21st Sep. 2015
JAPAN
ECONOMICS FOCUS
When will the BoJ have to start tapering its JGB purchases?
•
We estimate that QQE can continue for at least another five years even if the Bank of Japan steps
up the annual pace of expansion of the monetary base to ¥90 trillion in October. As such, the fate
of QQE will hinge on its success in boosting inflation rather than on any hard limits in terms of the
stock of available JGBs.
•
The Bank of Japan currently holds around a quarter of all outstanding Japanese Government Bonds
(JGBs) and is this year expanding its holdings by 10% of the total stock and by roughly three times
net annual JGB issuance. If it continues, QQE will run into supply shortages at some point.
•
We expect the budget deficit to remain broadly unchanged in coming years, with the bulk financed
by issuance of JGBs. Accordingly, we estimate that the stock of JGBs will expand by ¥120 trillion by
2020. In addition, Japanese insurance companies and pension funds could plausibly reduce their
bloated holdings of JGBs by ¥150 trillion, bringing their portfolios more into line with counterparts
elsewhere, which would free up more space for BoJ purchases.
•
Commercial banks use JGBs as collateral in financing operations with the central bank and in
interbank transactions. But their holdings of government securities are far above international (and
historical) standards, too. We estimate that depository corporations could sell more than ¥200 trillion
of JGBs for the BoJ to acquire.
•
All in all, we estimate that the pool of available JGBs could expand by nearly ¥500 trillion in
coming years, equivalent to six years of QQE at the BoJ’s current pace of purchases. Even if the
Bank steps up the annual pace of expansion of the monetary base to ¥90 trillion in October as we
expect, QQE could continue until 2020. As a result, yields on JGBs should remain pegged at low
levels. What’s more, we believe that the yen will continue to weaken against the dollar, while the
Nikkei should continue to outperform stock markets elsewhere.
•
While there are no hard limits on QQE in the near future, concerns about market liquidity may still
prompt the Bank to taper its purchases at an earlier stage. More generally, the Bank may reassess its
approach if the programme fails to deliver the hoped-for gains in inflation. The upshot is that QQE
will not end because the Bank runs out of JGBs to buy but because it either succeeds or
policymakers adopt a new – possibly much more radical – approach.
Marcel Thieliant
Tel: +65 6595 1514
North America
2 Bloor Street West, Suite 1740
Toronto, ON
M4W 3E2
Canada
Tel: +1 416 413 0428
Europe
150 Buckingham Palace Road
London
SW1W 9TR
United Kingdom
Tel: + 44 (0)20 7823 5000
Asia
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Tel: +65 6595 5190
Chief Global Economist
Chief Asia Economist
Japan Economist
Julian Jessop (julian.jessop@capitaleconomics.com)
Mark Williams (mark.williams@capitaleconomics.com)
Marcel Thieliant (marcel.thieliant@capitaleconomics.com)
Japan Economics Focus
1
When will the BoJ have to start tapering its JGB purchases?
The Bank of Japan is buying Japanese Government
Bonds at a rapid pace, and some commentators
think that a lack of available securities will force
the Bank to start tapering its asset purchases by
2017 or 2018 whether or not its policy goals are
being achieved. 1 In this Focus, we analyse how
long these purchases can continue before the pool
of available JGBs dries up.
0F
BoJ’s purchases well above net JGB issuance
When the Bank of Japan launched Quantitative
and Qualitative Easing (QQE) in April 2013, it
pledged to expand the monetary base by ¥70
trillion per annum. This target was to be achieved
primarily via purchases of Japanese Government
Bonds (JGBs), i.e. those government securities with
a maturity of more than one year, of ¥50 trillion
per annum. The remaining ¥20 trillion was to be
generated by an expansion of the Bank’s loan
support program and purchases of Treasury Bills,
i.e. securities with a maturity of up to twelve
months.
CHART 1: BOJ’S HOLDINGS OF JAPANESE GOVERNMENT
SECURITIES (% OF TOTAL OUTSTANDING)
Treasury Bills
70
70
JGBs
60
60
50
50
Launch of QQE
40
40
30
30
20
20
10
10
0
0
03
04
05
06
07
08
09
10
11
12
13
14
15
Source – Thomson Datastream
Last October, the Bank decided to step up the
overall pace of expansion of the monetary base to
¥80 trillion per annum. Since the Bank’s share of
outstanding Treasury Bills had surged since the
launch of QQE (See Chart 1) and yields on short-
Arslanalp, S. & Botman, D. “Portfolio
Rebalancing in Japan: Constraints and Implications
for Quantitative Easing”, IMF Working Paper, 2015
1
term securities had turned negative, policymakers
opted to focus their purchases entirely of JGBs.
At around 28% of the total stock of outstanding
JGBs, the Bank’s holdings surpassed those of
insurance companies and private pension funds
last quarter. Even if commercial banks did not
reduce their holdings further since end-June, the
BoJ would have emerged as the largest holder of
JGBs this quarter. (See Chart 2.)
CHART 2: HOLDINGS OF JAPANESE GOVERNMENT BONDS
(% OF TOTAL OUTSTANDING)
Banks
Insurance & Private Pensions
BoJ
Intragovernmental (Incl. GPIF)
Other (Incl. Overseas)
60
50
60
Launch of
QQE
50
40
40
30
30
20
20
10
10
0
0
98
00
02
04
06
08
10
12
14
Source – Thomson Datastream
As of Q2 2015, the amount of outstanding JGBs
was ¥885 trillion. The Bank is therefore expanding
its holdings by nearly 10% of the total stock this
year. What’s more, the volume of the Bank’s JGB
purchases vastly exceeds the annual net borrowing
requirement of Japan’s government, which will
amount to ¥31 trillion this year according to IMF
estimates. As such, if QQE were to continue, the
Bank would certainly run into supply shortages at
some point.
Net bond issuance should remain broadly stable
Future issuance of JGBs will depend on both the
government’s overall budget deficit as well as the
share of long-term government bonds used to
finance this spending shortfall. We expect the
budget deficit to shrink from 7.7% of GDP last year
to 5.5% in 2017, but we think that it will then start
widening again and level off at around 6.5% by
2020. (See our Focus, “Will Japan’s budget deficit
continue to shrink?”, 18th June 2015.) If we are
right, the government’s cumulative net borrowing
Japan Economics Focus
2
requirement over the coming five years will be
around ¥150 trillion.
CHART 4: HOLDINGS OF JAPANESE GOVERNMENT BONDS
(% OF ASSETS)
CHART 3: GOVERNMENT LIABILITIES BY TYPE (% OF TOTAL)
25
120
20
JGBs
Treasury Bills
Loans
120
Other
100
100
80
80
60
60
40
40
20
20
0
0
98
00
02
04
06
08
10
12
Banks (Latest =Jul.) (LHS)
Private Pension & Insurance Funds (Latest = Q2) (RHS)
Public Pension Funds (Latest = Q2) (RHS)
60
50
40
30
15
20
10
Launch of
QQE
10
0
5
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Source – Thomson Datastream
14
Source – Thomson Datastream
The Ministry of Finance has replaced bank loans
with JGBs and Treasury Bills since the late 1990s.
More recently, it has also scaled back issuance of
T-Bills, and JGBs have climbed to a fresh high as a
share of total outstanding debt. (See Chart 3.)
However, the Ministry of Finance’s debt issuance
plan for FY2015 foresees that the relative weights
of T-Bill and JGB issuance will match the share in
existing debt. Assuming that bank loans remain
stable in absolute terms as they have been for a
few years now, we estimate that the stock of
outstanding JGBs will rise by around ¥120 trillion
to roughly ¥1000 trillion by end-2020.
Demand for JGBs
With the BoJ every year buying government bonds
worth around three times annual net issuance,
other owners of JGBs must reduce their holdings in
order for QQE to continue. As Chart 4 shows,
banks have indeed reduced their ownership of
JGBs drastically since the launch of the
programme, and the holdings of public pension
funds have declined, too. Both the Government
Pension Investment Fund (GPIF) and smaller public
pensions have shed domestic bonds in favour of
domestic equities and overseas assets.
By contrast, holdings of insurance companies and
private pension funds have been little changed.
Japanese insurers hold far more government bonds
than their equivalents in other advanced countries.
The discrepancy is somewhat less pronounced for
pension funds, but still large. (See Chart 5.)
CHART 5: HOLDINGS OF GENERAL GOVERNMENT SECURITIES
(2014 OR LATEST AVAILABLE, % OF ASSETS)
50
50
45
45
Insurance Companies
40
40
Pension Funds (Private & Public)
35
35
30
30
*Insurance Companies
& Pension Fund Total
25
20
25
20
15
15
10
10
5
5
0
0
Germany
US
UK*
OECD
Average
Japan
Sources – Thomson Datastream, OECD, Office for National Statistics
One reason why insurance companies may have
been reluctant to sell JGBs is that they have been
acquiring longer-term JGBs in order to match the
duration of their assets with the duration of their
liabilities. But calculations by the Bank of Japan
reveal that insurance firms have made substantial
progress in reducing their duration mismatch.
Between FY2005 and FY2013, the latest year for
which the Bank has published its estimates, the
duration shortfall narrowed from seven years to
just under three years. Since firms continued to
acquire “super-long term bonds” (i.e. those with
maturities above 10 years), it should have declined
further since then. In fact, insurance companies in
recent months bought the least JGBs in almost a
decade, though they have yet to turn into net
sellers. (See Chart 6.) But it seems plausible that
they would be more willing to reduce their JGB
holdings in future.
Japan Economics Focus
3
CHART 6: NET PURCHASES OF JGBS BY INSURANCE COMPANIES
(YEN BILLION, 3 MONTH AVERAGE)
in importance lately. (See Chart 10.) The vast bulk
of them are secured by JGBs.
2000
2000
1800
1800
1600
1600
1400
1400
1200
1200
1000
1000
30
30
800
800
25
25
400
20
20
200
15
15
600
35
Japan
35
OECD Average
600
Launch of
QQE
400
CHART 8: INVESTMENT IN OVERSEAS EQUITIES & DEBT
SECURITIES (% OF ASSETS)
200
0
0
10
10
Source – Japan Securities Dealers Association
5
5
If insurance companies reduced their holdings of
government bonds to the OECD average, another
¥125 trillion worth of JGBs would become
available. The corresponding figure for private
and public pension funds would be ¥30 trillion.
Admittedly, the amount of corporate bonds
outstanding in Japan is rather small, so financial
institutions may struggle to replace JGBs with other
domestic bonds. (See Chart 7.) However, there is
still substantial scope to invest overseas,
particularly among insurers. (See Chart 8.)
0
05
06
07
08
09
10
11
12
13
14
15
0
Insurance Companies
Sources – Thomson Datastream, Eurostat
CHART 9: COLLATERAL ACCEPTED BY BOJ
(FACE VALUE, ¥ TRILLION)
180
JGBs
Other Bonds (Incl. T-Bills)
180
160
Loans to the Government
Other Loans
160
140
140
120
120
100
100
80
80
60
60
40
40
20
20
0
2010
CHART 7: CORPORATE BONDS
(2014 OR LATEST AVAILABLE, % OF GDP)
500
500
450
450
400
400
Non-Financial Corporations
350
350
Financial Corporations
300
Pension Funds (Private & Public)
0
2011
2012
2013
2014
2015
Source – BoJ
CHART 10: REPURCHASING AGREEMENTS & SECURITIES
LENDING (LIABILITIES, ¥ TRILLION)
300
250
250
180
200
200
160
150
150
140
140
100
100
120
120
50
50
100
100
0
0
80
80
60
60
40
40
20
20
Ger
Jap
Ita
US
Fra
UK
Sources – Thomson Datastream, Eurostat
The main constraint on a further decline in JGB
holdings of commercial banks is their usage as
collateral. We estimate that around ¥200 trillion
worth of JGBs are currently used as collateral,
equivalent to over 20% of the outstanding stock.
Despite a decline in recent years, JGBs remain the
main asset used as collateral in monetary
transactions with the BoJ. (See Chart 9.) What’s
more, private repurchase agreements have gained
Banks
Dealers & Brokers
Insurance firms
0
180
160
0
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Source – Thomson Datastream
However, there are various reasons why the use of
JGBs as collateral will not necessarily become a
binding constraint on QQE. For a start, the BoJ
could encourage commercial banks to use other
assets as collateral. The Bank accepted ¥25 trillion
of loans to the government as collateral at the end
Japan Economics Focus
4
of last quarter. This is well below the ¥160 trillion
of such loans outstanding. The potential to use
corporate bonds or loans to non-financial firms as
collateral is even larger. (See Chart 11.) The BoJ
could also allow banks to use their ¥230 trillion of
deposits held at the central bank as collateral, as
the ECB has done for banks’ fixed term deposits.
CHART 11: ASSET CLASSES ACCEPTED BY BOJ AS COLLATERAL
(OUTSTANDING AMOUNT, Q2 15, ¥ TRILLION)
1100
1000
900
800
700
600
500
400
300
200
100
0
1100
1000
900
800
700
600
500
400
300
200
100
0
*excl. financial sector
JGBs & T-Bills
Loans to NonFinancial
Corporations
Loans to
Government
Corporate
Bonds*
Source – Thomson Datastream
The main reason why other assets are less widely
used is that the BoJ applies larger haircuts on them.
(See Chart 12.) These rules could be relaxed. Loans
to the government in particular could be treated in
line with government bonds. An increased reliance
on other assets as collateral with the BoJ could
free up additional JGBs that the Bank could
purchase under QQE.
CHART 12: HAIRCUTS APPLIED BY BOJ BY MATURITY IN YEARS
(%)
35
35
Loans to Firms
Loans to Government
30
30
Corporate Bonds
25
25
JGBs & T-Bills
20
20
15
15
10
10
5
5
0
0
1
2
3
4
5
6
7
8
9
10
Source – BoJ
Admittedly, the amount of JGBs used in private
repurchase agreements is well above the amount
used as collateral with the BoJ, and there is no
straightforward way to reduce the reliance on
government bonds in such transactions.
However, there are two potential ways to address
this. One is relaxing the terms of the Bank’s
“Securities Lending Facility”, under which the BoJ
lends out some of its large holdings of JGBs to
other financial market participants. At the moment,
the facility is little used (See Chart 13), with only a
fraction of the amounts offered by the Bank
actually taken up. Unfavourable haircuts again
play a key role.
CHART 13: JGBS LENT UNDER SECURITIES LENDING FACILITY
(END-MONTH, YEN BILLION)
90
90
80
80
70
70
60
60
50
50
40
40
30
30
20
20
10
10
0
Jan-13
0
Jul-13
Jan-14
Jul-14
Jan-15
Jul-15
Source – Thomson Datastream
Second, if worst came to worst, the government
could simply issue more JGBs and deposit the
proceeds with commercial banks. This would raise
public gross debt, but would have no impact on
net debt. And given that yields for shorter maturity
JGBs remain near zero, the government may even
reap a small profit. That said, a larger issuance
volume could make it harder for the Bank to keep
yields down, and may worsen Japan’s credit rating.
Indeed, the amount of government bonds held by
Japanese banks seems to be well above the
minimum needed to ensure smooth functioning of
the interbank market. Government bonds account
for lower single-digit amounts of commercial bank
assets in most other G7 economies instead of the
18% in Japan. (See Chart 14.) Our best guess is
that no more than 5% of Japanese bank assets
need to be held in the form of JGBs, which would
imply a reduction in their holdings by around
¥210 trillion. In fact, 5% is the share of assets held
by Japanese lenders in the form of JGBs as recently
as the late 1990s. (See Chart 4 again.)
Japan Economics Focus
5
CHART 14: HOLDINGS OF GENERAL GOVERNMENT SECURITIES
BY DEPOSITORY CORPORATIONS (LATEST, % OF ASSETS)
18
18
16
16
14
14
12
12
10
10
8
8
6
6
4
4
2
2
0
0
USA
UK
France Germany Canada
Italy
Japan
Sources – Thomson Datastream, National Central Banks
Table 1 summaries our projections for the potential
supply of JGBs over the next five years. We believe
that there are enough JGBs available to continue
with QQE for another six years under the current
pace of purchases. Even if the Bank steps up the
annual pace of expansion of the monetary base to
¥90 trillion in October as we expect, QQE can
continue at least until 2020.
That said, it is possible that liquidity conditions in
the JGB market deteriorate well before quantitative
supply limits are reached. Indeed, the Bank has
recently started to intensify its monitoring of bond
market liquidity, and has begun to publish a
quarterly set of liquidity indicators. If some of these
indicators flash red, the Bank may start to taper its
purchases at an earlier stage than we project.
TABLE 1: POTENTIAL SUPPLY OF JGBS BY 2020
¥tn
Commercial Banks
Insurance Companies
Net Issuance of JGBs
Pension Funds (Private and Public)
210
125
120
25
Total
480
Source – Capital Economics
Can less become more?
QQE would still generate some benefits even if
the Bank decided to taper earlier. After all, a given
annual purchase volume translates into an ever
rising amount relative to the holdings of other
investors. This is illustrated in Chart 15. At the
moment, the Bank’s ¥80 trillion of annual JGB
purchases are equivalent to around 13% of the
currents holdings of other investors. But the stock
of JGBs held by other investors is diminishing and
so this ratio of BoJ purchases to outstanding stock
is set to nearly double over the coming five years.
If the Bank started to taper its purchases to ¥50
trillion per annum after 2019, it would still acquire
a larger share of the JGBs held elsewhere than it
does now. (See Chart 15.) JGB yields would
therefore probably stay low even if the Bank
reduced the scale of its purchases.
CHART 15: BOJ’S JGB PURCHASES BY YEAR OF TAPERING
(¥50 TRILLION PER ANNUM IN % OF STOCK HELD ELSEWHERE)
19
19
17
17
15
Current annual purchase volume of ¥80 trillion
in % of holdings of other investors
15
13
13
11
11
9
9
7
7
5
5
2015
2016
2017
2018
2019
2020
Sources – Thomson Datastream, Capital Economics
However, we wouldn’t take this argument too far.
Keeping nominal interest rates low is not the only
aim of QQE. The Bank also intends to lift inflation
expectations and encourage investors to shift to
riskier assets. The headline amount of JGB
purchases arguably plays an important role in the
formation of inflation expectations. Meanwhile, a
smaller absolute amount of purchases would also
lessen the need for investors to shift to other asset
classes, and reduce the speed of yen-depreciation.
For all these reasons, a premature tapering would
surely undermine the chances of hitting 2%
inflation anytime soon.
Conclusions and policy implications
Our analysis shows that the Bank of Japan should
be able to maintain its JGB purchases at the current
pace for another six years. Even if the Bank steps
up the annual pace of purchases to ¥90 trillion in
October as we expect, QQE could continue until
2020. As a result, the Bank of Japan won't run into
any hard limits on its ability to continue with QQE
any time soon. Yields on JGBs should therefore d
remain pegged at low levels. What’s more, we
Japan Economics Focus
6
believe that the yen will continue to weaken
against the dollar, while the Nikkei should
continue to outperform stock markets elsewhere.
But the fact that there are no hard limits on QQE in
the near future doesn’t mean that we should expect
more of the same from the BoJ over the next five
years. For one thing, concerns over market
liquidity may still prompt an earlier reduction in
the pace of purchases. More generally, if QQE is
still failing to generate sustained inflation pressure
in a couple of years time, we suspect that
policymakers will start to reassess their approach.
The upshot is that once QQE ends, it won’t be
because the Bank runs out of JGBs to buy but
because it either succeeds or policymakers adopt a
new – possibly much more radical – approach.
(See our Focus, “What could policymakers do next
if QQE doesn’t work?”, 16th Apr. 2015.)
Japan Economics Focus
7