fewer financial instruments, and clearer legal arrangements. That’s how sovereign debt used to work. The hierarchy of paying off sovereign debt was also legible. The IMF was at the top and below it were developed nation creditors known as the Paris Club and commercial banks below, both at broadly the same rank. So when a country couldn’t pay, everyone knew the rules. Creditors coordinated through the Paris and London clubs and debt sustainability analyses worked because the stock of debt was transparent enough to analyze. To be sure, the process was painful for the data country. But rules were clearer. But that simplicity is now eroding. Over the past decade, the liability structures of emerging markets have become incredibly more complicated with new financial instruments. And this matters enormously because it changes what happens when things go wrong, especially for poor and developing countries. For instance, when Zambia defaulted in 2020, it took over 4 years to reach even a partial resolution. And it wasn’t because of someone gaming the system, but because nobody could agree on who was owed what, who ranked where in the repayment queue, and who should absorb the losses. Ethiopia, meanwhile, has been stuck in restructuring mode for a few years. The old machinery of sovereign debt workouts which were built for a simpler world is struggling to process what sovereign debt has become. Now much of the story is based on two recent reports by financial advisory firm Lazard and the World Bank. Let’s dive in. Now the first layer of this new complexity is an unofficial hierarchy of claims that has crystallized across emerging market sovereign debt. So in theory, besides institutions like the IMF, most government creditors lend on somewhat equal terms. And in the event of a repayment, there should not be highly preferential arrangements among creditors. But in practice, a steep pecking order has emerged that determines who gets paid first and much of it is invisible to the people at the bottom. So at the top sits the IMF, protected by convention as the lender of last resort. Below it are the major multilateral development banks at the World Bank and the African Development Bank. And their preferred creditor status means they typically avoid taking losses so long as they keep lending through a crisis. And then come commercial creditors who happen to be guaranteed by one of these multilaterals. So if anything goes wrong, the guarantee kicks in and they’re repaid the guantee amount. Now below all of them sit collateralized creditors, lenders who have secured their loans against specific government assets or future revenue streams. And then come regional development banks with weaker protections. And at the very bottom are unsecured creditors who absorb the consequences of everyone else’s protection. But the existence of this hierarchy is just part of the problem. Additionally, it’s largely implicit, hardly codified on paper, and it’s getting more rigid. See, for instance, multilateral banks increasingly offer guarantees to commercial lenders to attract private money into financing developing countries. That’s a powerful multiplier for development finance, but it also creates a structural trap. When a lender activates that guarantee during a debt restructuring exercise, their commercial claim effectively transforms into a preferred multilateral claim, and everyone below sees their recovery shrink. Now, this hierarchy isn’t stable either. creditors are actively competing to climb it. For instance, China’s government-owned policy banks are now the largest bilateral creditors to low and middle inome countries, but they frequently resist being classified as either official or commercial creditors. Additionally, they often require that their loan terms remain confidential and we covered this in a recent story on China’s debt diplomacy. So, this ambiguity directly influences who is involved in the debt restructure and in what sequence. So in Zambia where China was the dominant bilateral lender, this contested ranking was a primary cause of years of delay. Now within this hierarchy, the collateral attached to this debt deserves its own scrutiny. So Angola is the clearest case study. After its civil war ended in 2002, Angola rebuilt largely on credit from Chinese policy banks, repaid not in cash but in future oil shipments. By 2011, the country had borrowed more than $20 billion against its oil revenues, and much of it was barely visible to the outside world. But this goes deeper than one country. A landmark study by the Natural Resource Government Institute examined 52 resourcebacked loans signed between 2004 and 2018 worth a combined $164 billion. 30 of these worth $66 billion went to subsahara and Africa with 53% of that amount supplied by China’s two main policy banks. Somehow only one of the 52 contracts was made public. So when World Bank researchers later tried to cross-check the subsaharan loans against their own data reporting system, they could identify only half. Some had been booked not as debt at all but as advanced payments to suppliers instead. So then collateral becomes a way for each creditor to demand their price if they’re not paid. If pledging a revenue stream reliably moves the lender up the repayment queue, then every new creditor will demand that protection. Whoever lends without collateral and earliest is only pushed further down the repayment schedule. Now the numbers across many African countries bear this out. Collateralized debt makes up 60% of external public debt in South Sudan, 54% in Guinea, 32% in Chad, and 28% in the Democratic Republic of Congo. Three of the four countries that sought debt restructuring featured resourcebacked loans. Angola is now trying to exit this model and it stopped contracting oilbacked loans in 2017 and has been reducing its Chinese debts. But the exit itself, replacing Chinese lending with Western private capital, is expensive since it means paying higher interest rates. And this exit causes new problems in the repayment schedule. See, in 2025, Angola borrowed $1 billion from JP Morgan and handed over $1.93 billion worth of newly issued bonds as collateral. If it pays JP Morgan, the collateral gets returned and Angola can service it at its own pace. But if Angola actually fails to pay the new loans, JP Morgan will assume full ownership of the collateral and that in turn dilutes the claims of any past creditors in Angola’s capital structure, pushing JP Morgan up the ladder and Angola loses freedom in servicing the bonds it first issued. So in other words, the hierarchy ends up being a different shade of complicated, not less. So all of this cascades on top of each other precisely when a country defaults and needs to restructure its debt. The G20 common framework launched in 2020 was supposed to handle exactly this. It was designed to bring China and other non-paris club bilateral lenders into a structured predictable restructuring process alongside traditional creditors. Four countries have applied: Chad, Ethiopia, Ghana, and Zambia. But as you probably guessed already, the results have been sobering. The first domino to fall was Zambia, which defaulted in November 2020. The first African sovereign to do so during the pandemic. It applied for the common framework almost immediately, and the official creditor committee co-chared by China and France reached a memorandum of understanding in 2023. But the first bilateral implementation agreement, which was with France, wasn’t signed until December 2024. That’s over 4 years from default to even partial resolution. Ethiopia’s experience has been worse. It applied in early 2021 and 5 years later is still negotiating peace meal with bilateral agreements only being signed this year and bond holders threatening litigation. The common framework has been very slow in helping with debt restructuring. So why is this the case? Now before anyone can negotiate haircuts, the parties first need to figure out who’s owed what and where they sit in the queue. Now in Zambia, the core dispute was comparability of treatment. China insisted that the bond holders restructuring Zambia’s $3 billion in euro bonds were getting a better deal than bilateral creditors had been offered. But the bond holders disagreed. Zambia was caught in the middle, unable to resolve a fight between its own creditors over whose losses were truly comparable. partly because the full scope of secured and unsecured claims was never transparent to begin with. Even the instruments designed to fix restructurings can make things worse. For instance, take value recovery instruments. They compensate creditors of a country’s economy outperformed certain projections and emerged partly because creditors and debtors disagreed about future growth prospects of the country and partly because creditors stopped trusting the IMF’s forecasts of other countries. Now that’s understandable, but they make the debt burden swing in ways that are hard to model and harder to negotiate around. So the textbook example where those dynamics came into play was Greece, which as we covered earlier, underwent the largest sovereign debt restructuring in history in 2012. Now, as part of the deal, creditors received GDP linked warrants that would pay out more if Greece’s economy performed better than expected over the following decades. And the idea was simple. creditors would accept losses immediately but retain some upside if Greece eventually recovered. Now, the problem was that these instruments were extraordinarily difficult to value. For years, Greece’s economy remained weak, making the warrants appear nearly worthless. But as the country’s recovery gathered pace in the 2020s, investors began to expect larger future payouts. Greece then exercised a contractual option to buy back the warrants, triggering a dispute over their fair value. So creditors argued the instruments were worth far more than the buyback price leading to years of litigation in London courts until recently when Greece won the case. India incidentally is no longer a bystander in this system. It co-chared Sri Lanka’s official creditor committee alongside Japan and France and signed the Zambia memorandum of understanding as a bilateral creditor. As India’s bilateral lending grows, it’ll increasingly face the same classification and coordination questions that have tangled up these restructurings. Not all new complexity is harmful. So, climate resilient debt clauses and genuine state contingent instruments can build automatic relief into a contract, sparing a country the need to default and renegotiate every time a hurricane hits. And the distinction isn’t between old and new instruments per se, but rather between instruments that are contingent and transparent and those that are opaque and subordinating. A few things would help like clarity on who actually enjoys preferred creditor status, data creditor data reconciliation, legal reforms to close the loopholes that allow offbalance sheet borrowing, and the ability of countries to write buyback options into complex instruments from day one so they can simplify their structures once they can afford to. In the 1980s, the hard part of a sovereign debt crisis was usually distributing losses across banks. In the 2000s, it was neutralizing holdouts who were creditors that refused to participate in the restructuring process that everyone else accepted. In the 2020s, the hard part is figuring out which debts are official, private, guaranteed, collateralized, domestic, external, preferred, or contingent all before the restructuring can even begin. Now coming to the tidbits. The Ministry of Railways approved a rupees 755 cr 42 km third railway line between Champa and Korba under mission 3000MT expected to add 5.95 MTP freight capacity and generate Rs 85 cr in additional annual earnings. Coming to the next tidbit, Tamil Nadu announced rupes 15,032 cr to build 231 new substations alongside 121 already underway at rupes 10,19 cr with a separate rups 2275 cr earmarked for Chennai’s urban distribution upgrade and plans to recruit 15,58 electricity personnel. Coming to the final tidbit, India’s textile and apparel exports fell 2% to $35.8 billion in FY26 from $36.61 61 billion with the rupee slide from 86.6 to 94.83 providing currency support even as US tariff uncertainty and West Asia slowdown weigh down volumes. That’s all the news I have for you. Thank you so much for watching and see you in the next one. Disclaimer, this content is forformational purposes only. None of the stocks, brands or products mentioned are recommendations or endorsements.