Japan Increasingly Alarmed US May Miss Debt Deadline

TOKYO — Japan is increasingly alarmed that the United States may miss the Aug. 2 deadline for raising its debt ceiling and Tokyo fears markets may be too optimistic about prospects of a lasting solution to the crisis, sources familiar with Japan's international and monetary affairs said.

Officials still hope Washington can manage to strike a last-minute deal and even if that proves impossible, will give priority to interest payments to international holders of U.S. Treasury debt to limit the immediate market impact, the sources said.

But Tokyo's concern is that, if the crisis drags on without clear and sustainable resolution, markets may be thrown into turmoil, just like it happened when Lehman Brothers collapsed in September 2008.

"There is nothing really concrete that supports the still predominant view that the U.S. will somehow clinch a deal in time and avoid default," said one of the sources.

"If there is a default, the impact on global markets will be huge."

Another source confirmed this view. "Nobody thought Washington would let Lehman collapse. But look what happened," the official, who declined to be named because of the sensitivity of the matter, said on Sunday.

Japan ranks only behind China on the list of United States' biggest international creditors. If markets go wild over a threat of U.S. debt default, Japan's first defence will be to ensure that Japanese financial institutions have sufficient supply of dollars, the sources indicated.

The Bank of Japan believes Japanese commercial banks have sufficient dollar cushion but will use its dollar swap arrangement with other central banks to prevent a dollar squeeze in case of market turmoil.

It is also prepared to flood markets with cash through its market operations in case inter-bank borrowing costs spike, BOJ officials say.

Another source of concern is the yen's ascent near a record high of 76.25 to the dollar hit days after the March quake.

Japanese monetary authorities are prepared to step into the currency market to stem yen rises if they see the moves as driven by speculators and damaging enough to the economy.

The BOJ may also consider easing monetary policy at its two-day rate review that ends on Friday, or even earlier, if the yen continues to spike enough to hurt business sentiment and derail a fragile economic recovery.