While the size of the JGB market is staggering, many investors have highlighted another statistic that they find equally pertinent when assessing the country’s level of debt sustainability. For many market participants, a country’s debt burden relative to its output provides a commonly used metric for gaining some insight into that country’s long-term debt sustainability. The International Monetary Fund (IMF) calculated Japan’s gross debt at 238% of its gross domestic product (GDP) in 2012. By way of historical perspective, Japan has had a debt burden exceeding 100% of GDP since 1997. As shown in the table below, the Japanese bond market currently provides the lowest interest rates in the world with the largest gross domestic debt to GDP.
G7 Economies: Gross Debt to GDP vs. Yield to Maturity
Traditionally, as a country’s debt burden increases, investors would demand higher interest rates to compensate them for the additional risk. However, Japan has had two primary factors contributing to its comparatively low yields: a predominantly domestic investor base and deflation.
At present, 90% of Japan’s government debt is held by domestic investors.4 Compared to other major economies, this “captive” investor base provides a significant portion of government funding. In a country like the United States, a much larger percentage of the government’s debt is financed by foreign creditors, who are more sensitive to large debt burdens. Also, a decade of deflation had boosted investor’s real returns as the trend in prices of goods and services declined. Therefore, Japanese investors were willing to receive a lower nominal yield as long as inflation remained low (or was negative). However, as we will show in future blog posts, both of these factors currently supporting low interest rates may soon be changing in response to Abenomics.
Ultimately, we believe that low borrowing costs may not persist indefinitely in Japan. In light of the variety of governmental policies seeking to boost the Japanese economy, we believe that higher interest rates may be a necessary by-product of Shinzo Abe’s reflationary agenda.
Read the full research here.
1Source: Japanese Ministry of Finance, 9/30/2013.
2Source: Barclays, 10/31/2013. Japan narrowly edged out the United States, which has a weight of 26.05%.
3Source: Bloomberg, as of 10/31/2013.
4Source: Japanese Ministry of Finance Japan Quarterly Newsletter, June 2013.
Important Risks Related to this Article
Investments focused in Japan are increasing the impact of events and developments associated with the region, which can adversely affect performance. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. In addition, when interest rates fall, income may decline. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline.