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Monday, April 11, 2005
You can lead a market to bonds, but you can't make it drink
The government budget for fiscal 2005 has been enacted, but the amount dependent on government bonds, although slightly lower than in fiscal 2004, is still above 40 percent.
At the end of March, the amount of outstanding national government bonds stood at 499 trillion yen. If refinancing bonds are included, the government's bond issuance is expected to reach 170 trillion yen in fiscal 2005 alone, pushing the outstanding amount to 540 trillion yen by the end of March 2006. If local government bonds are included, the total amount may reach 750 trillion yen.
Fresh efforts are needed to help the market absorb these bonds. One such effort has been a campaign to promote JGBs to overseas investors. Seminars were recently held in London and New York to explain simplified procedures for claiming tax deductions on purchases of JGBs, as well as legal changes that have paved way for foreign corporations to own inflation-indexed Japanese government bonds.
As of the end of September, foreign ownership of outstanding JGBs stood at a mere 4 percent. This is far below the United States and Germany, for example, where ownership ratios top 40 percent. Given the rapid progress in globalizing financial transactions, Japan is undeniably lagging behind international trends. But it is not so easy to get overseas investors to buy JGBs, and we must realize that campaigns like these may have negative impacts.
First of all, the campaign may give the rest of the world the impression that Japan, which has long been considered a country with excess savings, has finally come to the point where it needs to rely on overseas savings. Japan's savings ratio has declined to the 6 percent range -- still above U.S. levels, but well below those of Germany and France, which still have double-digit ratios.
Today, the Japanese themselves are turning increasingly to overseas financial tools, as evidenced by the sharp rise in foreign currency-denominated deposits and foreign currency-based investment trusts.
Behind this trend is Japan's extremely low interest rates. Now that the end of the government's unlimited guarantee on bank deposits has arrived, people are also looking to diversify their assets to better manage their risk.
Of course, there is still enough savings in Japan to meet demand for funds. But government efforts to promote foreign purchases of JGBs may draw attention to these background factors, which might negatively affect the nation's sovereign credit ratings.
The campaign also comes at a bad time. The U.S. Federal Reserve Board has hiked interest rates seven times since last year, and further hikes are likely, given the record high price of crude oil.
At a time when the Bank of Japan is maintaining a "zero-interest-rate" policy, who in the world is going to buy JGBs, which have far lower yields than U.S. and European government bonds?
Normally, the value of the currency of a country with low interest rates -- or low inflation -- will rise. But there is a worldwide perception that the Japanese government will try to prevent the yen from appreciating by engaging in market intervention.
How can investment in JGBs be attractive at a time when the government is heavily in debt, interest rates are extremely low and you can't expect capital gains from appreciation of the yen?
The yield on the 10-year government bond in Japan is around 1.35 percent, compared with 3.60 percent in Germany and 4.50 percent in the U.S. This shows that the Japanese market is a more attractive place for raising funds than it is for managing them. For those trying to raise funds, the interest costs are low, as are the risks of incurring capital losses from a stronger yen.
Overseas investors may temporarily buy JGBs as a means of diversifying their portfolio risk. However, it is unimaginable that foreign investors -- who have to pay more than their Japanese counterparts to buy JGBs -- will hold the bonds until maturity. They are more likely to buy or sell them while paying close attention to the course of interest rate fluctuations, which could result in greater instability in long-term rates. And such instability would affect the performance of financial institutions, which hold large amounts of JGBs, as well as the currency and stock markets.
There is a deep-rooted belief -- particularly among politicians -- that there is no problem with the government indulging in deficit-spending because Japan has surplus savings. However, we must remind ourselves that these savings are held by individuals and corporations, and in this era of globalization, the government cannot control how they will manage their assets.
Teruhiko Mano is a professor at Seigakuin University Graduate School.