The nation’s largest bank has drawn up a contingency plan to deal with a hypothetical plunge in Japanese government bond prices.
The Bank of Tokyo-Mitsubishi UFJ said it is possible that prices could fall markedly, pushing up the key long-term interest rate from about 1 percent to 3.5 percent toward 2016.
The bank owns 42 trillion yen ($551 billion) worth of government bonds, the second-largest holding after the Japan Post Bank, but said it would sell government bonds with a maturity of 10 years or longer, worth up to 3 trillion yen, in the event of a spike in the yield on a benchmark 10-year government bond.
If it did sell in bulk, other investors could follow suit, sending the interest rate even higher, increasing government debt-servicing costs and further straining public finances.
The bank set up a task force to compile the contingency plan, the first of its kind. It spent six months and completed its work at the end of 2011.
Under the plan, the bank will monitor 30 economic indexes, such as growth rates and foreign exchange rates.
If it detects changes that would lead to a plunge in government bond prices, the bank will sell part of its holding and take other measures to trim losses.
The bank will pay particular attention to Japan’s current-account balance. The bank said Japan may see a current-account deficit as early as 2016 due to a trade deficit and a decrease in overseas earnings.
It also said Japan will suffer a fiscal deficit even if the consumption tax rate is raised to 10 percent in 2015 and will continue to issue new government bonds.
The bank therefore estimates that the yield on the benchmark 10-year government bond could rise to 3.5 percent toward 2016, with a possible downgrade in Japan’s sovereign credit rating.
If the interest rate rises sharply, the bank will sell government bonds with a maturity of 10 years or longer and reinvest in government bonds that mature within a year. The repayment of short-term government bonds is considered to be more certain than longer-term bonds.
The Bank of Tokyo-Mitsubishi UFJ said, however, that it does not expect government bond prices to fall in the near future.
Japanese government bonds are considered safe assets compared with securities in Europe, which have been rocked by the sovereign debt crisis, and other countries.
Long-term interest rates, linked to the yield on the benchmark 10-year Japanese government bond, remain at about 1 percent, with bond prices currently at relatively high levels.
Outstanding government bonds were worth 748 trillion yen as of the end of September, according to the Bank of Japan. Banks owned 38 percent.
Despite Japan’s massive public debt, bond prices have been stable mainly because more than 90 percent of outstanding government bonds are owned by domestic investors.
The nation’s individual financial assets, such as savings and deposits, totaled 1,471 trillion yen as of the end of September, more than the 954 trillion yen in national debt, which includes government bonds.
The government calculates its debt-servicing costs assuming a 2-percent interest rate. In the fiscal 2012 budget proposal, debt-servicing costs account for 22 trillion yen out of a general account of about 90 trillion yen.
Sayuri Kawamura, chief economist at the Japan Research Institute, said interest payments on government bonds alone will increase by more than 20 trillion yen if the long-term interest rate rises to 3.5 percent, as envisaged under the Bank of Tokyo-Mitsubishi UFJ’s contingency plan.
Other banks are also concerned about a plunge in government bond prices.
Resona Bank said it would first sell government bonds worth 2.5 trillion yen, which it does not plan to hold until their maturity, if it suffers a certain amount of paper loss. It may sell additional bonds if necessary.
Mizuho Corporate Bank said a plunge in prices could eventually force it to sell midterm government bonds worth several trillion yen.
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