Japanese municipal officials are very interested in the U.S. system of state and local borrowing, but there are no current plants to establish tax exemption in the Land of the Rising Sun, according to Mitsuo Ichihashi, managing director of the Japan Local Bond Association.

In a fact-finding mission to the Public Securities Association last week, 22 delegates from the Japanese association -- a rough equivalent to the PSA, in that it promotes the market through newsletters and conferences -- were given a hands-on tour of the municipal market, especially the impact of the Tax Reform Act of 1986.

"We are trying to establish a better market for local bonds." Mr. Ichihashi said through an interpreter. "We don't know how we can do that, but we are studying it. In the future we hope to get more buyers."

More buyers most likely means a more diversified purchasing base, according to Heather Ruth, president of the PSA. Currently, the Japanese municipal profile looks much like the U.S market place did before tax reform. Banks, insurance companies, and individuals are all buyers, with the institutions snapping up the most.

The predominant theory among U.S. public finance officias is that Japanese local issuers anticipate smaller appetites from banks due to both capital guidelines imposed by the Bank of International Settlements and currency risk.

The result of the risk-weighted capital rules is that banks must shrink assets, and if the yen continues to weaken, it could exacerbate the need for shrinkage because more yen would be required to offset overseas transactions.

The U.S. market's penetration of the retail sector, therefore, is a desirable goal for Japanese officials, according to several sources, even though they lack one rather important factor: tax exemption. The obvious reason for individual buying in America -- after-tax income -- is unlikely to be duplicated.

The pivotal role played by tax exemption was not fully grasped by the delegates until Michael E. Dougherty, vice chairman of the PSA, offered an example of an individual living in New York City earning $75,000 a year. After Mr. Dougherty arrived at the healthy returns afforded by New York municipals, there was furious head-nodding throughout the room.

The closest equivalent to Japanese local bonds, in fact, appears to be U.S. Treasuries. Each debt sale must be approved by the Ministry of Home Affairs and carriers a federal guarantee, according to Katsunori Miyoshi, assistant director of the ministry's local finance bureau.

The only major difference between Japanese federal government debt and local bonds is a consideration adversely affecting bansk. Japan's Ministry of Finance has designated a 20% risk weighting for calculating the capital required for holding local bonds, while direct federal securities have a 0% requirement.

Local bonds, as a result, are less appealing from a capital-adequacy standpoint, yet they bear an almost identical yield. Mr. Miyoshi said coupon rates on both sets of securities -- currently 6.7% -- are set monthly by the Ministry of Home Affairs. Japanese government bonds were weaker yesterday morning due to a sinking yen and diminished prospect for a cut in the discount rate, and bonds traded at 6.81%.

There are 3,292 separate public entities -- prefectures, cities, towns, and villages -- that issued about $63.23 billion of debt during Japan's fiscal 1991, which ended March 31, according to the Japanese Local Bond Association. The volume increased more than 25% from 1980, and does not include the private placement market.

About 28% of the market, $18 billion, is privately placed. Interest rates on this debt are set by the municaplities and their underwriters, Mr. Miyoshi said.

The intense interest in tax reform was evident in the questions posed by several delegates. They wanted to know whether the legislation had made issuance more difficult, how the PSA influences Congress, and whether an issuance schedule or mechanism exists to make sales "go more smoothly."

One of the largest gaps between the U.S. and Japanese municipal markets is the tremendous credit-quality variations in America versus the uniformity in Japan. The delegates expressed an interest in correlations between ratings and defaults, but were told by Ms. Ruth that the default rate "is so low, insufficient information exists to make predictions about the relationship betwenn default rates and ratings."

In addition, the idea that municipal health-care bonds can carry 9.5% couposn, be rated below investment grade, and, for banks, required capital reserves of 100% is completely foreign.

Most of last week's meeting with the delegation amounted to a trip down memory lane, as PSA officials described the general and specific effects of tax reform and the disappearance of banks and property/casualty insurers from the municipal bond buying scene.

Perhaps the most interesting aspect of the presentation was the way the PSA characterized some of the more unpopular facets of tax reform. For example, arbitage rebate restrictions actually "make issuance more costly" to issuers, according to Mark Moore, director of policy analysis at the association, rather than preventing public entities from turning a profit on their proceeds.

And in describing what the PSA actually does, Ms. Ruth said influencing Congress can involve many things. "On Monday," she said, "we will trap congressional members, take them to see a municipal trading floor, and take them on a boat ride to watch the fireworks celebrating the victory in the Gulf War.

"After the boat ride," Ms. Ruth added, "the PSA staffers and congressional members will be friends for life."

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