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Tuesday, February 9, 1999 Published at 12:08 GMT


Business: The Economy

Japan in a bind over bonds



A row is brewing in Japan over how to fund plans for massive government borrowing which is needed to boost the country's flagging economy.

The government wants to finance recovery plans by issuing more than ¥30 trillion (£260bn, or $430bn) in bonds this year, but the plans could be jeopardised by the rising interest rates on government debt.

The prospect of such a huge issue - making up 90% of the government debt issued by all the major industrial countries this year - has already depressed the price of Japanese government bonds (JGBs) in issue.


[ image: The Bank of Japan has refused to intervene in bond markets]
The Bank of Japan has refused to intervene in bond markets
The total value of Japan's public sector debt is expected to rise to $2,500bn, overtaking the United States, whose $3,000bn debt has been falling with the US budget surpluses.

Yields (or interest rates) on Japanese government bonds -which are inversely related to price - have already risen from around 0.7% to nearly 2.5% in recent weeks.

This threatens to undermine the government's strategy of keeping interest rates low in order to boost economic recovery. Japan's central bank's base rate is only 0.5%, but the long-term interest rate paid by companies is more closely related to the interest rate on bonds. Most at risk could be the debt-laden banking sector, which is already receiving a massive injection of government cash.

The rising yields have also helped boost the yen, which also makes Japan's exports more expensive and hurts Japanese companies.

"The underlying reason for the high yield is that the market has lost confidence in government fiscal policy," said Yasushi Okada of Credit Suisse First Boston.

Japan's economy is in its worst recession since World War II, with no sign of a respite despite two years of negative growth. The government has already announced two recovery packages, comprising tax cuts and public works spending to help turn the tide.

"We believe that an increase in long-term bond yields is negative for the present fragile Japanese economy," said Ron Bevacqua of Merrill Lynch. "Japanese policymakers appear to be floundering - their deliberate efforts to raise interest rates do not seem to be part of a hard-landing scenario to promote reform."

Splits in the government

The Japanese government faces a dilemma as to whether to intervene in the bond market.

In the past, financing Japan's government deficit was not a problem.

Japanese consumers, who have a high rate of savings, put their money in the government-run postal savings system.

The Japanese government, through its Trust fund, then effectively repurchased its own securities.

But now the Trust Fund needs to sell some of those government bonds to finance the growing number of redemptions, as financial deregulation has led to more attractive savings and investment accounts elsewhere.

The government is pressing the Bank of Japan to take up the slack and buy more bonds.

Cabinet Secretary Hiromu Nonaka has urged the bank to take action.

"I think that responsibility for breaking out of the present severe situation rests with the Bank of Japan as the central bank .. the Bank has the responsibility to resolve the current situation by considering various means, including buying government bonds," he said.

But the Governor of the Bank of Japan, Masaru Hayami, says he is unconcerned about the high interest rates on bonds, and that the Bank's statutory independence prevents it from following government instructions.

Many commentators, however, believe that eventually Japan's growing public debt will have to be monetarised - that is, covered by the issue of money. Although that would be inflationary, they argue that in the current deflationary climate in Japan, it would be no bad thing.



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