Fiscal Discipline Only In Name, Staying Bearish JGBs
BMI View: The Japanese Cabinet has approved a JPY92.6trn budget for the upcoming fiscal year (April-March) along with other piecemeal steps to reform the tax system and reduce unemployment benefits. Despite these positive steps, we believe the government ' s revenue estimates are overly optimistic and we maintain our expectations for the growth of Japan ' s debt to increase. We forecast outstanding Japanese government bonds (JGBs) to reach 218.5% of GDP by end-2013. With the renewed potential for rising inflation expectations to trigger a collapse in bond market confidence, we remain bearish on JGBs.
The Japanese Cabinet has approved a JPY92.6trn (19.4% of GDP) budget for the upcoming fiscal year (April 2013-Mar 2014), a slightly smaller budget compared to the JPY92.9trn set out for FY2012. Despite the small glimmer of hope for some fiscal consolidation, there were notable expenditure increases for defence and public works. As such, we believe that the primary deficit is likely to come in at 7.1% of GDP, rather than the government's more optimistic estimate of 5.7%. This should see outstanding JGBs reach a staggering 218.5% of GDP by end-2013 (total government-guaranteed debt: 228.2% of GDP).
|Not Much To Cheer About|
|Japan - Forecasted Fiscal Revenue Streams For FY2013, JPYbn|
Finally, Some Fiscal Discipline?
The Liberal Democratic Party (LDP)-led government has repeatedly reiterated its commitment to fiscal discipline, and has highlighted the lower debt issuance of JPY42.9trn for FY2013 budget as proof of its efforts. We expect the Japanese government to continue to make these piecemeal steps to reassure opposition parties, the Bank of Japan, and bond investors that this goal has not fallen by the wayside. Indeed, based on government's forecasts, tax revenues would exceed the amount raised from debt for the first time in four years, if both its revenue and expenditure targets are met.
Moreover, recent findings that unemployment benefits were higher than the income of an average low-income person have led the government to cut standard benefit payments by 6.5%. This is estimated to save the government JPY74bn annually. Moreover, the central government's efforts to reduce revenue grants to local governments have pressured many prefectures to enact similar reforms and reduce their retirement payouts to arrest the rise in costs.
|Lack Of Fundamental Change Suggests Otherwise|
|Japan - Forecasted Fiscal Expenditures For FY2013, % Of Budget|
Still Too Little, Still Too Late
Despite the piecemeal improvements, we remain less optimistic than the government that these steps will be sufficient stem the acceleration of government debt. For one, the government's asset sales (such as the sale of shares in Japan Post Holdings Co) are unlikely to meet its estimates. This would mean that the government will need to issue more debt to finance its JPY13.1trn supplementary budget expenditures.
Secondly, the government's optimistic forecast for tax revenues to exceed debt issuance is based on its bullish real GDP forecast of 2.5% for FY2013. In its forecasts, the government expects export growth to rebound to 7.0% from an estimated contraction of 2.6% in 2012, together with a doubling of the growth of housing and capital investment, which we think is overly optimistic. Moreover, the LDP and its coalition partner, New Komeito, is seeking to amend the tax system to reduce corporate taxes based on additional hires or increasing pay (from FY 2013), which is likely to decrease tax revenues. Thus, we believe that the government's estimates for tax and non-tax revenue growth, forecasted to reach 1.2% y-o-y and 8.3% y-o-y respectively, may be too optimistic. The lack of any meaningful fiscal reform suggests that a fiscal crisis is a question of when and not if.
Maintaining Our Bearish JGB View
The ongoing downward trend of 10-year bonds yields seems to suggest that few market participants are worried about the risks of a fiscal crisis in the near-term. However, we are inclined to believe that the trend of 10-year yields is mainly due to the increasing probability that the BoJ will consider expanding its asset purchase program to include 10-year bonds (up from bonds maturing in 7 years). Indeed, the upward trajectory of 20-year and 30-year yields suggests that demand at the long end is waning. We believe that the action at the long end of the curve is likely to lead the short-end, and we continue to be bearish across the curve.