February 2, 2012 / 6:28 AM / in 6 years

Top Japan bank plans for JGB sell-off, no near-term shift seen

TOKYO (Reuters) - Japan’s top banking group, Mitsubishi UFJ Financial (8306.T), has drawn up a contingency plan that flags 2016 as the time when the nation’s current account may slide into deficit and trigger a government bond sell-off, a newspaper reported on Thursday.

Asahi newspaper said a plan prepared by a unit of the group -- Bank of Tokyo-Mitsubishi UFJ -- late last year estimated that 10-year bond yields could rise to around 3.5 percent in about four years’ time from about 1 percent today.

It said that in such case the bank, which held about 3 trillion yen ($39.41 billion) of bonds with more than 10 years to maturity, would sell as much as possible of those bonds and shift to short-term bills.

For more than a decade, Japan’s government has been able to fund its snowballing debt at home and at minimal cost thanks to a vast pool of domestic savings and Japanese investors’ aversion to assets they perceive as riskier, such as shares and foreign bonds.

But many economists, ratings agencies and even some Japanese policymakers warn that this may change in coming years as Japan’s debt pile continues to grow, while an aging population and dwindling current account surplus will weigh on savings.

“When a country’s borrowing continues to rise, as is the case now, we cannot rule out the risk of some trigger causing market confidence to suddenly be eroded,” Bank of Japan Deputy Governor Hirohide Yamaguchi said in a speech to business leaders.

Several bankers told Reuters that contingency plans such as the one reported by Asahi have been a part of Japanese institutions’ routine risk management for quite some time and they saw no immediate shift in their investment strategy.

“Banks have been doing all kinds of simulations under various stress scenarios like consumption tax hike not realized or Japan’s trade deficit getting big. It’s nothing new,” one banking source said.

However, Japan’s first annual trade deficit in 30 years reported last week, the euro zone’s ongoing debt crisis and a looming political deadlock over the government’s plan to raise the sales tax highlighted that Japan’s easy financing can no longer be taken for granted.

Japan’s debt burden is about twice the size of its gross domestic product and is the worst among industrial nations -- well above comparative levels of around 100 percent for the United States and 130 percent for Italy.

Despite its declared intention to bring its finances under control, the government keeps adding about $570 billion to the debt pile every year -- roughly the GDP of Switzerland -- with more budget spending covered by new borrowing than taxes.

Standard & Poor’s rating agency warned on Wednesday that even if Prime Minister Yoshihiko Noda managed to push through an unpopular plan to double the 5 percent sales tax, it would only slow growth in debt and more tax hikes and spending cuts were needed to improve Japan’s fiscal outlook.

    Paradoxically, for the time being, Europe’s debt woes, which cast a spotlight on the dire state of Japan’s public finances, are also helping keep borrowing costs low. Japanese and foreign investors still consider Japan’s deep and liquid government bond market a safe-haven compared with other more volatile markets where they have been cutting their exposure.

    A gap between credit default swap rates and bond yields reflects that. While CDS rates reflect concerns about Japan’s fiscal condition, low bond yields show that investors see a dearth of viable alternatives to Japanese government debt.

    “If banks think that 10-year JGB yields would go up to 3.5 percent by 2016 and if they have massive positions in the long end of the curve then they have to start to shorten durations now,” said Masaru Hamasaki, senior strategist at Toyota Asset Management.

    “My thinking is that if a bank is seriously worried about such a risk then they would have to start acting very soon,” Hamasaki said.

    “But at the moment, investors are more concerned about managing their massive liquidity and JGBs are still in favor. Banks and institutional investors are expected to jump in to buy them should JGB yields start rising rapidly.”

    ($1 = 76.1300 Japanese yen)

    Additional reporting by Chikafumi Hodo and Tetsushi Kajimoto; Writing by Tomasz Janowski; Editing by Joseph Radford and Michael Urquhart

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