Reference no: EM132838561

Japan's Surging Samurai Bond Market

Following the implosion of Japan's stock market and real estate bubbles in the early 1990s, the country had to contend with a decade of poor economic performance. The economy seemingly teetered constantly on the brink of a serious recession, and sustained growth remained elusive. In an effort to keep the bleak economic clouds at bay, the Bank of Japan repeatedly lowered interest rates to try to encourage corporate and consumer spending. As a result, by early 2001 Japan had the lowest interest rates in the world. In March 2001 10-year Japanese government bonds yielded 1.24 percent, compared with 5 percent for comparable U.S. government debt. Despite these low interest rates, many Japanese corporations continue to focus on restructuring and downsizing rather than investing in new capacity, as they struggle with the sustained hangover from the boom years of the 1980s and early 1990s. Consequently, Japanese corporations have not taken advantage of the low interest rates to issue additional debt. Nor have consumers responded to the lower interest rates by increasing their consumption. Instead, the personal savings rate in Japan remains stubbornly high, even though many Japanese hold the majority of their savings in post office accounts that pay very low interest rates.

However, there is a silver lining to this bleak economic outlook-for foreign corporations and governments that is. Increasingly, they have been taking advantage of Japan's low interest rate to issue yen-denominated debt. With the yen/dollar exchange rate relatively stable, this seems like a shrewd economic bet. Moreover, yield-hungry retail investors, who are looking for better returns than the 1 to 2 percent they get on post office savings accounts, have snapped up foreign debt offerings in Japan. As the equivalent of some $1 trillion in Japanese postal savings reached maturity between April 2000 and April 2002, a huge wave of retail money entered the market looking for higher returns. Japan's equity markets have been flirting with 10-year lows, and with the economy near recession, few retail investors are putting their money in Japanese stocks. With Japanese corporations issuing only a few bonds, few investment opportunities are available there. This leaves foreign bonds as one of the few attractive investment opportunities for retail investors looking for higher yields.

An increasing number of foreigners took advantage of this opportunity. The number of Samurai bond issues increased from less than 20 in 1998 to over 120 in 2000, and seemed set to exceed that number in 2001. In 2001, foreigners issuing yen-denominated debt raised some $24 billion in the Japanese bond market, up from $9 billion in 1998. Countries including Croatia, Uruguay, and Brazil have raised money for their treasuries by issuing Samurai bonds. For example, in February 2002 the government of Uruguay issued ¥30 billion of five-year bonds. The interest rate it had to pay on those bonds was just 2.2 percent. In contrast, Uruguay had to pay 7.6 percent for five-year dollar borrowings. Similarly, an increasing number of corporations have been issuing Samurai bonds. In late 2000, Citigroup completed an offering of ¥155 billion ($1.43 billion) in Samurai bonds. Several U.S. investment banks, including Morgan Stanley, Merrill Lynch, and Lehman Brothers, also issued Samurai bonds in 2000. In early 2001, the trend continued with a major Samurai bond issue placed by Deutsche Telekom, which offered ¥500 billion ($4.5 billion) in bonds. In addition, Posco, Korea's largest steel company, came to the market with a ¥30 billion five-year offering. In both cases, these companies chose to raise debt in Japan as opposed to other markets because even factoring in the costs of hedging against fluctuations in the value of the Japanese yen, they could significantly reduce their cost of capital by doing so.

Case Discussion Questions

1. What were the macroeconomic underpinnings of the increase in Samurai bond issues?
2. How might an increase in Japan's rate of economic growth affect the vitality of the Samurai bond market?
3. For a company like Deutsche Telekom, which issues yen-denominated debt to raise funds for investments outside of Japan, the lower interest rate must be offset against higher costs. What are these higher costs, and what determines their magnitude?
4. What would happen to activity in the Samurai bond market if the yen started to appreciate significantly against the dollar, but interest rate differentials between the United States and Japan stayed constant? What would happen if the yen depreciated against the dollar? What does this tell you about the risks of issuing foreign bonds?