From the onset, investors had misgivings about the new DPJ-led government's ability to implement their campaign promise spending plans without resorting to a significantly higher level of JGB issuance.
The Hatoyama Administration was able to terminate JPY2.926 trillion of programs included in the JPY14.7 trillion supplementary budget implemented by the LDP-led Aso Administration, versus a goal of JPY3 trillion savings. For the FY2010 budget, however, at least four ministries ended up asking for more money, despite instructions from Finance Minister Hirohisa Fujii to keep spending, except for campaign promises, below levels in the initial fiscal 2009 budget.
The ministries have evidently used the DPJ campaign promises as an excuse to pork up their budget requests. The Welfare Ministry's requested FY28.88 trillion, up some JPY3.7 trillion (over 14%) from the initial budget for FY2009. It also withheld spending figures for 11 budget items that it plans to review by year's end, leaving open the possibility of another increase of JPY1~JPY2 trillion in its budget. The Ministry of Agriculture, Forestry and Fisheries requested JPY2.75 trillion, or 7.5% more than its share of this fiscal year's initial budget. The Ministry of Internal Affairs and Communications wants a 4.8% increase to JPY18.59 trillion On the other hand, the Ministry of Land, Infrastructure, Transport and Tourism, meanwhile, was able to shrink its budget 2.6% to 6.19 trillion yen by slashing spending on public works and in other areas. The Environment, Defense, and Foreign Affairs ministries are also among those turning in smaller budget requests.
The news that the FY2010 budget could well exceed JPY90 trillion is making JGB investors skittish, as the Japanese government may need more bonds financing than initially planned to finance what is expected to be a record budget for the fiscal year starting in April 2010. The other part of the picture is that tax revenues are likely to fall short of government projections by a wide margin.
As the FT has pointed out, Japan's bond market (already the biggest in the world) could get a whole lot larger if the new DPJ-led government is not able to reign in spending. FY2009's budgeted increase in JGB issuance was already a whopping JPY130 trillion on top of JPY846 trillion outstanding even before there was any suggestion that additional issuance will be needed. Prime Minister Yukio Hatoyama is already hedging by suggesting that more deficit-covering bonds "may be unavoidable" to offset tax revenue shortages. Japan's Ministry of Finance has requested JPY21.9 trillion yen for debt-servicing costs in the budget for 2010/11, starting next April 1, which is up JPY1.6 trillion yen YoY.
Since JGB yields were trading as high as 2% as recently as 2007 versus around 1.25% at present, we would not be at all surprised to see a return to a 2% handle on the 10-Year JGB in the next couple of years. However, a full scale crash is unlikely even if the DPJ-led government has to resort to more deficit-covering bond issues. JGBs were bid down to current levels because of evidence that deflation is accelerating, and on forecasts for a continued strong yen, which at least once currency strategists sees surging to JPY50/USD. With central governments also significantly diversifying away from USD in their forex reserves into the Euro and the Yen, JGBs could continue to be supported by cash-rich domestic financial institutions, foreign government purchases and foreign investors looking to hedge what they see as structural weakness in USD.
