Having rung up over US$25bn in debts, and four state bailouts in the past decade, Japan Airlines – Asia’s largest airline – has finally filed for bankruptcy protection. The beleaguered company made the filing yesterday, and although the government has pledged to keep the carrier in the air, almost 16,000 jobs will be slashed in a bid for survival. The firm will also receive a further JPY900bn (roughly US$10bn) of loans from state-backed Enterprise Turnaround and the government in order to restructure its operations.

In my view, the demise of Japan Airlines comes down to a failure to adapt to an unsustainable debt load, excessive expenditure, and subdued consumer demand. While the fact the government has let an unprofitable company fail is encouraging, my concern, from a macroeconomic perspective, is that the sovereign shares many of Japan Airlines’ weaknesses. With the government looking to push through a second supplementary budget worth JPY7.2trn for FY2009 (April-March), there appears to be little stopping the public sector debt load smashing above 200% of GDP. Meanwhile, with the Japanese economy still on the ropes – nominal GDP fell 5.6% y-o-y in Q309 – one must question how Japan will fund future fiscal deficits, especially as its ageing population starts to run down its savings pool.

For this reason, I believe that the outlook for Japanese sovereign debt looks pretty ominous. Japan’s sovereign JGB 5-Year credit default swap (CDS) spread has already blown out to 81bps, the highest since November. A clean break above this level could see further spread widening towards trendline support at 95bps, deepening the divergence of Japan’s CDS performance compared to its developed world peers.