Discussion Paper No. 888

WHY HAS JAPAN’S MASSIVE
GOVERNMENT DEBT
NOT WREAKED HAVOC (YET)?

Charles Yuji Horioka
Takaaki Nomoto
Akiko Terada-Hagiwara

October 2013
Revised January 2014

The Institute of Social and Economic Research
Osaka University
6-1 Mihogaoka, Ibaraki, Osaka 567-0047, Japan

WHY HAS JAPAN’S MASSIVE GOVERNMENT DEBT NOT WREAKEDHAVOC (YET)?*Charles Yuji Horioka**
School of Economics, University of the Philippines; National Bureau of Economic
Research; and Institute of Social and Economic Research, Osaka University
Takaaki Nomoto
Office of Regional and Economic Integration, Asian Development Bank
Akiko Terada-Hagiwara
Economic and Research Department, Asian Development Bank
October 21, 2013; Revised January 28, 2014
Abstract: In this paper, we present data on trends over time in government debt financing inJapan since 2000 with emphasis on the importance of foreign holders and speculate about thedeterminants of those trends. We find that Japanese government securities were held primarily
by domestic holders until recently because robust domestic saving, especially household saving,(combined with strong home bias) made it possible for domestic investors to absorb most of thegovernment debt but that foreign holdings of Japanese government securities have increased
sharply in recent years, especially in the case of short-term government securities. We showthat trends in foreign holdings of Japanese government securities can be explained byconventional economic factors such as returns and risks and that the recent surge in foreign
holdings of short-term Japanese government securities is attributable to foreign investors insearch of a safe haven for their funds in the face of the Global Financial Crisis of 2008-09
precipitated by the Lehman crisis. Our analysis suggests that the surge in foreign holdings ofJapanese government securities will subside (in fact, it already has), and this, combined withthe projected decline in domestic saving (especially household saving) caused by population
aging, will make it necessary for Japan to reduce its government debt-to-GDP ratio. Thus,
Japan’s massive government debt has not wreaked havoc in the past because of robust
domestic saving and a temporary inflow of foreign capital caused by the Global Financial Crisis,
but it may wreak havoc in the future as both of these factors become less applicable unless thegovernment debt-to-GDP ratio can be brought under control.
Key words: Government debt; government securities; government bonds; government bills;
government notes; sovereign debt; debt securities; debt financing; government debt financing;debt holdings; government debt holdings; foreign debt; foreign debt holdings; foreign debt
investments; foreign investors; capital flows; international capital flows; short-term capital
movements; cross-border portfolio investments; safe haven; capital flight; flight to safety; debt
rollover; home bias; sovereign debt crisis; eurozone crisis; eurozone; Japan
Journal of Economic Literature classification codes: F32 (Current Account Adjustment; ShortTerm Capital Movements); F34 (International Lending and Debt Problems); G15 (International
Financial Markets); H63 (Debt; Debt Management; Sovereign Debt); and O53 (Asia including
Middle East)*This paper was prepared for Asian Development Bank Technical Assistance 7859: AsianDevelopment Outlook 2012. The authors are indebted to Maria Socorro Bautista, Iris Claus, Hal
Hill, Yoshihiko Kadoya, Masahiro Kawai, Changyong Rhee, T. N. Srinivasan, A. Maria Toyoda,
Bijung Wang, and participants of the Asian Development Review Conference on Development
Issues in Asia, held at the Asian Development Bank in Manila, The Philippines, on May 15-16,
2012, especially Joseph Lim and Peter Morgan, for their valuable comments and to Shiela
Camingue for her superb assistance.
**Corresponding author: Charles Yuji Horioka, School of Economics, University of thePhilippines, Diliman, Quezon City 1101, The Philippines. Email: horioka@iser.osaka-u.ac.jp,
telephone: 63-2-927-9686, ext. 222, 223, fax: 63-2-920-5461.

1. INTRODUCTION

Arguably the most momentous economic event in the world during the 2010-2012 period was
the eurozone sovereign debt crisis.

The sovereign debt crises in the PIIGS economies(Portugal, Ireland, Italy, Greece, Spain) and other eurozone economies led to a substantial
downgrading in the credit ratings of private and government debt in many eurozone economies.
Heightened uncertainty in the eurozone should have led to an adjustment of investor portfolios
away from eurozone assets and towards alternative assets including those of Japan, emerging
Asia, and other non-eurozone economies.

However, the (potential) sovereign debt crisis in Japan looks even more serious than those in
the eurozone economies if one looks only at the gross general government debt-to-GDP ratio.
Table 1 shows the gross general government debt-to-GDP ratio for the member countries of theOrganisation for Economic Cooperation and Development (OECD) in 2012, and as can be seenfrom this table, this ratio ranged from 90 to 166 percent in the PIIGS economies in 2012 (“only”
165.6 percent in Greece, 140.2 percent in Italy, 138.8 percent in Portugal, 123.3 percent in
Ireland, and 90.5 percent in Spain) but was a full 219.1 percent in Japan in the same year.
Thus, Japan’s gross general government debt-to-GDP ratio is more than twice the OECD-wide
average (108.8 percent) and by far the highest in the developed world. Moreover, the OECD
projects that Japan’s gross general government debt-to-GDP ratio will increase even further to228.4 percent in 2013 and to 233.1 percent in 2014.

Why has Japan been able to avoid the fiscal crises of the magnitude faced by the PIIGS
economies even though its gross general government debt-to-GDP ratio is much higher? Whatis different about Japan? The most commonly given answer is that domestic saving is muchhigher (relative to domestic investment) and home bias is much stronger in Japan, as a result of1

which a much higher proportion of its massive government debt could be absorbed domesticallywithout having to rely on foreign investors.

However, Reinhart and Rogoff (2008) have argued that domestic sovereign debt is just as
important as external sovereign debt and that it is the total amount of sovereign debt that is ofparamount importance.

The objective of this paper is to present data on trends over time in government debt financing
in Japan since 2000 with emphasis on the importance of foreign holders and to speculate about
the determinants of those trends, thereby shedding light on why Japan’s massive government
debt has not wreaked havoc—at least not yet.

To summarize our main findings, we find that Japanese government securities were held
primarily by domestic holders until recently because robust domestic saving, especiallyhousehold saving, (combined with strong home bias) made it possible for domestic investors toabsorb most of the government debt but that foreign holdings of Japanese government
securities have increased sharply in recent years, especially in the case of short-term
government securities.

We show that trends in foreign holdings of Japanese government

securities can be explained by conventional economic factors such as returns and risks and thatthe recent surge in foreign holdings of short-term Japanese government securities is attributable
to foreign investors in search of a safe haven for their funds in the face of the Global Financial
Crisis of 2008-09 precipitated by the Lehman crisis. Our analysis suggests that the surge in
foreign holdings of Japanese government securities will subside (in fact, it already has), and this,combined with the projected decline in domestic saving (especially household saving) causedby population aging, will make it necessary for Japan to reduce its government debt-to-GDP
ratio. Thus, Japan’s massive government debt has not wreaked havoc in the past because of2

robust domestic saving and a temporary inflow of foreign capital caused by the Global Financial
Crisis, but it may wreak havoc in the future as both of these factors become less applicable
unless the government debt-to-GDP ratio can be brought under control.

The remainder of this paper is organized as follows: In section 2, we describe the data sources
used in this paper; in section 3, we present data on trends over time in government debt
financing in Japan since 2000 with emphasis on the importance of foreign holders; in section 4,
we explore the reasons for the sharp increase in foreign holdings of short-term Japanese
government securities in recent years; and in section 5, we summarize our findings and explore
the policy implications of our findings.

2. DATA SOURCES

In this section, we describe the data sources used in this paper.

The data on trends over time in government debt financing in Japan in subsections 3.1, 3.2, and3.3 are taken from the Bank of Japan’s Flow of Funds Accounts (FFA) Statistics (Shikin Junkan
Toukei). The FFA records movements of financial assets and liabilities among institutional units
called sectors, such as financial institutions, corporations, and households, for various financial
instruments called transaction items such as deposits and loans. Thus, the FFA includes dataon holdings of government securities by each sector of the economy and hence can shed lighton who is financing Japan’s government debt. For a more detailed description of the FFA in
English, refer to http://www.boj.or.jp/en/statistics/sj/index.htm/

3

The data on foreign debt holdings by economy or region in subsection 3.4 are taken from the
Coordinated Portfolio Investment Survey (CPIS) of the International Monetary Fund (IMF),
which collects year-end data on portfolio investment holdings (equity and debt securities) fromparticipating economies. The data on Japan in this survey are taken from, and hence are
identical to, the Bank of Japan’s Balance of Payments Statistics.

3. TRENDS IN GOVERNMENT DEBT FINANCING IN JAPAN, 2000-2011

In this section, we present data on trends over time in government debt financing in Japan
during the 2000-2011 period.

Since short-term government securities (government bills or

money market instruments with maturities of less than one year) and medium- and long-term
government securities (government bonds and notes with maturities of one year or more) show
very different patterns and trends over time, we analyze the two categories of government
securities separately.

3.1.

Trends in Domestic Holdings of Japanese Government Securities, 2000-2011

In this subsection, we discuss trends over time in domestic holdings of Japanese government
securities during the 2000-2011 period.

Figure 1 shows trends over time in the shares of short-term Japanese government securities ofeach sector during the 2000-2011 period, and as can be seen from this figure, private banks
have been by far the dominant holder of short-term government securities throughout the 20002011 period, with their share fluctuating in the 50 to 90 percent range and far exceeding the4shares of the Bank of Japan, government financial institutions, the general government, foreign
holders, and other sectors. However, the share of private banks declined sharply during the
2000-2011 period--from more than 90 percent in 2000 to less than 50 percent in 2011, and theshare of government financial institutions increased between 2000 and 2006 but declined
sharply to virtually zero thereafter, presumably due to the Japanese government’s policy of
relying less on postal savings as a source of funds for financing the government debt.1

Figure 2 shows trends over time in the shares of medium- and long-term Japanese government
securities of each sector during the 2000-2011 period, and as can be seen from this figure,private banks have been by far the dominant holder of medium- and long-term government
securities throughout the 2000-2011 period, as in the case of short-term government securities,
but their share (30 to 45 percent) has been far lower than in the case of short-term government
securities, and government financial institutions, insurance companies, the Bank of Japan, andpublic pensions have also held relatively large shares, at least during certain periods. Looking
at trends over time, the share of private banks has increased throughout the 2000-2011 period(unlike in the case of short-term government securities) and the shares of private insurancecompanies and public pensions have also increased, whereas the shares of government
financial institutions decreased sharply to virtually zero due to the Japanese government’s
policy of relying less on postal savings as a source of funds for financing the government debt.
(The share of the Bank of Japan increased until 2002, declined until December 2009, and has
shown a renewed upturn since then.)1

Until 2000, postal savings and pension reserves had to be invested in the Trust Funds Bureau of the Ministry of
Finance and provided the source of funds for the Fiscal Loan and Investment Program (FILP), which was initiallyused for direct government spending and loans to quasi-governmental corporations but was increasingly used forthe purchase of government securities. A law enacted in May 2000 put an end to the compulsory deposit of postal
savings and pension reserves in the Ministry of Finance’s Trust Fund Bureau and required that FILP raise funds,
on an as-needed basis, by floating "FILP bonds" (essentially Japanese government bonds) on the market.

5Thus, private investors (especially private banks) have been the dominant holders of Japanese
government securities, and their relative importance has increased over time in the case of
medium- and long-term government securities. By contrast, the relative importance of public
investors (especially government financial institutions, which until the 1990s were the major
holders of Japanese government securities and played the important role of ensuring a stableflow of funds from postal savings to government securities) has decreased sharply over time. It
should be noted, however, that private investors include Japan Postal Bank and Japan Post
Insurance, the privatized versions of the formerly government-owned postal savings and postal
life insurance systems. Although Japan Postal Bank and Japan Post Insurance are technicallyprivate, their shares are still 100 percent government-owned and the current government has
the explicit goal of deprivatizing them. The combined share of Japan Postal Bank and Japan
Post Insurance in total government debt was 23 percent in 2011, and the total share of public
investors was 43 percent in the same year if Japan Postal Bank and Japan Post Insurance areclassified as public investors.

Thus, the high and rising share of private investors in total

government debt is largely illusory.2

As for household holdings of Japanese government securities, the share of direct holdings ofgovernment securities by Japanese households has been very low throughout the 2000-2011
period: they have been zero throughout this period in the case of short-term government
securities and increased from 2 percent in 2000 to about 5 percent since 2007 in the case of
medium- and long-term government securities.

Note, however, that holdings of Japanese

government securities by government financial institutions, private banks, and insurancecompanies are financed by the bank and postal deposits, insurance policies, and pension fundsof households and hence are indirectly held by households. Thus, households have played acrucial albeit indirect role in government debt financing, and the high household saving rate in2

We are indebted to Peter Morgan for this point.

6

past years helped make possible the largely domestic absorption of Japanese government
securities.

3.2.

Trends in the Share of Short-term Japanese Government Securities, 2000-2011

In this subsection, we discuss trends over time in the share of short-term Japanese government
securities in Japanese government securities of all maturities during the 2000-2011 period.

Figure 3 shows trends over time in the share of short-term Japanese government securities inJapanese government securities of all maturities of each sector during the 2000-2011 period,
and as can be seen from this figure, the share of short-term Japanese government securities inJapanese government securities of all maturities varies greatly from sector to sector. In recent
years, it has been high for government financial institutions and foreign holders, lower for the
Bank of Japan and private banks, and lowest for private insurance companies.

Turning to trends over time in the share of short-term Japanese government securities inJapanese government securities of all maturities, this share has increased for most types ofholders but increased the most sharply for government financial institutions (until 2009), foreign
holders, and the Bank of Japan (until 2009), with private insurance companies and privatebanks not showing a clear trend one way or the other.

As a result, the share of short-term government securities in government securities of all
maturities increased from 10.1 percent in March 2000 to 37.4 percent in September 2011 in thecase of foreign holdings, which is much higher than the corresponding figures for the Bank ofJapan (25 percent) and private banks (20 percent). This implies greater risk of capital flight7

since short-term securities are more liquid than medium- and long-term securities.

The

corresponding figure for all holders increased through the 2000-2011 period (from 10.8 percent
in March 2000 to 18.6 percent in September 2011) but is still relatively low because pension
funds invest a significant amount in medium- to long-term securities but almost nothing in shortterm securities.

3.3.

Trends in Foreign Holdings of Japanese Government Securities, 2000-2011 (Aggregate)

In this subsection, we discuss trends over time in foreign holdings of Japanese government
securities during the 2000-2011 period.

Figure 4 shows trends over time in foreign holdings of Japanese government securities during
the 2000-2011 period for both short-term and medium- and long-term securities, and as can beseen from this figure, the share of foreign holdings of Japanese government securities has been
low until recently in the case of both short-term and medium- and long-term government
securities, with the share of foreign holders of short-term government securities ranging from
2.4 to 7.3 percent and that of medium- and long-term government securities ranging from 2.7 to
6.7 percent during the March 2000 to September 2007 period.

However, the two shares diverged greatly thereafter: the share of foreign holdings of short-term
government securities increased sharply to 14.8 percent in June 2008 before falling to 10.1
percent in December 2008 and increasing anew to 17.0 percent in March 2011 before levelingoff, whereas the share of foreign holdings of medium- and long-term government securities hasremained low, never exceeding the 7.8 percent level (increasing to 7.8 percent in September82008 before falling to 4.6 percent in March 2010 and increasing anew to 6.3 percent in
September 2011).

Thus, the share of foreign holdings of government securities increased in the case of both shortterm and medium- and long-term government securities but increased much more sharply andwas often more than twice as high in the case of short-term government securities than in thecase of medium- and long-term government securities.

Abundant domestic saving (especially household saving), combined with strong home bias (see,for example, Feldstein and Horioka (1980)), has until recently made it possible for Japan toabsorb virtually all of the massive debt of the Japanese government domestically without having
to rely on foreign holdings. Japan’s household saving rate, which was for many years one of
the highest in the world (see Horioka (1990) for a comprehensive survey of the possible reasonsfor Japan’s high household saving rate), has shown a steady downtrend since the mid-1970s,
but robust corporate saving has more than offset the decline in household saving, as a result of
which private saving has remained robust. Nonetheless, the rapid increase in the debt of theJapanese government has made it increasingly difficult for all of it to be absorbed domestically,
and this is one factor that has led to increased foreign holdings in recent years.

Moreover, since 2005, the Japanese government has sought to diversify holders of Japanese
government securities and to increase the previously low holdings of foreign investors, and thisgovernment policy is undoubtedly at least partly responsible for the steady increase in the shareof foreign holdings of Japanese government securities since 2005.

However, neither trends in domestic saving nor the Japanese government’s policy of
encouraging foreign holdings of government securities can explain the divergent trends in the9foreign holdings of short-term government securities and those of medium- and long-term
government securities and thus other factors must be at play.

The divergent trends for short-term and medium- and long-term securities suggest that thegrowth in the appetite of foreign investors for Japanese government securities was muchgreater in the case of short-term securities than in the case of medium- and long-term securities,
which in turn suggests that foreign investors regarded Japan as a “safe haven” (an economy
offering safe and stable returns) and Japanese government securities as a temporary (shortterm) repository into which to invest their liquid assets in response to increased political and/or
economic instability elsewhere (see, for example, Isard and Stekler (1985), Dornbusch (1986),
and Habib and Stracca (2011)).

Turning to comparative data for other economies to put the figures for Japan in international
perspective, the share of foreign holdings of Italy’s government debt was 44 percent in 2010,
according to International Monetary Fund estimates, and 47 percent, according to Morgan
Stanley estimates. The corresponding figure for the United Kingdom was 32.0 percent in 2010,
according to an article in the April 28, 2010, issue of Keizai Rebyuu (Bank of Tokyo-MitsubishiUFJ). Finally, the share of foreign holdings of United States Treasury securities increased
sharply from 17 percent in 2001 to 31 percent in 2011, according to United States government
data. As shown above, the corresponding figure for Japan has been at most 17 percent for
short-term securities and at most 8 percent for medium- and long-term securities. Thus, theshare of foreign holdings of government securities is much lower in Japan than in Italy, theUnited Kingdom, and the United States.

The Asian Bonds Online data base of the Asian Development Bank (Asian Development Bank
(2012a)) provides data on trends over time in the share of foreign holdings of local currency
10

government bonds in selected Asian economies since 1996, and as can be seen from this database, the share of foreign holdings of local currency government bonds used to be higher inJapan than in other Asian economies but is now higher in the other Asian economies. For
example, it has been higher than in Japan in Malaysia since 2004 (as high as 27 percent), in
Indonesia since 2005 (as high as 34 percent), in Korea in 2007-08 and since 2009 (as high as
11 percent), and in Thailand since 2010 (as high as 13 percent).

Thus, Japan has been

overtaken by many Asian economies with respect to foreign holdings of government bonds, andthe share of foreign holdings of government securities is now much lower in Japan than in bothWestern as well as Asian economies.

This suggests that barriers to international capital

mobility are higher in the case of Japan than in the case of other economies, but the fact that
capital inflows are non-negligible even in the case of Japan suggests that home bias is not so
extreme even in the case of Japan. Our findings are broadly consistent with previous studies(see Obstfeld and Rogoff (2001), Apergis and Tsoumas (2009), and Horioka and TeradaHagiwara (2013) for surveys of this literature and Horioka, Nomoto, and Terada-Hagiwara(2014) for recent evidence).

3.4.

Trends in Foreign Holdings of Japanese Government Securities, 2000-2011 (byEconomy or Region)

In the previous subsection, we discussed trends over time in total foreign holdings of Japanese
government securities during the 2000-2011 period, but in this subsection, we discuss trends
over time in the holdings of Japanese debt (mostly Japanese government securities) byindividual economies and regions during the 2000-2011 period. (The figures have been omitted
due to space limitations.)11

Looking first at short-term debt, western Europe excluding the United Kingdom was the largest
foreign holder of short-term Japanese debt in 2003-04 and 2007-09 and international institutions
were the largest foreign holder of Japanese debt in the intervening years (viz., 2005-06 and2010-12).

By contrast, the importance of the ASEAN economies as holders of short-term

Japanese debt has increased sharply in recent years, rising to third place in 2009 and to second
place in 2010-11.

Turning to medium- and long-term debt, the United Kingdom was the largest foreign holder andwestern Europe excluding the United Kingdom was the second largest foreign holder of
medium- and long-term Japanese debt through 2009, but they were both surpassed byinternational institutions and the ASEAN economies in 2010-11.

Turning finally to debt of all maturities, the United Kingdom was the largest foreign holder ofJapanese debt of all maturities until 2007 before falling to second place in 2008-09 and fifth
place in 2010-11, while western Europe excluding the United Kingdom was the second largest
foreign holder of Japanese debt of all maturities until 2007 before rising to first place in 2008-09
and falling anew to third place in 2010-11. By contrast, international institutions rose sharply
from third place in 2009 to first place in 2010-11, while the ASEAN economies rose sharply fromfourth place in 2009 to second place in 2010-11 and the PRC rose sharply from last (eighth)place to fourth place in 2010-11.

Note, however, that in the case of the PRC, the lion’s share of holdings of Japanese
government securities are held by the monetary authorities (the People’s Bank of China) as partof their foreign currency reserves, not by private investors, who face restrictions on purchases of12foreign securities, and that the decision-making calculus of the monetary authorities is likely to
be very different from that of private investors.3

In sum, Europe was the largest foreign holder of Japanese debt of all maturities until 2009,
suggesting that European investors were the most in need of temporary safe havens for theirfunds until 2009, but that it has been surpassed by international institutions, the ASEAN
economies, and the PRC since 2009.

4. REASONS FOR THE SHARP INCREASE IN FOREIGN HOLDINGS OF SHORT-TERM
JAPANESE GOVERNMENT SECURITIESOne of the most striking findings of the previous section is that there has been a sharp increasein foreign holdings of short-term Japanese government securities in recent years. Horioka,
Nomoto, and Terada-Hagiwara (2014) search for the reasons why foreign investors haveincreased their holdings of short-term Japanese government securities so sharply in recent
years and find that it can be largely explained by the fact that (1) their yields increased relative
to the yields on the government securities of other economies and regions because yields
elsewhere fell sharply in 2008-09 due to monetary easing in response to the Lehman crisis andthat (2) the gap between risk levels on Japanese government securities and those on thegovernment securities of other economies and regions widened dramatically from late 2008 until
early 2010 not because risk levels in Japan declined but because risk levels elsewhere
increased sharply due to the advent of the eurozone crisis. Both factors caused risk-adjusted

3

Since it was primarily euruzone government securities that became riskier after the Global Financial Crisis of 200809, private investors presumably shifted their funds primarily from Europe to Asia, but the monetary authorities of
the PRC diverted funds primarily from the United States (in particular, from United States government securities) toAsia. We are indebted to Peter Morgan for this point.

13

hedged returns on government securities in other economies and regions to converge toJapanese levels in 2008-09 and remain below Japanese levels thereafter as well in some cases,
which in turn induced foreign investors to at least temporarily shift their portfolios from thegovernment securities of other economies and regions to Japanese government securities andcaused foreign holdings of short-term Japanese government securities to increase sharply inrecent years.

Moreover, Horioka, Nomoto, and Terada-Hagiwara (2014) conduct an econometric analysis of
the determinants of foreign holdings of debt securities in eleven economies including sevendeveloping Asian economies (Hong Kong, Indonesia, Korea, Malaysia, the Philippines,
Singapore, and Thailand) and four major industrialized economies (the eurozone, Japan, theUnited Kingdom, and the United States) using data for the 2001-11 period and find.that riskadjusted returns are a significant determinant of foreign holdings of debt securities. This finding
corroborates our contention that the fact that risk-adjusted returns elsewhere converged toJapanese levels in 2008-09 was responsible for the sharp increase in foreign holdings of shortterm Japanese government securities after 2007 and suggests that conventional economic
factors such as returns and risks can explain the behavior of foreign investors without having toresort to non-economic explanations (such as strategic considerations that might be motivating
China’s monetary authorities).

It should be noted, however, that the sharp increase in foreign holdings of short-term Japanese
government securities was largely attributable to central banks, especially the People’s Bank of
China, and that central banks may have very different motivations from those of private
investors. For example, these central banks wanted to diversify away from U.S. government
securities for various reasons and chose to shift into short-term Japanese government securities

14since they are more liquid than longer-term securities and hence more suitable for holding as
foreign exchange reserves.4

Unfortunately, a breakdown of foreign holdings of Japanese government securities by type ofholder is not available and hence we cannot ascertain the importance of the “central bankhypothesis” directly.

However a breakdown of foreign holdings of Japanese government

securities by economy and region is available, and in the case of short-term debt, Europe
excluding the United Kingdom was the largest foreign holder of short-term Japanese debt in
2003-04 and 2007-09 and international institutions were the largest foreign holder of Japanesedebt in the intervening years (viz., 2005-06 and 2010-12). By contrast, the importance of theASEAN economies as holders of short-term Japanese debt has increased sharply in recent
years, rising to third place in 2009 and to second place in 2010-11. Thus, China has not held adominant share of short-term Japanese debt until recently, suggesting that the “central bankhypothesis” has not been of dominant importance, at least until recently.

5. SUMMARY OF FINDINGS AND POLICY IMPLICATIONSIn this paper, we analyze data on trends over time in government debt financing in Japan since2010 with emphasis on the importance of foreign holders and speculate about the determinantsof those trends.

To summarize our main points, we find that Japanese government securities were held primarily
by domestic holders until recently because robust domestic saving, especially household saving,(combined with strong home bias) made it possible for domestic investors to absorb most of the4

We are indebted to an anonymous referee for this point.

15

government debt but that foreign holdings of Japanese government securities have increased
sharply in recent years, especially in the case of short-term government securities. We argue
that trends in foreign holdings of Japanese government securities can be explained byconventional economic factors such returns and risks and that the recent surge in foreign
holdings of short-term Japanese government securities is attributable to foreign investors insearch of a safe haven for their funds in the face of the Global Financial Crisis of 2008-09
precipitated by the Lehman crisis.

Thus, we find that Japan (in particular, the Japanese government) benefited greatly from theeurozone crisis even though Japan’s fiscal situation continues to be wobbly because it
prompted at least a temporary shift in the portfolios of foreign investors towards relatively safe
Japanese government securities, especially short-term Japanese government securities, which
in turn has kept yields thereon lower than they would have been otherwise.

However, the surge in foreign holdings of Japanese government securities will not continue
indefinitely because risks in the rest of the world will eventually decline (in fact, risk levels on
government securities in economies and regions other than Japan had already declined sharply
by early 2010), because investors’ appetite for risk will eventually return as the eurozone crisis
subsides, and because bond markets are developing in emerging Asia and creating increasing
competition for Japanese bonds, especially since they offer higher yields and the possibility ofcurrency appreciation. There is a possibility that there will be a revival of yen carry tradeutilizing the interest rate gap between the U.S. and Japan, as was observed around 2007, andthis may have the effect of stabilizing foreign holdings of short-term Japanese government
securities at a high level, but as of this writing, the share of foreign holdings of short-term
Japanese government securities has fallen somewhat since peaking at 30.2 percent in

16

September 2012, presumably for all of the aforementioned reasons, and was only 28.1 percent
in September 2013.

Moreover, the current situation is even more tenuous than appears at first blush because theincreasing share of foreign holdings and the shortening of maturities on Japanese government
securities, especially on foreign holdings thereof, increase the difficulty of rollover and the risk ofcapital flight and because household and private saving rates in Japan can be expected to
decline even further due to the continuing aging of its population (see, for example, Horioka,
1989, 1991, 1992, and 1997), meaning that domestic banks and insurance companies will notcontinue to have sufficient bank and postal deposits, insurance policies, and pension funds fromthe household sector to invest in Japanese government securities.

The policy implication of these findings is that, although Japan was able to “buy time” by
inducing foreign investors to invest temporarily in Japanese government securities, theJapanese government faces increasing pressures to reduce its massive government debt-toGDP ratio. One way of doing so is to reduce the government debt itself by increasing tax
revenues (for example, by raising the consumption tax, which is very low by international
standards, as the Japanese government is in the process of doing) and/or by cutting
government expenditures (for example, by reforming the public pension system and other social
safety nets). The other way of doing so is by stimulating economic growth, which Prime Minister
Shinzo Abe is trying to do using the three arrows of “Abenomics” (massive fiscal stimulus, moreaggressive monetary easing, and structural reforms to boost Japan’s competitiveness). Prime
Minister Abe is trying to accomplish both goals simultaneously but it is a Herculean task to
skillfully combine all of the policy levers at his disposal because the two goals are often
conflicting (for example, raising the consumption tax will reduce the government debt but may,at the same, put a damper on economic growth).
17

Japan’s massive government debt has not wreaked havoc in the past because of robust
domestic saving and a temporary inflow of foreign capital caused by the Global Financial Crisis,
but it may wreak havoc in the future as both of these factors become less applicable unless thegovernment debt can be brought under control quickly.

18

REFERENCES
Apergis, Nicholas, and Tsoumas, Chris (2009), “A Survey on the Feldstein-Horioka Puzzle:
What Has Been Done and Where We Stand, Research in Economics, vol. 63, no. 2 (June), pp.
64-76.
Asian Development Bank (2012a), AsianBondsOnline Data Base, available at:
http://asianbondsonline.adb.org/regional/data/bondmarket.php?code=Foreign_Holdings
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20

Table 1: General Government Debt as a Percentage of GDP, OECDCountries, 2012
Country
General Government Debt/GDP
Japan
219.1
Greece
165.6
Italy
140.2
Portugal
138.8
Iceland131.8
Ireland123.3
France109.7
United States
106.3
Belgium
104.1
United Kingdom
103.9
Spain
90.5
Germany
89.2
Hungary
89.0
Canada85.5
Austria
84.9
Netherlands
82.6
Israel
72.9
Finland63.3
Poland62.6
Slovenia
61.0
Denmark
58.9
Slovak Republic
56.6
Czech Republic
55.9
Sweden48.7
New Zealand
44.3
Switzerland
43.8
Korea
35.1
Norway34.6
Australia
32.4
Luxembourg
28.4
Estonia14.2Euro area （15 countries)
103.9
OECD - Total
108.8
Note: The figures show the ratio of general government gross financial liabilities
as a perrcentage of Gross Domestic Product (GDP) (in percent).
Source: Organisation for Economic Co-operation and Development (OECD),OECD Economic Outlook , no. 93 (May 2013).

21

Figure 1: Holdings of Short-term Japanese Government Securities by
Sector, 2000-11 (Shares)
100.0

90.0

80.0

70.0

60.0

50.0

40.0

30.0

20.0

10.0

Bank of Japan

Government financial institutions

Source: Bank of Japan’s Flow of Funds Accounts Statistics

22

Foreign

Jul-11Mar-11

Jul-10Nov-10Mar-10Jul-09General government

Nov-09Mar-09Jul-08Nov-08Mar-08

Jul-07

Nov-07Mar-07

Jul-06

Nov-06Mar-06

Jul-05

Nov-05Mar-05Jul-04

Nov-04

Nov-03

Private banks

Mar-04

Jul-03Mar-03

Jul-02

Nov-02Mar-02

Jul-01

Nov-01

Nov-00Mar-01

Jul-00Mar-000.0

Figure 2: Holdings of Medium- and Long-term Japanese Government
Securities by Sector, 2000-11 (Shares)
50.0

45.0

40.0

35.0

30.0

25.0

20.0

15.0

10.0

5.0

Private banks

Private insurance companies

Social security trust funds

Government financial institutions

Foreign

Source: Bank of Japan’s Flow of Funds Accounts Statistics

23

Jul-11Mar-11

Jul-10Nov-10Mar-10Jul-09Bank of Japan

Nov-09Mar-09Jul-08Nov-08Mar-08

Jul-07

Nov-07Mar-07

Jul-06

Nov-06Mar-06

Jul-05

Nov-05Mar-05Jul-04

Nov-04Mar-04

Jul-03

Nov-03Mar-03

Jul-02

Nov-02Mar-02

Jul-01

Nov-01

Nov-00Mar-01

Jul-00Mar-000.0

Figure 3: The Share of Short-term Securities in Japanese Government
Securities of All Maturities by Sector, 2000-2011
45.0

40.0

35.0

30.0

25.0

20.0

15.0

10.0

5.0

Bank of Japan

Private insurance companies

Source: Bank of Japan’s Flow of Funds Accounts Statistics

24

Foreign

Total

Jul-11Mar-11

Jul-10Nov-10Mar-10Jul-09

Nov-09Mar-09Jul-08Nov-08Nov-07Mar-08

Jul-07Mar-07

Jul-06

Nov-06Mar-06

Jul-05

Nov-05Mar-05Jul-04

Private banks

Nov-04Mar-04

Jul-03

Nov-03Mar-03

Jul-02

Nov-02Mar-02

Jul-01

Nov-01Mar-01

Jul-00

Nov-00Mar-000.0

Medium-/Long-term

25

Source: Bank of Japan’s Flow of Funds Accounts Statistics
Short-term

201109201106

201103

201012

201009201006201003

200912

200909200906200903

200812

200809200806200803200712

200709200706200703

200612

200609200606200603

200512

200509200506200503

200412

200409200406200403

200312

200309200306200303

200212

200209200206200203

200112200109200106200103

200012200009200006200003Figure 4: The Share of Foreign Holdings of Japanese Government
Securities, 2000-2011

18.0

16.0

14.0

12.0

10.0

8.0

6.0

4.0

2.0

0.0