Sunday, March 7, 2010



By Gwen Robinson, FT | 8 March 2010

Is Japan, mired in debt and deflation, the next Greece?, asks the FT in an attention-grabbing line of an editorial comment on Tuesday.

After all even Shizuka Kamei, the country's financial services minister, thinks Japan Post, the giant bank his ministry oversees, should consider diversifying out of Japanese government bonds and buy corporate bonds and— of all things— US Treasuries. Such "incendiary comments" came as S&P, alarmed at escalating debt levels and sluggish growth, has warned that it might lower Japan's credit rating. But talk of a massive JGB bubble— let alone default— is "farfetched", in the FT's view:

Certainly, Japan is not in the rudest of fiscal health. The government has spent to keep its economy going. That, combined with falling tax revenues, has pushed the country's gross debt towards 200 per cent of GDP. With an ageing population, this alarming figure could get worse. So the 10-year JGB yield, at about 1.3 per cent, looks low. What do the markets think they know?

That said, it often doesn't matter what the markets think they know if the upshot is a substantial investor backlash. And right now, the mutterings about Japan are growing louder, although among domestic investors, there is a certain sanguine— or should we say complacent?— view. To delve a little more: while it's a familiar Japanese refrain used to explain the country's various pecularities— the FT's editorial, quite rightly, asserts that Japan is indeed "different", by several key criteria:

First, gross debt levels are misleading. Japan's debt, after netting off the state's own holdings, is less than 100 per cent of GDP. Second, the cost of servicing its debt is low, at roughly 1.3 per cent of GDP. That compares with 1.8 per cent in the US, 2.3 per cent in the UK and 5.3 per cent in Italy. Third, Japan has fiscal wiggle room: sales tax is just 5 per cent. Fourth, 95 per cent of Japan's debt is domestically owned. Fickle foreigners have almost no sway.

Indeed, as the FT reminds us, Japan's problem is still an excess of savings:

Banks are awash with deposits that they need to place somewhere. For some time yet, the government will not find it hard to secure buyers for JGBs. Japan's debt problem will be worked out in the family.

That said, S&P was clearly none too happy with Japan's massive fiscal consolidation plan, as FT Alphaville noted last month.

In his weekly Greed & Fear newsletter, CLSA's Christopher Wood is similarly doubtful about the JGB outlook, noting last week's data highlighting the deflationary trend in Japan:

Thus, while the nationwide core CPI fell by "only" 1.3% YoY in December, compared with a 1.7% decline in November, the leading Tokyo core CPI for January fell by 2.0% YoY. More importantly, a record 64% of the 585 items that make up the nationwide CPI declined in December.

The Bank of Japan may be hoping for a pick-up in external demand; but, notes Wood, the recent data highlight the danger if end demand does not recover as much as anticipated and if the yen stays strong. Yet, he says, there's no doubt that "deflationary conditions are worse now than then, indicating perhaps that the dramatic fiscal deterioration of the past year is causing Japanese investors to think twice before further adding to their JGB exposure". The other key issue in Wood's view is the extent to which there will be continuing demand for JGBs from the postal savings system— particularly in light of Kamei's remarks about diversifying Japan Post Bank's investments into US Treasuries and corporate bonds.

Considering that Japan Post Bank held ¥158,500bn of JGBs at the end of December, accounting for 82 per cent of its total assets under management, a big shift would have massive consequences. Still, says the FT editorial, Japan "does not need to apply the fiscal brakes just yet". Better to consolidate the recovery through loose fiscal policy a while longer.

In one area, though, Japan is being too complacent. That is in the fight against deflation. So, the BoJ should be in there buying those JGBs, the editorial concludes:

No other central bank has been as relaxed about falling prices as the Bank of Japan. The BoJ should do more. It could increase its purchase of JGBs, monetising part of the debt. Though the fiscal situation is not as bad as it appears, a bit of nominal growth would make it look a whole lot better.



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