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JGB Rebound Seen as Yosano Joins Kan’s Cabinet: Japan Credit

Naoto Kan, Japan's prime minister
Naoto Kan, Japan's prime minister. Photographer: Tomohiro Ohsumi/Bloomberg

Japanese Prime Minister Naoto Kan’s decision to bring former finance minister Kaoru Yosano into his Cabinet signals a return to fiscal reforms that helped send benchmark bond yields to a seven-year low last August.

After Kan came to office in June pledging to limit bond sales and balance the budget, bonds yields dropped as much as 40 basis points, or 0.4 percentage point, in two months. The appointment of Yosano, who advocates increasing Japan’s 5 percent sales tax, follows government and central bank stimulus efforts that pushed yields to the highest since May last month.

Yosano’s inclusion in the cabinet may be a sign the government is moving closer to raising the consumption tax, which was last increased in 1997 when the economy went into recession. While Japan’s borrowing costs are the lowest in the world, the appointment underscores Kan’s concern about the nation’s debt, which will reach 210 percent of gross domestic product next year, according to the Organization for Economic Cooperation and Development.

“Yosano will be welcomed by the financial markets given his push for tax and fiscal reform,” said Tokuyoshi Takano, manager of the financial derivatives section at Mitsui Sumitomo Insurance Co., who controls 20 billion yen ($242 million) in assets including debt and interest-rate derivatives. At least in the short term, “it will be hard to sell bonds.”

The nation’s benchmark bonds rose last week, with the 10-year yield finishing at 1.2 percent at Japan Bond Trading Co., the nation’s largest interdealer debt broker. The yield on the 10-year Treasury note was 3.32 percent and the yield on the 10-year bund reached 3.04 percent on Friday.

Tax Policy

Yosano, 72, joined the administration on Jan. 14 after quitting as a member of the opposition Sunrise Party, which he formed in April. Before that he was a member of the former ruling party, the Liberal Democrats, and he served as finance minister in 2009.

The new economy minister called in 2008 for doubling the sales tax rate to reduce the country’s debt and pay for the medical and welfare expenses of an aging population.

“It would be hard to lift the consumption tax by 5 percent in one go, but if we don’t raise the rate in stages to around 10 percent by the middle of the decade, the country’s finances may be bust,” he said in November 2008.

Yosano said it’s an “illusion” that Japan’s fiscal woes can be fixed without higher taxes. “It’s the height of irresponsibility to spread the illusion that fiscal reform is possible without raising the consumption tax rate,” Yosano wrote in a joint magazine commentary last year with lawmaker Hiroyuki Sonoda.

Government Borrowing

Japan’s public debt is set to exceed twice the size of the economy this year, the highest among countries tracked by the OECD. Social-security costs have increased 60 percent since 2000.

“Concerns about interest rates rising due to the fiscal situation may recede,” after Yosano’s appointment, said Jun Fukashiro, who helps oversee about $18 billion as chief fund manager at Toyota Asset Management Co.

Ten-year government bond rates rose as high as 1.195 percent after Kan faced a leadership challenge for the ruling Democratic Party of Japan from Ichiro Ozawa, who ran on a platform of increased public spending and subsidies to households. Kan’s victory over Ozawa sent rates to 0.82 percent on Oct. 6, the lowest since July 2003.

Credit Default Swaps

The cost to protect Japanese government debt also tumbled in October. Five-year credit-default swaps on Japanese government bonds reached as low as 52.780, reflecting $52,780 to protect $10 million of face value, the least in a year. The CDS was 83.56 on Jan. 13, CMA prices in New York show, compared with 75.90 for China and 43.05 for the U.S. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to debt agreements.

Deflation, a general drop in prices, has supported demand for the fixed payments from bonds. Japanese consumer prices excluding fresh food fell in November for a 21st-consecutive month. Inflation-linked bonds signal an annual 0.60 percent drop in Japanese prices in the next five years. The comparable rate is 1.88 percent in the U.S.

To combat deflation and support the economy, the Bank of Japan cut the key overnight lending rate to a range between zero and 0.1 percent. It also created a 5 trillion yen ($60.4 billion) fund to buy securities, which added to a 30 trillion yen lending program.

Debt Looms

Kan, 64, is preparing to present to parliament a budget plan that will involve selling a record 144.9 trillion yen of debt in the fiscal year starting April 1.

The prime minister’s popularity has fallen from 61.5 percent when he took office in June to 32.2 percent on Jan. 15 as he struggles to jump-start an economy that probably contracted last quarter as stimulus measures expired and the strong yen threatened exporter profits, according to a Kyodo News telephone survey.

Kan’s lack of public support may stifle plans to raise sales taxes even with Yosano. Earlier this month, Kan said there should be a national debate on increasing the sales tax.

“It’s questionable whether Yosano will be able to focus on pushing ahead with raising the consumption tax rate and fiscal reform at a time when the administration’s footing is so unstable,” said Mitsui Sumitomo Insurance’s Takano.

The Japanese government doesn’t have much time to waste to fix its finances, said Satoshi Yamada, who helps oversee $11 billion as a manager of fixed-income trading at Okasan Asset Management Co. in Tokyo.

“They’ve got to press ahead with the debate on fiscal reform. It can’t wait for the next Lower House election,” Yamada said. The next parliamentary election needs to be held by the middle of 2013, though the prime minister can call for a snap election before then.

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