Japan must raise its sales tax to at least 20 percent by the time the Olympics come to Tokyo in 2020 to avert a “disaster” in its bond market, according to the head of a panel advising the world’s biggest pension fund.

The consumption levy, due to increase in April for the first time since 1997, will need to quadruple from current levels to handle Japan’s increasing welfare costs and rein in the nation’s debt, said Takatoshi Ito, who leads an investment panel for the 121 trillion yen ($1.23 trillion) Government Pension Investment Fund. He said funds like GPIF are at risk of being too dependent on Japanese government bonds, where 10-year yields of 0.670 percent are the lowest globally. 

Prime Minister Shinzo Abe is expected to decide next month if Japan’s economy can weather an increase in the tax to 8 percent in April. Current rates of 5 percent are a fifth of the value-added taxes imposed in Nordic countries like Sweden, and need to be raised to prevent the implosion of a debt burden that’s more than double the size of Japan’s economy, Ito said.

“There is a narrow path to escape from the disaster,” Ito, the dean of Tokyo University’s Graduate School of Public Policy, said in an interview Tuesday. “The good news is that there is a big fiscal space to increase taxes.”

Abe will announce his decision on Oct. 1 after the release of the Bank of Japan’s Tankan survey of business sentiment. He has pledged to defeat 15 years of deflation and spur growth in the world’s third-largest economy using the so-called three arrows of fiscal stimulus, monetary easing and a package of growth-oriented initiatives including deregulation.

The BOJ unveiled an unprecedented monetary stimulus program in April, saying it would double monthly JGB purchases to more than 7 trillion yen in pursuit of a 2 percent inflation target. The easing has kept a lid on bond yields as it helped Japan’s exporters by sending the yen to a 4 1/2-year low of 103.74 per dollar in May. It was at 98.74 as of 9:41 a.m. in Tokyo.

Even as Japan’s economy recovers from the effects of an earthquake and nuclear crisis in 2011, it hasn’t begun to chip away at its debt pile. Government obligations will grow to 245 percent of economic output this year, the highest ratio globally, according to International Monetary Fund estimates, compared with Greece’s 179 percent and 108 percent for the U.S.

Italy, whose debt is expected to expand to 131 percent of its gross domestic product in 2013, is slated to raise its value-added tax to 22 percent on Oct. 1.

While more than 90 percent of JGBs are held domestically, Japan’s declining population and expanding welfare expenses mean that the country will eventually lose the ability to fund its debts, Ito said. Without an increase in the tax rate toward 20 percent or higher by 2020, “my prediction is that a big disaster happens in 2023,” he said, citing projections for household wealth and government borrowing. (Bloomberg)