Japan’s own ‘fiscal cliff’ threatens to roil JGBs

Time is running out before Japan faces its own version of a “fiscal cliff” as political wrangling prevents the passage of a bill to raise the debt ceiling, stoking concerns of a possible government shutdown and disruptions in the bond market.

The legislation is necessary to issue bonds to finance some 40 percent of this year’s budget. The government has warned that unless political parties come to terms and enact the bill, it won’t have the cash to pay for previously allocated spending.

“The possibility isn’t zero,” a finance ministry official said, referring to the prospect of Japan suffering the kind of government shutdown that hit Washington in 1995.

The Japanese government has already taken the unprecedented step of suspending some spending, and if parliamentary gridlock over the bill isn’t resolved in a month, it would have to suspend bond offerings, starting with either an auction of two-year Japanese government bonds on November 27 or 10-year bonds on December 4, analysts said. That would be the first cancellation ever for a two-year tender and the first for a 10-year sale in 25 years, ministry officials have said.

In a bid to address market participants’ worries that such a disruption of debt issuance may raise volatility in Japanese government bonds, the finance ministry is set to hold an extraordinary meeting with JGB primary dealers on Friday.

The fate of the bond-issuance bill has been up in the air as the main opposition parties have refused to back it unless prime minister Yoshihiko Noda promises them an early snap election in return. The bill needs the support of the opposition, which controls one of the two chambers of the parliament, but Noda hasn’t agreed to give an election date, resulting in an impasse even as the parliament looks likely to reconvene next week.

Views are split among analysts on how JGB yields will react if new issuance comes to a halt.

The lack of fresh supply could lead investors to rush to existing bonds, putting downward pressure on JGB yields, which move inversely to prices. JGBs remain popular among Japanese banks, which are flush with cash obtained under the Bank of Japan’s ultra-easy monetary policy.

On the other hand, the suspension of bond auctions would mean that the finance ministry would have to sell a larger amount of bonds through regular offerings once the bill is enacted, possibly causing indigestion in the secondary market and pushing up yields.

Some analysts say the confusion could further erode confidence in Japan’s fiscal policy, leading investors to shun JGBs in the longer term.

“Foreign investors including hedge funds may sell off JGB futures due to a loss of fiscal governance and the ensuing risk of rating downgrades, and that eventually could make domestic players reluctant to buy cash bonds,” said Jun Ishii, chief JGB strategist at Mitsubishi UFJ Morgan Stanley Securities.

Reflecting such concerns, the yield on superlong JGBs, the most sensitive to the fiscal outlook, has risen recently. The 30-year JGB yield hit a more-than-six-month high of 1.960 percent on Wednesday.

But with yields on foreign bonds declining amid a global monetary easing trend, Japanese investors, notably life insurers, are expected to buy JGBs, putting a cap on yields. Investment plans by major life insurers announced this week showed that they are eager to boost purchases of long and superlong JGBs.

As the clock ticks toward the end-November deadline, there has been increased debate over whether a work-around can be found to avert a government shutdown.

Japan’s budget law allows the government to raise as much as JPY 20 trillion (about $250 billion) within a fiscal year by issuing short-term debt. That is conditional on the government being able to repay it within the same fiscal year. Some experts say that as long as the bond-issuance bill is enacted by the end of March, when the fiscal year finishes, the government can resort to this measure.

But officials say that isn’t an option as the Cabinet has agreed that enactment of the bond-issuance bill is a prerequisite for any new borrowing.

Sales of financial assets held by the government or receiving bank lending would both require parliamentary approval, a process unlikely given that the opposition parties control one of the two houses of parliament.

The face-off over the bond bill has become an annual scene in Japanese politics. Last year, then-Prime minister Naoto Kan agreed to step down in return for opposition backing for the bill.

While the constitution grants parliament’s lower house de facto power to enact the budget on its own, other bills, including those to raise the debt ceiling, require the approval of both houses.

Noda said he recently called on opposition leaders to jointly look into a framework to enact both the budget and bills required to fund it simultaneously, but that the proposal was shot down.

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Category: FinanceAsia