Japan to disappoint on debt policy, stocks at risk

By Stanley White – Analysis

TOKYO (BestGrowthStock) – Displease voters ahead of upper house elections expected in July by taking a firm hand to Japan’s tattered public finances or risk a credit ratings downgrade and opt for loose, mostly symbolic fiscal goals?

The Democratic Party-led government will decide next month which of the two options to take and despite attacks by the opposition who argue that the Greek crisis pointed to the need for stronger steps, analysts are convinced the government will go for a soft approach.

The consequences of such a decision, however, could be more than a sovereign credit downgrade and a decline in the bond market that investors may be prepared for. In fact it is the stock market that could suffer more, they say.

“The share market is a lot more fast-moving than the bond market, reflecting higher foreign exposure,” said Shane Oliver, head of investment strategy and chief economist at AMP Capital Investors in Sydney.

“I suspect the (government) language will be there to reduce debt over time, but a lack of action might be a concern of the markets.”

Foreign investors, whose confidence has already been shaken by the euro zone debt crisis, are much more sensitive to moves by credit agencies than Japanese investors because many funds cut or increase their investments based on these ratings.

That means they will be forced to sell if Japan suffers a sovereign downgrade and the impact will be harder felt in the stock market where overseas holding is a quarter of total shares based on value as of the end of last year, according to Bank of Japan data. By contrast, foreign funds hold just 5 percent of Japanese government bonds (JGBs).

Selling will likely be the heaviest in financials because of their JGB holdings, and shares of companies that rely on domestic consumption could fall as borrowing costs rise, Oliver added.

Japan’s gross debt last year was already 217.7 percent of its gross domestic product, worse than Greece’s debt-GDP ratio of 115.1 percent, according to the International Monetary Fund.

In five years, Japan’s debts could grow to about 2.5 times its economy, versus an expected debt-GDP ratio of 109.7 percent for the United States and 90.6 percent for Britain, the IMF says.


Successive Japanese governments have for years failed to deal with the country’s growing debt and senior policymakers in the current administration, likewise, have hardly convinced markets of their ability to tackle the issue.

Finance Minister Naoto Kan wants to take a firm stance and put a lid on the burgeoning deficit by raising the consumption tax and limiting new bond issuance at this year’s level.

But the government has struggled to reach a consensus, with stiff opposition from Prime Minister Yukio Hatoyama’s Democratic Party and even within the cabinet on fears cutting spending would only erode the already-low approval rating ahead of elections likely in July.

With public support already falling to just 20 percent over the issue of relocating a U.S. Marine base in Okinawa, Kan was forced to shelve his plan to submit to parliament a bill setting a legally binding target for reducing the budget deficits.

When it announces its long-term fiscal framework next month, the government is likely announce a series of only soft measures, such a spending target for the next three years and a loose commitment to bring the primary budget deficit back to a surplus.

That will not be enough to convince investors that its debt problems will be on a mend.

The government needs go further and cap new bond issuance at a much lower level than this year’s record 44.3 trillion yen and raise the consumption tax from current 5 percent soon, economists say.

“The risks are more for a downgrade than for the ratings agencies staying on hold,” said Masamichi Adachi, a senior economist at JPMorgan in Tokyo.

“Distrust in the government is rising. That’s why the approval rating is so low. In this kind of environment, how can you believe in 44.3 trillion yen?”


History shows that getting tough of fiscal discipline can backfire.

When former Japanese Prime Minister Ryutaro Hashimoto of the Liberal Democratic Party (LDP) raised the sales tax in 1997 it helped trigger a recession and earned the LDP a drubbing in an upper house election the following year. Hashimoto was forced to step down as premier and the head of LDP after the election.

Unlike Greece, most of Japan’s public debt is head by domestic investors and that is offsetting any risk of default.

But even that is slowly changing due to the aging population. Average savings per household fell for the fourth year in 2009 to 16.38 million yen, the lowest level in 12 years, meaning there are less funds available to buy JGBs.

The government expects the population to shrink by 3.5 percent over the next 10 years. Over the next 20 years, the population is seen likely to decline by 9.4 percent.

In fact, investors have already started to seek a higher premium on JGBs than those on U.S. and UK debt as the Greek crisis unfolded.

Japan’s five-year credit default swaps (CDS) have risen 23.5 basis points this month to 94.2 basis points, the highest since March 2009, while U.S. and UK CDS have widened only 5.3 basis points and 4.2 basis points respectively.

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(Editing by Kazunori Takada)

Japan to disappoint on debt policy, stocks at risk