It is one of the big ironies of global markets. At a time of fears over sovereign debt, foreign ownership of Japanese government bonds – the world’s most indebted country – has never been higher.
Data released last month by the Bank of Japan showed that ownership of the country’s debt by non-Japanese residents jumped almost a third to a record Y75.7tn ($986bn) at the end of September, from Y57.9tn a year earlier. As a percentage of the total debt outstanding, foreign holdings stood at 8.2 per cent, not far off the all-time high of 8.5 per cent in the third quarter of 2008.
Kohei Noda, a deputy director for debt management policy, says that, since 2005, the Japanese government has pursued an “active policy of diversification” through the marketing of bonds to foreign investors.
By encouraging overseas sovereign wealth funds, central banks, pension funds and life insurers to buy debt, the theory goes, they will help to anchor long-term yields in the world’s second-biggest public debt market. Japan’s Ministry of Finance expects gross central and local-government debt to top Y937tn at the end of the fiscal year beginning in April – or Y7.3m ($90,000) for every man, woman and child.
But, what should be of concern for Japan’s MoF, is that the majority of foreign buying has been in the form of T-bills – government debt with a maturity of one year or less – rather than longer-term JGBs. Purchases of such shorter-dated debt are less desirable as they could easily reverse as broader sentiment improves.
“Overseas investors are flocking to Japan’s debt now, but there may be a sudden rise in yields when the mood changes and they begin to seek higher returns,” says Naomi Hasegawa, senior fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities in Tokyo.
At 16.6 per cent of the total, foreign holdings of T-bills are a whisker away from the record 17 per cent of the first quarter of last year. Analysts say that foreign ownership is likely to have increased further in the fourth quarter, meaning that these average holdings last year were almost 50 per cent higher than 2009-2010 levels.
This is a symptom of concerns over the eurozone, which has spurred a “rush for dollars,” says Hideki Nagai, head of rates trading at Barclays Capital.
As interest rates on basis swaps to exchange dollars for yen have fallen to multi-decade lows, this has enabled dollar holders to access very cheap yen funding to park in bills and bonds.
Yet as eurozone debt concerns persist, it is understandable that foreign money-market funds would seek shelter in a market where bids are almost always at least twice the amount offered, and where the views of credit rating agencies seem to have no effect on prices. (The removal of Japan’s triple-A in December by domestic agency Rating and Investment Information was mere “noise,” says Naka Matsuzawa, chief investment strategist at Nomura.)
But persuading more foreign buyers that JGBs are a sound longer-term investment could prove “critical” in supporting prices this year, says Christian Carrillo, Tokyo-based head of Asia-Pacific interest-rate strategy at Société Générale. By Mr Carrillo’s “guesstimates,” overseas investors will account for Y12.5tn of net JGB demand in the coming fiscal year – more than banks (Y12tn), insurers (Y9tn) and the Bank of Japan (Y9.5tn).
Further out, the government’s reliance on foreign funding seems bound to increase. The nation’s current account surplus shrunk by more than a quarter over the first nine months last year, to 2.6 per cent of gross domestic product. JPMorgan chief economist Masaaki Kanno predicted last week that Japan will swing into a “persistent” current account deficit as early as 2015. “Japan will become an importer of capital,” he wrote. “The fiscal deficit will have to be financed, on the margin, by foreign investors.”
The MoF itself accepts that the overseas debt crisis is not, in local parlance, “a fire on the other side of the river.” Mr Noda says the Ministry is aiming to resume JGB roadshows in 2012, after last year’s travels were affected by disaster.
If it is to ever find a way out of its fiscal problem, Japan needs foreign debt purchases to become a matter of habit, and not just a symptom of distress.