Japanese government bond (JGB) yields are likely to trend upwards if Japan fails to deliver the much-anticipated hike in sales tax from 5% to 8% in April 2014, making it much more difficult for the nation to deal with its mounting debt problems, say bankers. This is because lower-than-expected tax receipts would force the government to issue more bonds to finance its spending.
As a result, the government needs to restore fiscal dynamics in order to keep refinancing costs at sustainable levels and to boost investor confidence. Nominal yields are currently at 0.7%, which is very low, highlight economists.
“The government is not going to have better refinancing plan for the JGBs because no sales tax hike means no tax revenue,” said a Tokyo-based head of debt capital markets (DCM) to Asiamoney PLUS on September 11. “If this happens, investors will become less confident in JGBs – so they will start selling, resulting in a rise in yields.”
Junko Nishioka, Tokyo-based Japan economist at Royal Bank of Scotland (RBS) agrees: “No one knows how much the yields are going to increase with the failure of the consumption tax hike. If nominal yields increase close to 2%, it will increase the nation’s debt payment cost.”
The deteriorating fiscal situation and heavy government bond issuance have led to mounting concerns about Japan’s fiscal stability and solvency in recent years. Any indications that the government is unwilling to address this issue could threaten the current low-interest rate environment and lead to an eventual debt crisis, note experts.
Bank of Japan (BoJ) governor Haruhiko Kuroda on September 5 also urged the government to stick to its plan to raise the sales tax next April, saying JGB prices could collapse if it fails to do so, according to the Japan Times.
“What Kuroda-san is trying to say is that the possible negative impact to the financial markets is more massive compared to the short-lived negative contraction of the GDP after the tax hike,” said RBS’ Nishioka.
This is not a risk that the Japanese economy can afford, especially given the hard and successful efforts made by prime minister Shinzo Abe to boost the nation’s growth, lifting Japan out of years of deflation. This is helped in large part by aggressive quantitative easing from the BoJ.
Also, the JGB market has been relatively calm in recent weeks despite growing fiscal disquiet. After briefly shooting up to 1% in May, yields on 10-year JGBs are back down to 0.74% on September 11, even as inflation expectations have firmed up.
“The economy has responded well to ‘Abenomics’ since prime minister Shinzo Abe took office in December 2012,” said Betty Rui Wang, Japan economist at Standard Chartered. “Raising the sales tax would be a clear first step towards fiscal consolidation, a key component of the long-term growth strategy – the so-called ‘third arrow’ of Abenomics.”
Abe has said he will make a decision on whether to raise the sales tax after examining the most recent economic data, including the results of BoJ’s tankan business sentiment survey due out October 1.
Japan has the world’s highest public debt-to-GDP ratio, which a quadrupled from 34.3% in 1997 to 134.5% in 2012. Gross government debt as a share of GDP doubled to 238% during the same period. Also the nation is facing a growing social security bill as the population ages.
JGB investors prevent shock
While there are worries that a failure to raise sales tax could lead to a selloff in JGBs, investors are publicly making announcements to prevent any unwarranted shock to the domestic bond market.
On September 9, Japan Post, the nation’s largest savings institution and largest insurer, said it will not seek to move away from holding massive quantities of domestic government bonds.
It holds almost US$2 trillion-worth of JGBs, making it Japan’s largest credit ahead of the central bank, which holds the equivalent of US$1.6 trillion in debt after a buying spree that accelerated this year.
Despite increased worries, Japan has ample firepower to support its problematic fiscal dynamics if it needs to, say experts, suggesting that investors should not act to rashly amid such uncertainty.
“Looking at the balance sheet of Japan, we are fine because we have very huge sticky deposit base and a lot of international government bonds such as US Treasuries,” said the head of DCM. “If we really need money we can sell the US Treasuries, but obviously nobody wants to see that.”
As of August 16, Japan holds US$1.1 trillion of US Treasuries, the second largest after China, which possesses US$1.3 trillion.