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Bond Market Is Too Slow to Force Deficit Cuts, Shirai Warned

Sayuri Shirai, nominated to the Bank of Japan’s board this week, warned as a scholar that governments shouldn’t be fooled into confidence in their debt levels by a lack of stress in the bond market, which can react too slowly to emerging crises.

“The problem with using market indicators is that they don’t rise enough until an economic crisis hits, making it difficult to say they are effectively preventing an expansion of deficits and debt levels,” Shirai, 48, an economics professor at Keio University in Tokyo, wrote in a June 2009 paper that discusses the importance of fiscal rules in Europe.

In Japan, which has the world’s lowest bond yields even with the biggest public debt, Prime Minister Naoto Kan has failed to convince lawmakers to endorse higher taxes to rein in borrowing. Shirai also warned in 2009 that central banks’ credibility can be hurt by rescuing governments in a fiscal crisis if the liquidity injections cause inflation to soar.

“The Bank of Japan knows very well that at some point, it’s going to have to bail out the government,” said Martin Schulz, a former researcher at the central bank and now senior economist at Fujitsu Research Institute in Tokyo. “It’s certainly a relief for the bank that a candidate proposed by the government is not entirely on the dovish side, that the candidate has a strong position toward the debt situation.”

Low Yields

Japan’s benchmark 10-year government bonds yielded 1.295 percent as of 11:19 a.m. in Tokyo, compared with their average of about 1.39 percent over the past decade. By comparison, U.S. Treasuries with a similar maturity yield 3.48 percent, while German bunds are at 3.28 percent.

Shirai, nominated on March 8 to replace retiring BOJ board member Miyako Suda, didn’t answer a call to her office, or immediately respond to an e-mailed request for comment. Her office at Keio University said it was unable to comment on her current views.

Shirai voiced concern specifically about Japan’s fiscal health in a July 2010 interview with Nikkei Business Online. Japan’s domestic investors, currently holding more than 90 percent of outstanding debt, may soon be unable sustain the nation’s borrowing needs as the population ages, she said, according to the report.

“The respite won’t last for long -- if the current fiscal situation continues, we’ll eventually need foreign investors to take on a massive amount of the bonds,” she said, according to Nikkei Business Online. “Then, we won’t have the luxury to be complacent. The world understands the abnormal nature of the current situation better than the Japanese people do.”

Rating Cut

Standard & Poor’s cut Japan’s credit rating to the fourth-highest level in January, citing the lack of a strategy by Kan to curb deficits. Public debt is forecast to reach 210 percent of gross domestic in 2012, the highest among countries tracked by the Organization for Economic Cooperation and Development.

Moody’s Investors Service lowered its outlook on Japan’s rating to “negative” last month as political gridlock clouded prospects for budget negotiations and tax changes.

Shirai’s inclusion on the BOJ board may reinforce the prevailing consensus at the Bank of Japan that it must do all it can to avoid the appearance of financing public outlays.

BOJ Governor Masaaki Shirakawa on Feb. 7 said that the central bank’s purchases of government bonds aren’t intended to finance deficit spending. The bank is purchasing so-called JGBs as part of its “comprehensive” monetary easing aimed at defeating deflation.

Credibility Risk

“Excessive deficits make it harder for countries to pay off their debts, forcing the central bank to bail out the nation,” Shirai, who is a former International Monetary Fund economist, wrote in the June 2009 paper. “If the government rescue leads to growth in money supply, the central bank’s inflation-fighting policies will lose credibility.”

The decision to pick Shirai was made by a committee meeting of lawmakers from both chambers of the Diet. That they chose someone likely to reinforce Shirakawa’s views on avoiding debt monetization suggests the government agrees that would be unwise, according to former BOJ official Masamichi Adachi.

“The nomination shows that the relationship between the BOJ and the government is very favorable right now,” said Adachi, now a senior economist at JPMorgan Chase & Co. in Tokyo.

Shirai earned her doctorate in economics from Columbia University in 1993, where she studied international trade, and has published books on the IMF, Asia’s financial crisis and Europe’s sovereign debt turmoil. If approved by the full parliament, she would succeed board member Suda, who has been the bank’s biggest opponent of monetary easing.

Analysts said Shirai hasn’t said enough about Japanese monetary policy to gauge how she would vote in the board’s monthly rate-setting meetings.

“Either way, it’s very hard to go your own way when you first get appointed to the policy board,” said Yoshimasa Maruyama, a senior economist at Itochu Corp. in Tokyo. “Putting aside which way Shirai will turn, Suda’s departure will increase the influence of Shirakawa and his deputies.”

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