The recent disaster has ended the deadlock over the budget for 2011/12, as well as producing a supplementary budget to cover the costs of rescue and reconstruction operations. Various estimates suggest that these costs could amount to 4% of GDP over several years. This raises the question of affordability at a time when Japan's gross public debt is rapidly approaching 200% of annual GDP, by far the highest level in the developed world. Against this backdrop, the additional costs of reconstruction do not fundamentally alter the already bleak outlook for Japan's public finances. Although the government is likely to be able to continue to roll over its obligations relatively easily and cheaply, the country's long-term debt dynamics are unsustainable and getting worse. The Bank of Japan (BOJ, the central bank) has reacted forcefully to the catastrophe, maintaining its near-zero interest rate policy and announcing a slew of emergency measures to pre-empt turmoil in the money markets. Interest rates are unlikely to rise until the second half of 2012.

There are some early indications that the earthquake and its aftermath could induce a greater degree of consensus among Japan's political parties in favour of fiscal consolidation, including tax increases. Clearly, action must be taken to avoid further damage to the country's creditworthiness, following a downgrade in its sovereign rating in January by a credit-rating agency, Standard & Poor's (S&P). Japan is not flirting with sovereign default as some euro zone countries are, but the downgrade to its long-term debt rating by S&P has offered a stark reminder of the country's severe fiscal problems. Unless policymakers grasp the nettle of tax reform, the country is setting itself up for a future sovereign payments crisis. The timing of such an event is highly uncertain and could be far in the future, but the worry is that Japan may already be close to passing the point of no return in terms of its ability to repair its fiscal position.