Japanese just love our dollar bonds

A passion for buying kiwi dollar bonds - which may increase the risk of a "hard landing" for the economy - is unlikely to abate anytime soon, says an expert working for Japan's largest investment bank.

So far this year Japanese retail investors, who are just ordinary people looking for somewhere to put their savings, have bought a record $12 billion worth of the New Zealand dollar bonds known as uridashi.

Local interest rates of up to 7 per cent continue to wow Japanese "mum and dad" investors who can expect to get as little as 0.1 per cent interest from their bank deposits. The official cash rate in Japan is 0 per cent.

Reserve Bank Governor Alan Bollard and some economists have highlighted Japanese demand for New Zealand dollar bonds as one of the uncontrollable factors overheating the economy.

There has been some hope that Japanese investors will be deterred from investing in kiwi dollar bonds because of concerns that the currency is overvalued.

Exchange rate losses have the potential to wipe out any gains they make on interest rates.

But uridashi were already "part of the furniture" in Australian currency markets, said Gerard Perrignon, Australasian co-head of debt capital markets for Japanese investment banking giant Nomura.

Australian dollar uridashi have been popular for several years but the Japanese have been buying significant volumes of the kiwi version only since 2003.

New Zealand was going to have to get used to their impact as a structural part of the exchange rate equation, Perrignon said.

"At the end of the day it really is a yield play for Japanese investors," he said. "I wouldn't get too concerned that a short-term decline in the currency is going to take the heart out of the New Zealand dollar uridashi market."

Red hot demand for the uridashi was the single biggest explanation for the continued strength of New Zealand dollar demand this year, said Westpac currency strategist Jonathan Bayley.

That demand was helping maintain the strength of the dollar at a time when it should probably be falling, he said.

Economic fundamentals such as the whopping size of New Zealand's current account deficit - the gap between what the nation spends and what it earns - made institutional currency investors nervous.

But Japanese retail investors weren't paying attention to those kind of issues.

"The small investor doesn't know what a current account deficit looks like," Bayley said.

New Zealand dollar uridashi were being aggressively marketed in Japan, Bayley said.

"These days if you walk through Tokyo there are posters advertising uridashi that have pictures of the beautiful scenery," he said.

Although New Zealand uridashi returns looked good - about 38 per cent for those who invested in 2003 - they had been out-performed over the same period by the Japanese stock market, Bayley said.

But the uridashi products were being sold as part of a diversified portfolio to investors who were less worried about exchange rate risk than they were about the fickle fortunes of the Nikkei.

Bayley believes the level of investment will drop next year but the Japanese have invested $182 billion in foreign currency debt so far this year. The uridashi phenomenon is not going to go away.