Japan starts its experiment with negative interest rates today. Already, Japanese government bonds, up to maturities of almost 10 years, have effectively turned into cash: safe IOUs that pay no interest. But even with capital so cheap, there's still no sign of any boom in factory investment or wages that would permanently slay deflation. Imagine then what good Japan could do to both its own moribund economy and to emerging Asia by allowing its savings glut to spill out into illiquid infrastructure assets in the region.
The potential for a mutually beneficial investment arrangement between Tokyo on one side and New Delhi, Jakarta and Manila on the other is large enough perhaps to invent Kuro-Shiro securities: Shiro, in honor of Masaaki Shirakawa, the former Bank of Japan governor who was skeptical of inflation reaching 2 percent in aging Japan; and Kuro, as a nod to Haruhiko Kuroda, his successor who made the country's lack of inflation a monetary challenge and threw almost everything at it, alas to no avail.
Kuro-Shiro also translates as black-and-white, a perfect moniker for notes that meld Japan's deflationary past, present and future with the promise of growth that lies in the region's relatively younger and poorer economies.
Think about it: If Japanese capital stays at home, it earns nothing except a deflation premium. When the securities mature, investors will be repaid in yen that may very well buy more goods and services than now. To break the hold that this self-fulfilling deflationary mindset has on investors' psyche, three things need to happen.
First, there has to be a relatively high coupon to entice Japan's Government Pension Investment Fund and other long-term investors who need to earn a steady income to pay their own clients.
Second, there mustn't be an exchange-rate loss. The dramatic rise in the yen from 125 to the dollar in August to about 115 now is bound to make investors fearful even of earning 10 percent a year in the borrower's currency only to get, say, 50 percent fewer yen five years later for taking the trouble of investing in rupees, pesos and rupiah.
Finally, Japanese investors need assurance their investment won't get expropriated on some pretext. That's the political risk, and it can be quite large in emerging markets.
Enter Kuro-Shiro, a 10-year yen-denominated bond that has no currency risk for Japanese investors, comes with a 2 percent coupon and an attached GDP warrant, which promises, say, 0.25 percent additional interest for every 0.5 percentage point economic growth in the receiving country comes in higher than 5 percent a year. Until the projects for which Kuro-Shiro are issued become operational, the coupons are paid for by an agency like the Japan Bank for International Cooperation. That interest expense is either capitalized and loaded onto the project cost to repay JBIC, or is turned into a Japanese government grant aimed at countering China's growing influence in the region.
Investors might face the usual emerging-market uncertainties once it's time for the toll road, power plant or other infrastructure asset in question to start paying interest on the debt.
To allay those concerns, in the event of any adverse change in the cash flow promised to investors, Kuro-Shiro securities will automatically become the receiving sovereign's yen-denominated liability.
Look at this from recipient nations' point of view. India sees its growth for the current fiscal year at 7.6 percent, better than China's. Humor the Indian statistics office by believing the number to be true. If Indian Railways were to borrow via Kuro-Shiro, it would pay a 3.25 percent coupon, yen denominated. (Regular interest of 2 percent plus five times 0.25 percent for the 2.6 percentage points in excess of minimum GDP.) The Indian government's own cost of borrowing is 7.76 percent in rupee terms while Indian corporate dollar bonds pay an average 5.28 percent. Ten-year sovereign bonds in Indonesia yield almost 8 percent.
Borrowers will face a currency risk, which they don't need to hedge. After all, every new bridge or road in these countries will be disinflationary. The more of them there are, funded by Kuro-Shiro, the lower the risk of runaway inflation and currency depreciation in beneficiary nations.
Indonesia chose a Chinese-funded high-speed railway because the financing norms were better than what Japan could offer. India has accepted Japanese money for its prototype bullet train, but that's just scratching the surface of what's possible with these sorts of securities. For Japanese investors: No currency risk, no political risk and a much higher coupon than on domestic debentures. For recipients in emerging Asia: a deep source of cheap and patient money.
Kuro-Shiro can be a pump to recycle unwanted capital out of Japan and put it to work where it's most needed. If nothing else, the bonds will be a tribute to the two governors who tried and failed, in their own different ways, to bring inflation to the nation. They were simply looking for it in the wrong place.
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