Japan's yield spillover effect could exceed forecasts: IMF

Japan's large public debt makes it increasingly vulnerable to a rise in bond yields, and the "spillover" impact on yields in other countries could be greater than economic models suggest because of fiscal strains there, the International Monetary Fund said on Tuesday.
A rise in yields and a decline in equities could force Japanese banks to shed riskier assets from their balance sheets as banks hold more than 40 percent of outstanding Japanese government debt, the IMF said, citing other member countries' analysis of Japan's economy.
Under this scenario, the Bank of Japan would continue with its ultra-easy monetary policy for two more years by purchasing debt and other risk assets, but BoJ monetary policy would have hardly any impact on overseas markets and the yen, the IMF said. "The growth outlook for advanced economies is more fragile, suggesting that negative developments in Japan could have a substantially stronger effect on global growth," the IMF wrote in a report.
This is the first year that the fund is conducting "spillover" analysis where Britain, China, the euro zone, Japan and the United States review each other's economic policies.
Japanese financial markets tend not to trigger major shocks in foreign markets, because Japanese bond and equity markets are geared more toward domestic investors, the IMF report said.
Still, some member countries were cautious about using historical data to model future market moves, because the links between different countries' sovereign risk have become stronger since the global financial crisis, the report said.
The spillover report was part of the IMF's annual Article IV assessment of the economic outlook for member countries, which recommended last month that Japan raise its 5 percent sales tax to as much as 8 percent next year to pay for reconstruction after a magnitude 9.0 earthquake and nuclear meltdown in March. Any further delay in fiscal rebuilding could lead to a rise in yields, the IMF said.
Japan's top banks could absorb a 300 basis point increase in Japanese government bond yields without falling below capital adequacy ratios, the report said. Any further rise would likely force Japanese banks to reduce foreign lending, the report said. The yield on 10-year Japanese government bonds traded at an eight-month low of 1.065 percent on Tuesday.