How Japan tips money down the drain

Japan’s 12 public-sector borrowers have become a bit of a standing joke among investment bankers in London.

Each time one launches a bond issue, a team of senior officials from the institution descends on London for the signing ceremony (a practice other borrowers abandoned years ago). The officials ­ often former bureaucrats from the Ministry of Finance (MoF) ­ seem more interested in playing golf and shopping than in meeting potential investors. One institution is infamous for combining its London trip with a tour ostensibly to meet investors. In the past, it has taken in such well-known financial centres as Istanbul and Venice.

The price the borrowers have to pay for their funds is the subject of derision too. The issues are all irrevocably guaranteed by the Japanese government ­ they are, in other words, pure Japan sovereign risk. Yet the deals come at a much higher spread over US treasuries than bonds from similar credits. In November, for instance, Österreichische Kontrollbank, owned by the Austrian government, launched a 10-year Eurobond at 23 basis points (bp) over treasuries. Over the previous two months, five 10-year Japanese government guaranteed issues had hit the market ­ at spreads ranging from 27 to 29 over.

When Export-Import Bank of Japan (Jexim) launched a $750 million bond in July it was greeted by the market as a break-through. It was the largest-ever Eurodollar issue by a Japanese government credit and, at five years, the maturity was more attractive to investors than the usual 10-year deals. Nonetheless, the spread was a disappointing 14bp over treasuries. Many issuers have this year achieved better pricing (see table on following page), including Japanese private-sector borrowers Toyota and NTT, both of which came in at 11 over. Shouldn’t Japan, as the world’s second largest economy, be able to fund itself at close to treasuries and certainly cheaper than any other sovereign borrower?

“The problem,” says the head of syndicate at a foreign investment bank in Tokyo, “is that the officials in charge of borrowing at these institutions are not as sensitive to costs as are their western counterparts.” He and other bankers estimate that, with properly executed deals, Japan ought to be able to borrow at close to the level achieved by the World Bank ­ perhaps at 20 over for 10-year deals, and five over for five-year ones. That would save it about 10 basis points, or $50 million in interest on the $5 billion its guaranteed borrowers raise internationally each year. Over 10 years, the saving would amount to nearly $3 billion.

There are 12 borrowers, divided into three groups: large agencies such as Japan Development Bank (JDB) and Japan Highway Public Corp, local government entities (Tokyo, Yokohama and Kobe), and a mixed group, ranging from Kansai International Airport to Trans-Tokyo Bay Highway Corp. In the government’s budget every year, the amount each is allowed to borrow overseas is decided in discussions between the MoF and the controlling ministry, for example the construction ministry in the case of Japan Highway.

Farce

But this is a somewhat farcical procedure because the amount budgeted is unconnected to how much the issuer will be allowed to borrow. JDB, for instance, is allocated $1.2 billion each year but in practice MoF allows it to use only half that. More than 90% of JDB’s funding comes from MoF itself, in the form of zaito money ­ funds deposited by the postal savings system with the Trust Fund Bureau of the ministry. MoF is desperate to use zaito money whenever possible but, because the interest rate is often higher than plain bank borrowing (and almost always more expensive than issuing a Eurobond), it needs to cajole public-sector borrowers to take the funds from it.

This explains one of the key reasons why Japanese government guaranteed borrowers’ funds are so dear: simply, their issues are too small. “We would like to do a bigger issue,” says Kenjiro Kobayashi, director of finance and planning at JDB, “so we could create a benchmark.” JDB is said to have pushed MoF hard this autumn to allow it to bring a jumbo dollar issue but after much argument had to settle for a relatively large ¥50 billion Euroyen issue. Jexim (which has an allotment of $1.7 billion) managed to persuade MoF to let it bring a $750 million issue in June.

But most issues, especially from the local authorities, are $200 million to $300 million. Many western institutions won’t buy issues so small, except for a quick in-and-out arbitrage. This means the bonds end up mainly with European retail investors and Japanese institutions and quickly become illiquid.

The savings available from issuing internationally are substantial, particularly now that the dollar/yen swap rate greatly favours swapping from dollars into yen. One borrower estimates that its most recent Eurodollar issue was 60bp cheaper after a swap into yen than the equivalent yen issue in the domestic market would have been. It is not surprisingly that a borrower such as the Japan Finance Corp for Municipal Enterprises (which borrowed $900 million overseas in 1996) is pleading with MoF to increase the amount it can borrow abroad from 3% of its total funds to nearer 10%.

After budget allocation is made, individual borrowers outline to the government debt division of MoF the currencies they wish to borrow in during the year and the rough timing. (They cannot change this plan even if an interesting issuing opportunity arises in another currency during the year.)

It is in the run-up to each issue that the bureaucratic horse-trading becomes intense. Three departments are involved: the government debt division of MoF, the fund investment division of MoF (which distributes zaito money), and the issuer’s controlling ministry (which, in the case of Jexim and JDB is yet another division of MoF). The controlling ministry is often a problem, since the officials have little understanding of finance. In the case of the Metropolis of Tokyo, which department of the home affairs ministry is responsible depends on how the funds are to be used: port development funds are handled by a different department from roads. Within MoF, the public bond and fund investment divisions are often at loggerheads, the former favouring more efficient overseas issuance, the latter more zaito borrowing.

It takes three or four weeks for all the bureaucrats to stamp the official papers. Bizarrely, this is one of the major reasons for the high cost of borrowing. The period between the announcement date of an issue and the payment date is a big factor in the attractiveness of an issue. For the Japan government issuers this period is four or five weeks. The best international borrowers such as the World Bank have reduced the period to three days. This keeps the cost of the swap low and pleases investors, who do not like having to commit their money four weeks in advance.

There is also a technical reason why a short payment period would keep the yield down. “The interest is not paid for four weeks,” says a foreign investment banker in Tokyo (who, like all the bankers interviewed for this article, asked not to be quoted). “That means these are not 10-year bonds but 10-year one-month bonds. If the interest accrued straight away, the spread over treasuries would immediately fall by three basis points. Sadly, the MoF doesn’t understand this problem.”

MoF blames other ministries. Keizo Hamada, director of the government debt division, says MoF gives formal approval in as little as a day and a half but other ministries take as long as two-and-a-half weeks. “There could be a way of speeding this up,” he says, “but it is not something we can do alone.”

These cumbersome procedures prevent the government issuers taking advantage of arbitrage borrowing opportunities. Most important, they exclude the possibility of their issuing off medium-term-note (MTN) programmes, where a decision to go ahead often has to be made within 30 minutes.

Most big sovereign and supranational borrowers find the most effective way to raise money is a combination of big jumbo issues and small MTN private placements. With a triple-A-rated Japan government guarantee, the likes of JDB would be perfectly placed to issue structured notes off an MTN programme. But the problem is not only in the timing. MoF would have to give a blanket government guarantee for the programme in advance. Even using an MTN programme as a documentation shelf therefore becomes problematical. “We’d love to be able to do an MTN but it seems impossible,” concludes one borrower.

Some bankers have begun to propose radical solutions. Why not, they argue, organize a joint issue. If the government issuers formed a special-purpose vehicle to borrow on their behalf, with an annual requirement of $5 billion it could issue jumbos at low cost and pass on the funds. If that is too extreme, perhaps just the three municipal borrowers could join together. The bankers point to the initiative of several of the Länder (states) in Germany, which issued jointly last year.

The borrowers themselves find little attraction in the idea. “We are not very interested,” says Yoshinaga Kumano, director of the bond section in the Tokyo metropolitan government. “The conditions would certainly be better, but we’d have to compromise over the timing and conditions. We want to keep our name in front of investors. It is not just a matter of looking at issuing costs.”

For many of the borrowers, this is a question of pride ­ a joint issue would mean the institution’s name disappeared from the market and would leave them without any work to do. Sceptics say it would also end their junkets overseas to attend signing ceremonies. But the borrowers do make one serious point: a joint borrowing institution would probably be hijacked by MoF, increasing the ministry’s power even more. “We shouldn’t strengthen the government’s role in borrowing,” comments Atsuyoshi Yatsunami, president of IBJ Securities in Tokyo.

Eventually, a more radical solution seems inevitable. “A lot of people now think that changing this system is impossible,” says a Japanese banker in London. “But in future these are topics they’ll have to think about. Some government guaranteed borrowers will have to merge. And they will need to discuss whether they need a government guarantee at all.” At the least, he say, the borrowers should be allocated a set amount which they can borrow with a government guarantee each year, and then given autonomy in how they use it. “Why restrict where they can borrow? Shouldn’t they just borrow where it’s cheapest?”

At the MoF, Hamada is more cautious. “We don’t feel there is a need to change the system so quickly,” he says. “But we are aware that maybe the government-guaranteed borrowers are not issuing as cheaply as they can. We are making efforts to remove the barriers [to efficient borrowing] as much as we can within the limits of what we can do.”

In the end, political leadership will be necessary to break the bureaucratic impasse. With Japan’s budget deficit last year reaching 8% of GDP, perhaps the prospect of cutting costs by $3 billion over 10 years will entice the politicians to act.