Japanese government bonds have been in the spotlight over the past month or so, amid renewed debate over the sustainability of Japan’s fiscal position.
The intensity of the debate, and the shorting of the JGB market that went with it, has calmed down for now. The flight to safety over the past couple of days has also helped reduce benchmark 10-year yields.
Given that overseas investors make up just 6 per cent of the JGB cash market, at first glance they may not appear a significant group, although they are a relatively verbal one.
Japan’s government has been lucky thus far, in that it could rely on domestic institutions to buy its massive total debt that is set to reach nearly 200 per cent of gross domestic product. Domestic institutions have had little else to purchase in a deflationary climate.
While deflation is back to haunt Japan, the structure of the main domestic investor base looks set to change over the long term. This is likely to lead to a need for more overseas investors, though preferably a stable rather than speculative investor base.
Japan Post, which invests its deposits into JGBs, is one example of the structural change in market share ahead. At the moment it holds 23.4 per cent of outstanding JGBs. The Ministry of Finance projects the balance of regular JGBs to reach nearly Y1,000,000bn (£7,000bn, €7,800bn, $11,500bn) by March 2023.
According to Barclays Capital’s calculations, assuming that a direct investment of deposits into JGBs is rolling over maturing positions, Japan Post would need at least 4.5 per cent annual growth in its deposit base to maintain its current JGB ownership share. However, the size of deposits at the post office’s bank has been falling over the past five years at least.
The concerns do not only lie with Japan Post, but also with pension funds and the country’s ageing population. Akitoshi Masuda, executive portfolio manager for institutional clients at asset manager Diam, says: “From next year, pensions are starting to pay out more cash so the amount they can invest in JGBs will diminish over the years.”
These structural changes will happen slowly. In the immediate and medium term, domestic demand should remain solid. Household demand has dwindled but households buy a relatively small amount of JGBs.
Domestic banks, which as of June held 12.4 per cent of JGBs, have been solid buyers. Companies have been holding back on capital expenditure in the current economic climate giving banks higher deposits to invest in JGBs. However, this situation is likely to change when the economy recovers.
Meanwhile, the life insurers continue to buy the longer dated bonds to reduce the mismatch between their assets and liabilities.
One important factor for investors both in the immediate and long term is supply in the next fiscal year and in the future.
Investors are dealing with a new government led by the Democratic Party of Japan, which is overhauling the bureaucratic system for fiscal planning. As a result investors – both domestic and foreign – have complained of a lack of a cohesive message from the DPJ regarding fiscal policy.
Alexander Düring, head of relative value research Asia-Pacific at Deutsche, says: “At some point MoF needs to come out and say something concrete about what they want to do.”
Mr Masuda points out that promises the DPJ has made are costed at an estimated Y16,800bn to March 2013. However, there are questions over how all that will be funded.
That is even more pertinent when considering the government has said it is aiming to keep new bond issuance at Y44,000bn in the year starting March.
Although the economy has started growing again, companies are making profits from cost cutting rather than from a significant return of demand.
Mr Masuda says: “The risks lie in the long term. One such risk is the potential for the debt to GDP ratio to keep on climbing. The return of Japan to healthier public finances is something that [domestic investors] will increasingly focus on over the long term.”