Will Japanese retail investors start dumping their investments in Australian bonds as they scramble to cover the huge losses inflicted by last Friday’s devastating earthquake and tsunami?

It now appears likely that Friday’s devastating earthquake and tsunami has resulted in more uninsured damage in north-east Japan than any other event in history. Japanese households and businesses will be forced dig into their savings to pay for a large slice of the repair bill.

Undoubtedly, they’ll be forced to liquidate some of their offshore assets. According to Citigroup, Japanese investment trusts — the main vehicles that Japanese retail investors use to invest offshore — hold $US342.1 billion in foreign assets. The US accounts for a little over one-third of their investments. The Japanese trusts own $121.5 billion of US assets, including $21 billion of US shares and $48 billion in US bonds (which represents a mere 0.3% of the total US bond market).

But it’s a completely different story in Australia, which is the second favourite investment destination for the Japanese investment trusts. They have poured $US61.4 billion into Australian assets, including $52.4 billion in bonds, and $1.9 billion in shares. Their equity investments account for a very minor (0.2%) proportion of the free float of the Australian share market, so any selling there is likely to have little impact on the overall market.

But in the case of bonds, the Japanese investment trusts own 3.7% of total bonds on issue. So there could be a marked impact on Australia’s bond market if Japanese retail investors start withdrawing money out of investment trusts, forcing the trusts to sell off assets. If the Japanese trusts start selling Australian bonds, prices will likely fall, pushing long-term interest rates higher.

(New Zealand, which ranks ninth in terms of Japanese offshore investment destinations, is even more vulnerable. Japanese trusts have invested $5.1 billion in New Zealand, of which $4.8 billion has been spent buying bonds. This means that Japanese trusts account own a staggering 11.2% of total New Zealand bond market. Their only similar level of concentration is in Vietnam, where the Japanese investment trusts shares worth $211 million, representing 7.3% of the free float of the entire Vietnamese equity market.)

At this stage, we don’t know the timing, or the extent to which Japanese retail investors will start withdrawing funds. And it’s possible that retail investors will choose to sell off their US and eurozone bond investments (the Japanese trusts have invested $41.6 billion in eurozone assets, of which $29.3 billion is in bonds), because of the extremely low yields that these bonds offer.

Of course, Japanese households and businesses won’t be the only ones facing huge losses as a result of Friday’s shattering earthquake and tsunami. Japanese banks  — particularly the small, regional ones that have their operations focused in north-eastern Japan — will suffer a massive rise in their problem loans as a result of Friday’s catastrophe. This poses a huge challenge to the Japanese banking system, which is already grappling with low levels of profitability.

It’s not surprising then that in recent days, the Japanese central bank has been pumping trillions of yen into Japanese money markets in an attempt to shore up Japan’s fragile financial system.

*This article first appeared on Business Spectator.

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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