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Japanese government bond yields may surge if Prime Minister Naoto Kan fails to carry out financial reforms, prompting an exodus of foreign money that had been drawn to the safety of the nation’s assets, Barclays Capital Japan Ltd. said.

Stable returns, low volatility and ample demand create a “virtuous circle” that supports Japan’s debt market, Tetsufumi Yamakawa, cohead of Japan research at Barclays in Tokyo, said in a forum Tuesday.

“The Greek and European debt crisis has drawn investor focus to the sovereign markets of many countries, and overseas investors aren’t so bearish on JGBs,” Yamakawa said.

Japan’s 10-year yields dropped to 1.045 percent on July 22, the lowest since Aug. 14, 2003. The yield was at 1.065 percent Wednesday.

Japan’s ¥700 trillion in outstanding bonds have a “peculiar ownership condition,” he said, with groups such as retirement funds and Japan Post Bank holding about 60 percent of the total. Pension funds are starting to divest as the population gets older, meaning purchases by the Bank of Japan and overseas investors must increase over the long term, he said.

China is heading for its biggest annual increase in its purchases of JGBs since at least 2005, the Finance Ministry reported this month. Japan’s public pension fund sold more government bonds last fiscal year than it bought for the first time since 2000, central bank data showed this month.

Measures like the Sharpe ratio, a gauge of gains that takes volatility into account, show Japanese debt is outperforming U.S. Treasuries and global stocks, Yamakawa said. Delays in deregulation and tax reforms will cause destabilization in the debt market and a decline in risk-adjusted returns, which may trigger investor flight, he said.

Japan’s public debt is 180 percent of gross domestic product, the highest among members of the Organization for Economic Cooperation and Development. Central and local government borrowing totaled ¥882.9 trillion as of March 31, up 4.3 percent from a year earlier, according to the Finance Ministry.

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