By Keiko Ujikane and Thomas R. Keene
Sept. 8 (Bloomberg) -- Japan’s incoming government is likely to favor spending and tax policies that may cause a surge in government borrowing and higher long-term bond yields, said international economist Carl B. Weinberg.
The election win by the Democratic Party of Japan “will set in motion spending plans and tax cuts that will destabilize Japan’s public finances,” Weinberg, chief economist at High Frequency Economics in Valhalla, New York, said in an e-mailed response to questions.
Weinberg’s judgment reflects skepticism among private analysts that the DPJ, led by Yukio Hatoyama, will follow through on its pledge to avert an increase in government bond issuance. The incoming administration has said it will pay for its priorities -- increased funds for child care, education and employment -- partly through diverting as much as 5 trillion yen ($54 billion) of stimulus spending already approved.
“A catastrophic breakdown of Japan’s public-sector finances will be the biggest story ever to hit the world economy in our times, eclipsing the current financial crisis,” Weinberg said. “Coming in the midst of the yet-to-be-resolved global financial crunch, it will worsen and prolong that still- unfolding crisis.”
Japan’s bond market has shown little evidence that investors are concerned about the DPJ’s victory. The party unseated the Liberal Democratic Party that held power for most of the nation’s postwar history. Benchmark 10-year bonds yielded 1.355 percent today, compared with 1.31 percent before the Aug. 30 vote.
Election Promises
The DPJ needs to find 7.1 trillion yen to fund its election pledges in the year starting April 1, and the amount would swell to 16.8 trillion yen in 2013, according to its campaign manifesto.
It may be hard to fulfill the promises without worsening a public debt already nearing 200 percent of gross domestic product, especially when the economic slump is trimming tax receipts, economists say.
“Most of the DPJ’s pledged spending requires semi- permanent funding, and tax revenue is falling,” said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo. “If the DPJ implements all the promises, it may end up increasing bond sales and eventually will need to raise the sales tax to finance them.”
Outgoing Finance Minister Kaoru Yosano said on Aug. 4 that the DPJ’s policies would require a sales tax of 25 percent or more. Hatoyama has said he won’t raise the consumption tax from the current 5 percent for the next four years.
New Bond Sales
Muto said the DPJ may be able to scrape together enough money to fulfill Hatoyama’s pledge of preventing next year’s new bond sales from exceeding the current period’s record 44.1 trillion yen. The year starting April 2011 is a different story, Muto added, saying issuances may exceed 50 trillion yen.
“Even though Japan is dealing with a once-in-a-century recession, it’s crazy to expand spending more given these fiscal conditions,” he said.
Weinberg predicted “a near-vertical yield curve at the end of the day.” A yield curve is a graph of the same type of bond with differing maturities. The curve for Japan’s government debt market is currently flatter, or has narrower spreads between shorter-dated and longer-dated securities, than those of other markets.
The spread between two-year and 10-year Japanese securities is 1.12 percentage point, compared with 2.51 percentage points for similar-maturity U.S. Treasuries, and 2.16 percentage points for German notes.
Falling Prices
Some analysts say falling consumer prices and weak economic growth will keep Japanese bond yields low.
“It’s highly uncertain whether the DPJ will manage to cut wasteful spending and finance its pledges,” said Nobuto Yamazaki, executive fund manager at DIAM Asset Management Co. in Tokyo. “But Japan is in deflation and the economic recovery is likely to be slow, preventing bond yields from rising.”
Martin Schulz, senior economist at Fujitsu Research Institute in Tokyo, said bond investors will only tolerate the incoming government’s fiscal expansion for so long before they demand an “exit strategy.”
“By the latter half of next year, the market will have to see a framework about what they plan to do about taxes and social security,” Schulz said. “They’ll need to raise taxes, there’s no other way out of this.”
To contact the reporters on this story: Thomas R. Keene in New York at tkeene@bloomberg.net; Keiko Ujikane in Tokyo at kujikane@bloomberg.net
Last Updated: September 7, 2009 11:01 EDT