The Bank of Japan (BoJ) has been maintaining a zero interest rate policy “to ensure permeation of the effects of monetary easing”, as it said in a recent statement. For domestic private investors, miniscule deposit rates are a disincentive to holding cash. Yet cash is precisely what many will find themselves having to deal with over the coming months, as ¥106,000bn (€1,035bn) of fixed rate postal savings start to mature. Reinvestment in a new post office account offers the unexciting prospect of 0.2% interest. Japanese government bond (JGB) investors are indeed living in interesting times.
The BoJ stance has faced criticism both internally and internationally. Although politics will play its part, the BoJ is expected to reach the point where it feels the economy is strong enough to survive an interest rate rise. Capital spending forecasts have been raised as a result of improved business confidence, and increased corporate profits have already pushed the Nikkei 225 back over 20,000. The BoJ governor recently underlined the prospects for change by saying “the risk of a deflationary spiral has receded considerably”. The Euroyen futures yield curve now suggests the move away from 0% is around six months away.
While the threat of rising short-term interest rates is largely discounted, there are other clouds hanging over the bond market. Moody’s, the rating agency, has announced that it is placing the Aa1 yen-denominated government debt rating under review for a possible downgrade, due to concerns about Japan’s structural economic problems. The agency expects that public sector debt levels, measured as a percentage of GDP, will soon be the highest among industrialised countries. One estimate is that total outstanding national and local debt will exceed 120% of GDP by the end of 2000.
While the warning from Moody’s surprised many foreign observers, there was surprisingly little concern in the JGB market. This was probably due to the interesting ownership spread of JGBs, with government institutions holding about 50% of the total.
The post office is a particularly heavy investor, using JGBs as backing for the fixed rate postal savings bonds. It is unlikely that any government institution would sell on the threat of a rating downgrade. Foreign investors, who would have been expected to be less sanguine, hold only 6% of JGBs with the remainder held by domestic private investors.
Moody’s is not alone in registering concern. In March the Economic Planning Agency (EPA) published data showing that the economy shrunk by 1.4% in the fourth quarter of 1999, the second consecutive quarter of decline.
The statistics were met with considerable scepticism both inside and outside Japan: For example, Richard Jerram, an economist at ING Barings, was quoted in the Financial Times as saying, “It is ridiculous to say there is a recession – the GDP figures are just bizarre”.
Other economic measures, such as industrial production, point to a growing economy. Setting the EPA’s figures to one side, the Japanese economy ought to grow during 2000, helped by government stimulus and increased export-led production. However this recovery will not be the same as in the 1980s. The corporate sector’s new-found emphasis on enhancing productivity and cost control will constrain consumer spending, which accounts for about 60% of GDP. Thus this economic upturn is not expected to be particularly powerful.
Continuing consumer caution and a sluggish recovery increases the need for supplementary fiscal packages during the year but, due to Japan’s debt levels, the scope for such packages is increasingly constrained.
Such are the problems in the quality and interpretation of economic data, the prime minister has intervened. He is facing an impending election and would prefer the EPA not to talk of a recession if none exists. For the BoJ, suspect data does not make it any easier to decide when to end the zero interest rate policy.
Given this mixed tone, JGB yields will probably remain range-bound in the short term. The yields on offer have domestic appeal, even if they are unattractive in global terms. But against this, international investors are aware that heavy JGB issuance means their weighting is steadily growing in international bond indices.
Interesting times indeed.
Jeffrey Sacks is director of Baring Asset Management