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Japan Bond Market ’Jitters’ Loom as Kan Struggles, Feldman Says

Naoto Kan, Japan's prime minister. Photographer: Haruyoshi Yamaguchi/Bloomberg
Naoto Kan, Japan's prime minister. Photographer: Haruyoshi Yamaguchi/Bloomberg

Japanese Prime Minister Naoto Kan’s failure to pass legislation approving an increase in bond sales risks forcing officials to seek alternative funding methods and unsettling investors, according to Morgan Stanley.

“I envisage jitters related to government paralysis -- yields would start to rise” without parliament enacting the measure, Robert Feldman, head of economic research at Morgan Stanley in Tokyo, said in an e-mail yesterday. Among the government’s options: diverting cash from debt sales for public construction projects, ramping up bill issuance and, if needed to avoid default, seeking central bank aid, according to Feldman.

Kan’s challenges are an echo of the Obama administration’s struggle to get congressional approval for raising the federal U.S. debt limit as developed nations grapple with the consequence of fiscal stimulus measures adopted during the financial crisis. In Japan, which has the world’s biggest public debt load, Kan has seen voter support dwindle as his party is roiled by campaign-finance violations.

Japan for now continues to enjoy the lowest government bond yields, with benchmark 10-year notes at 1.295 percent late yesterday in Tokyo. Similar-maturity U.S. Treasuries yielded 3.51 percent, with German bunds at 3.28 percent. Yields on so-called JGBs remain less than their 1.48 percent average of the past five years even as debt approached 200 percent of gross domestic product.

Bridge Financing

The Ministry of Finance can use its authority to issue as much as 20 trillion yen ($243 billion) of short-term securities to keep the government financed even with the failure of the Diet to approve Kan’s financing bills by the start of the fiscal year that begins April 1. That may only serve as a bridge until June, according to Feldman. Chotaro Morita, chief strategist at Barclays Capital Japan Ltd. in Tokyo, estimates it will last until sometime between July and September.

Morita and Feldman both ruled out the risk of Japan defaulting, and Morita predicted lawmakers will approve deficit-financing bond sales by the end of the current Diet session in June. Feldman said that any emergency request for financing by the Bank of Japan would likely be met.

With public support falling, Kan, 64, has been unable to convince opposition lawmakers to authorize 44.3 trillion yen in government bonds to finance the budget and faces dissent in his Democratic Party over a push to raise the sales tax to cope with soaring debt costs. Kan’s approval rating dropped to 24 percent, the worst since he took office in June 2010, from 27 percent last month, the Yomiuri newspaper said this week.

Debt to Swell

Japan’s debt will probably swell to 997.7 trillion yen in the year starting April 1, the Ministry of Finance said in January.

Standard & Poor’s cut its sovereign rating for Japan the same month, to the fourth-highest investment grade, citing the lack of a “coherent strategy” for reining in borrowing. Moody’s Investors Service lowered its outlook on Japan’s Aa2 grade, the third highest, last month, also flagging the risk of political gridlock, with economic and fiscal policies in danger of failing to contain “the inexorable rise in debt.”

Feldman, who used to work at the Federal Reserve Bank of New York and has analyzed Japan’s economy for more than two decades, said policy “paralysis” deepened with the March 6 resignation of Foreign Minister Seiji Maehara, cited in polls as the most popular ruling-party leader.

The Democratic Party of Japan came to office in 2009 having unseated the Liberal Democratic Party that governed the nation for almost all of the postwar period. The DPJ swept to power on voter disillusion with the LDP’s failure to end a stream of campaign-finance scandals that unseated Cabinet members as well as an inability to eradicate deflation.

Now, similar issues are undermining support for Kan. Maehara, 48, resigned after admitting he had received an illegal campaign donation. The party was already hit by former leader Ichiro Ozawa’s indictment on unrelated charges of violating campaign financing laws.

“A general election has become more likely,” Feldman said in a research note two days ago, while adding that the likely result would still leave Japan “extremely difficult to govern.”

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