Japan’s interdependence with China has been highlighted by recent events like the 3/11 earthquake and the Diaoyou/Senkaku Island dispute. Japan is China’s largest investor, and China is Japan’s largest trading partner and financier. Due to this interdependence, Japan would be greatly affected by a Chinese political or economic shock. Factors that are necessary to measure the fallout are Japanese macroeconomic conditions and the degree of interrelatedness between the two countries.
Japan’s debt to GDP ratio is 212%, the highest out of any developed nation. However, this will not affect their ability to raise capital to combat an external shock because the majority of it is owned domestically and a history of current account surpluses have kept the JGB market stable. This will be a problem in the medium to long term if debt continues to increase, especially as people become less risk averse and as the population ages.
An external shock in China could be of either a economic or political nature. There are a multitude of possible shocks under each of these types of shocks, but an example of an economic shock would be a real estate bubble in China’s major cities and an example of a political shock would be escalation of the Diaoyou/Senkaku Island dispute. The main difference between the two types of shocks is that if the shock was economic, it would not only affect Japan, but also the rest of Asia and the global economy. If it were political, Japan’s trading relationship and interdependence with China would leave Japan vulnerable, but Japan would also be able to look to other areas of Asia to capitalize on growth. It is therefore, in Japan’s best interest to decrease the public debt to gross domestic product ratio and lengthen the maturity on Japanese government bonds in order to mitigate the effects of a future external shock from China.