Japan: Selected Issues

Abstract

Japan: Selected Issues

Is Home Bias Weakening?1

This paper examines the recent developments in Japan’s debt home bias in a cross-country context. Home bias appears to have declined globally after the European debt crisis. We find that the Bank of Japan (BoJ)’s quantitative and qualitative easing (QQE) seems to have contributed to the decline in Japan’s home bias, possibly by increasing domestic investors’ risk appetite for foreign debt securities. Going forward, sustained and structural declines in home bias could raise funding costs for the government once the BoJ exits from QQE given the high public debt environment.

A. Introduction

The large resident holdings of government debt are considered as one of the key factors that have contributed to the low sovereign risk premium in Japan. Gross general government debt amounted to about 248 percent of GDP by end-2015, and 85 percent of this debt is in the form of Japanese government bonds (JGBs). One of the most important reasons why such a high level of sovereign debt could be sustained until now is widely believed to be the extremely large holdings of JGBs by residents, resulting from their strong home bias and large pool of savings (Lam and Tokuoda, 2011). Indeed, cross-country evidence suggests that the fact that about 90 percent of total sovereign debt is held directly by residents or through domestic financial institutions has contributed to the low yields of JGBs (October 2014 GFSR; Figures 1a1b).

Figure 1a.
Figure 1a.

Residents’ Holdings of Domestic Sovereign Debt

(In percent of total domestic sovereign debt)

Citation: IMF Staff Country Reports 2016, 268; 10.5089/9781475522525.002.A007

Sources: Arslanalp and Tsuda (2012, 2014); and IMF staff calculations.
Figure 1b.
Figure 1b.

10-Year Local-Currency Government Bond Yields

(In percent)

Citation: IMF Staff Country Reports 2016, 268; 10.5089/9781475522525.002.A007

Sources: Bloomberg, L.P.; Haver Analytics; and IMF staff calculations.

The strong demand for safe and liquid assets such as JGBs from residents is partly due to high risk aversion and the strong incentives for precautionary savings stemming from their long-lasting deflationary mindset and aging and retirement concerns. However, the BoJ’s QQE has accelerated the portfolio rebalacing of domestic financial institutions away from JGBs towards more risky assets including foreign securities (Figures 2a2b). This paper focuses on home bias in debt securities rather than in equities since the former is more directly linked to the public debt overhang in Japan. Sustained declines in debt home bias could reduce the fiscal breathing space for governments with high public debt and raise debt sustainability risk (Asonuma and others, 2015; IMF, 2015).

Figure 2a.
Figure 2a.

Japan: Financial Institutions' Holdings of JGBs

(In trillion yen)

Citation: IMF Staff Country Reports 2016, 268; 10.5089/9781475522525.002.A007

Source: Bank of Japan.
Figure 2b.
Figure 2b.

Japan: Financial Institutions' Holdings of Foreign Securities

(In trillion yen)

Citation: IMF Staff Country Reports 2016, 268; 10.5089/9781475522525.002.A007

Source: Bank of Japan.

The Domestic Asset Acceptance Ratio (DAAR) has been widely used as an empirical measure of home bias:2

Home Biasi=1Share of country’s holdings of foreign debtShare of foreign debt in the global debt portfolio’

The measure is bounded between 0 and 1 with a higher value indicating a stronger home bias. The measure shows a declining trend across the globe after the European debt crisis. Moreover, although home bias in Japan does not seem to be extremely high compared to that in the U.S. or the other advanced Asian countries (in line with the literature using the same measure of home bias), there is a positive correlation between a country’s home bias and the share of domestic sovereign debt in its total sovereign debt holdings in a cross-country context (Figures 3a3b).

Figure 3a.
Figure 3a.

Home Bias in Debt Securities (DAAR measure)

Citation: IMF Staff Country Reports 2016, 268; 10.5089/9781475522525.002.A007

Sources: Bank for Internaional Settlements; Coordinated Portfolio Investment Survey; Haver Analytics; and IMF staff calculations.
Figure 3b.
Figure 3b.

Home Bias and Holdings of Domestic Sovereign Debt (2015)

Citation: IMF Staff Country Reports 2016, 268; 10.5089/9781475522525.002.A007

Sources: BIS; CPIS; Arslanalp and Tsuda (2012, 2014); Haver Analytics; and Fund staff calculations.

B. Empirical Analysis and Results

Cross-country panel regressions suggest that the expansion of central bank’s balance sheets have a significant impact on home bias (Table 1). Drawn mainly from the existing literature, the explanatory variables are categorized into four groups:

  • Macroeconomic developments: higher real GDP per capita or lower inflation tend to reduce home bias, while higher real exchange rate volatility increases the uncertainty of investments in foreign debt securities and hence increases home bias.

  • Financial variables: the return on domestic debt securities, proxied by the 10-year government bond yield, has a positive impact on home bias.

  • Structural factors: financial openness and institutional quality have significantly negative effects on home bias.

  • Policy changes: central banks’ purchases of domestic sovereign bonds lower the (expected) returns of domestic assets. As a result, domestic investors—to offset the losses from such lower returns—would raise their risk appetite towards riskier assets including foreign debt securities. In particular, specifications V and VI suggest that the impact of a decline in the yield on home bias could be larger when the central bank increases its holdings of domestic sovereign bonds.

Table 1.

Panel Estimates of Determinants of Home Bias

article image
Source: IMF staff estimates.Note: 24 advanced economies plus Latvia and Lithuania (whose government bonds were also purchased by the ECB) are included in the regressions. CBBS represents the central bank’s holdings of domestic government bonds, including the ECB’s public sector purchase program (PSPP). Lagged values for all explanatory variables except financial variables. Robust standard errors are reported in parentheses. * denotes significance at 10% level, ** significance at 5% level, and *** significance at 1 percent level.

Lower global risk aversion after the European debt crisis has also contributed to the decline in home bias. We decompose the change in each country’s home bias into contributions from each aforementioned factor (Figure 4). In Japan, QQE seems to have contributed significantly to the decline in home bias during 2013–14. Moreover, global common factors (year effects), positively correlated with the VIX, are also important in driving the dynamics of home bias (Figure 5).

Figure 4.
Figure 4.

Decomposition of Home Bias

Citation: IMF Staff Country Reports 2016, 268; 10.5089/9781475522525.002.A007

Sources: Bank for Internaional Settlements; Arslanalp and Tsuda (2012, 2014); Haver Analytics; IMF's WEO and IFS databases; and IMF staff calculations based on the panel specification III in Table 1.
Figure 5.
Figure 5.

Year Effects and Global Risk Aversion

(2011-2015)

Citation: IMF Staff Country Reports 2016, 268; 10.5089/9781475522525.002.A007

Sources: Bank for Internaional Settlements; Arslanalp and Tsuda (2012, 2014); Haver Analytics; IMF's WEO and IFS databases; and IMF staff calculations based on the panel specification III in Table 1.

C. Conclusions and Policy Implications

Home bias in debt securities has broadly declined globally after the European debt crisis. In particular, Japan’s debt home bias is not extremely high in a cross-country context, and has declined along with other countries since 2012 as global risk aversion subsided.

Common factors such as global risk aversion played an important role in driving the dynamics of home bias in all countries. Idiosyncratic factors, including macroeconomic developments, structural factors, and changes in QE programs also tend to have a significant effect on each country’s home bias. In particular, the BoJ’s QQE has contributed to the decline in Japan’s home bias, possibly by raising domestic investors’ risk appetite for foreign debt securities to mitigate the loss from lower returns on domestic bonds. Sustained declines in Japan’s home bias would reduce the sovereign-financial nexus, but also increase debt sustainability risks once the BoJ exits the QQE in the future as interest rates would rise amid greater reliance on foreign investors.

References

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1

Prepared by Fei Han (MCM).

2

The measure has been used in Ahearne et al. (2004), Kho et al. (2009), Coeurdacier and Rey (2012), Vanpee and De Moor (2012), Asonuma et al. (2015), and IMF (2015).

Japan: Selected Issues
Author: International Monetary Fund. Asia and Pacific Dept