Q+A-JGB market doubts opposition can avoid more supply

Wed Aug 26, 2009 2:38am EDT

By Satomi Noguchi

TOKYO, Aug 26 (Reuters) - Japanese government bond yields are expected to nudge higher in the coming months on concerns about whether the main opposition party can fund its spending plans without raising fresh debt if it wins the election on Sunday.

The Democratic Party of Japan (DPJ) is an unknown quantity for the financial markets as the ruling Liberal Democratic Party (LDP) has governed almost uninterrupted for half a century.

Bond market players say that unfamiliarity alone could prompt investors to demand a premium for investing in government debt, at least until they see signs of prudent economic management.

Following are some questions and answers on how the market sees the DPJ's economic policies.

HOW DOES THE MARKET SEE DPJ'S ECONOMIC PLAN?

The DPJ wants to stimulate growth by increasing disposable income, as opposed to the LDP's long-time practice of pump-priming through public works and other steps that benefit companies.

For a FACTBOX on key pledges by both the DPJ and the LDP click [ID:nT356653]

Long-term, the Democrats want to build up domestic demand as a stronger engine of growth, but critics say its plan to raise 16.8 trillion yen ($178.5 billion) over four years to fund its spending plan lacks specifics.

Some also say the pledged 9.1 trillion yen from cuts in wasteful spending looks optimistic and that 4-5 trillion yen is more realistic.

A new government could be pressured by public expectation and a weak economy into more expansive policies before it has secured commensurate finances from spending cuts, which could come as a result of the party's lack of experience in running a country, particularly dealing with bureaucrats.

DPJ Secretary-General Katsuya Okada has said he does not rule out fresh economic measures if the economy remains weak although one option could be to bring forward policies the party is considering starting next fiscal year. [ID:nT241454]

For an analysis on DPJ's policies and their expected impact on the economy see [ID:nT115439].

Analysts say a DPJ-led government may be forced to issue more debt to cover for shortfalls, although estimates of how much might be needed are hard to come by at this stage as the market wants more details on the fiscal plan.

Japan's public debt already runs at about 170 percent of the country's gross domestic product, the highest among the industrialised nations.

The 10-year JGB yield JP10YTN=JBTC is now at 1.31 percent. Nikko Citigroup analyst Kazuhiko Sano sees it trading between 1.30 and 1.50 percent with upward pressure towards the year-end. But low expectations for economic growth should keep yields in check.

Others, such as Goldman Sachs analysts, note the risk of a rise in long-term yields due to prospects for prolonged deterioration in the fiscal balance, though they also say the DPJ's proposals would provide a boost for growth in 2010.

WHAT WILL BE THE FIRST TEST OF THEIR CREDENTIALS?

The budget. The DPJ wants to reorganise budget-setting to make it more driven by politicians than bureaucrats. The first test will come when they prepare the 2010 budget towards the end of the year.

Vice finance spokesman Kohei Otsuka has said the party wants to finalise a draft budget in late December. In it, it plans to fund the first 7.1 trillion yen of the 16.8 trillion yen spending plan.

However the new budget process may not be smooth. In 1993-94, when the LDP was briefly replaced by a multi-party coalition, the budget was delayed. Analysts say a delay this time could feed concerns about leadership and bond supply, although political experts say the process should be smoother as the DPJ will be in charge.

WHAT HAPPENS IF DEBT DOES GO UP? WILL THE BOJ BUY MORE?

The LDP passed an extra stimulus package this year which entails an additional 16.9 trillion yen in bond issues.

The benchmark 10-year bond hit an eight-month high of 1.56 percent in June before the new supply began but the debt has been reasonably well absorbed while the economy remains weak.

But some are unsure how much investors are willing to take if more debt issuance becomes required later in the year as a result of a shortfall in revenues.

The DPJ is thought to be more in favour of central bank independence than the LDP, but some analysts say the DPJ could lean on the Bank of Japan to purchase more debt if economic or financial conditions worsen.

The Bank of Japan has ramped up its buying of government debt to 1.8 trillion yen a month from 1.2 trillion yen late last year to ensure stability in financial markets. (Additional reporting by Tetsushi Kajimoto; Editing by Kazunori Takada)