TOKYO - The countdown has begun to the
Japanese central bank's exit from years of
ultra-loose, near-zero-interest-rate monetary
policy, amid growing signs of a recovery taking
root and chronic deflation finally releasing its
grip on the world's second-largest economy.
The Bank of Japan's departure from its
so-called "quantitative easing" policy, possibly
as early as next week and probably by
the
end of April at the latest, is widely seen as a
foregone conclusion. So the biggest questions now
are: Exactly when will the BOJ make the move? And
what will come next?
BOJ governor
Toshihiko Fukui has suggested for a while that the
end to the quantitative easing policy is coming
soon. In his strongest signal to that effect,
Fukui told an upper house committee of the diet,
Japan's parliament, on last Thursday that he hopes
"immediately" to end quantitative easing once the
conditions for doing so are met.
Under the
present policy, which was introduced in March
2001, the BOJ flooded Japanese financial markets
with excess cash in the hope of encouraging
lending, while anchoring short-term interest rates
near zero. The BOJ has vowed that it will stick to
the policy until deflation (a continuous decline
in prices), which has long plagued the Japanese
economy, is beaten. Deflation has acted as a drag
on the economy by eroding corporate earnings and
paychecks. Fukui, who took the BOJ helm in March
2003, has won the confidence of the markets
largely by being seen as more firmly committed
than his predecessor, Masaru Hayami, to quelling
deflation.
The BOJ has set three
conditions for ending the quantitative easing
policy:
Year-on-year changes in the core consumer
price index (CPI), which excludes volatile prices
of fresh foods, must remain stable above zero.
BOJ board members must be convinced that
deflation will not return.
There should be no other factors that warrant
keeping the loose monetary settings in place.
The BOJ has not always done a stand-up job
in fulfilling its mission. In August 2000, it
announced an end to its zero-interest-rate policy,
which had been in place since February 1999, and
raised interest rates too early. This, coupled
with the bursting of the information-technology
bubble in the United States, plunged the Japanese
economy back into recession. In the face of a
barrage of criticism, the BOJ restored the
zero-interest-rate policy and introduced the
quantitative easing as a main tool to steer its
monetary policy.
This time around,
however, the BOJ is more confident of its policy
shift. Concerns over Japanese financial
institutions have eased significantly as the
once-huge mountains of bad bank loans returned to
normal levels. Major companies have cleared away
the excess debts, equipment and labor that had
weighed on their fortunes, and are expected to log
record profits for the current fiscal year ending
this month. The BOJ has been increasingly
encouraged by recent upbeat economic data showing
that Japan has finally emerged from the decade of
stagnation that ensued after the "bubble economy"
burst in the early 1990s.
Industrial
output in 2005 posted its highest level since
2000. In a preliminary report on Tuesday, the
government said industrial production rose a
seasonally adjusted 0.3% in January from the
previous month, the sixth straight monthly
increase. The January output index stood at its
highest level since 2000.
Unemployment
declined for the third year in a row in 2005, to
4.4% from 4.7% in 2004, with the December figure
down 0.2 percentage point from November's 4.6%. In
December, the number of job offers and job seekers
matched for the first time in more than 13 years.
Amid the improving job environment, Japanese
consumers are loosening their purse strings. The
consumption propensity of Japanese wage-earning
households, which is measured by the ratio of
household spending to disposal income, registered
its highest level in 15 years, at 74.7%, in 2005.
Furthermore, the average stock price on
the Tokyo Stock Exchange (TSE) rose by about 40%
in 2005. Toward the end of the calendar year, the
benchmark Nikkei 225 index topped the 16,000 level
for the first time in more than five years.
Japanese stock prices have weathered the "Livedoor
shock" that hit the country in mid-January.
Enjoying a tailwind from positive economic data,
the Nikkei average has been hovering in the 16,000
range in recent days.
Indeed, economic
data show that deflation seems to be nearing an
end. The core CPI rose 0.1% in December from a
year earlier after a 0.1% increase in November,
which was the first two-month run of increases in
almost eight years. The core CPI in October was
flat.
Government data released on February
17 show that Japan's gross domestic product (GDP)
expanded for the fourth quarter in a row during
the October-December quarter, posting robust 1.4%
growth from the previous quarter and an annualized
5.5% growth in real terms. On February 9, the BOJ
kept its assessment of the economy unchanged,
saying in its monthly report that a steady
recovery is continuing.
After the release
of the GDP figures, the government of Prime
Minister Junichiro Koizumi on February 22 upgraded
its own assessment of the overall economy for the
first time in six months. "The economy is
recovering," the Cabinet Office said in its
monthly report for February, using more upbeat
language than the previous month's report, which
stated that the economy was "recovering at a
moderate pace".
In late December, the
Koizumi government projected modest economic
growth of 1.9% in real terms in fiscal 2006, which
starts on April 1: 1.5% from domestic demand and
0.4% from exports. It also forecast that the CPI
will register a year-on-year rise of 0.5% and that
the GDP deflator, which reflects general price
movements, will inch up by 0.1% in fiscal 2006.
Even as it continued to claim that its
quantitative easing policy has helped the Japanese
economy emerge from years of stagnation and beaten
deflation, the BOJ recently began to stress one of
the major negative effects of that policy. Last
Thursday, it released an estimate that Japanese
households have suffered a total of 304 trillion
yen (US$2.6 trillion) in lost interest revenue
because of the extremely low interest rates of
recent years. The BOJ had long minimized this
negative aspect of its policy by saying that
interest revenue accounts for only about 5% of
overall Japanese household income, while salaries
and other payments by companies make up about 80%.
The BOJ vs the government The
Koizumi government and the ruling Liberal
Democratic Party (LDP) have often clashed with the
BOJ over the state of the Japanese economy.
Government ministers and LDP officials have urged
the BOJ to be cautious about ending the
ultra-loose monetary policy, so as not to choke
off the nascent economic recovery. At the height
of the policy battle with the BOJ, some LDP
officials, including Hidenao Nakagawa, the party
policy chief, even called for revisions to the BOJ
law to put pressure on the central bank.
Indeed, the BOJ Law was revised in 1998,
for the first time in 56 years, to ensure the
central bank's greater independence from the
government and transparency in policy decisions.
Under the revised law, the government lost the
power to fire the BOJ governor, although it
retained the right to appoint him. The nine-member
BOJ Policy Board was created. It became obligatory
for the BOJ to release minutes of board meetings
and the BOJ governor to give testimony before the
diet at least twice a year. While Article 3 of the
BOJ Law guarantees the central bank's independence
from the government in currency and monetary
policy adjustments, Article 4 of the law calls for
the central bank to communicate fully with the
government to ensure that its policy is consistent
with the basic government economic policy.
If the BOJ commits a policy blunder, as it
did when it prematurely lifted its
zero-interest-rate policy in the summer of 2000
under the strongly independence-minded
then-governor Hayami, formidable political
pressure could mount for further amendments to the
law to weaken the BOJ's independence.
The
government is not completely convinced that the
deflation menace is gone. During the
October-December quarter, the GDP deflator, a
barometer of the overall trend in prices, fell
1.6% from a year earlier. The drop in the GDP
deflator was larger than 1.3% during the
July-September quarter. Emphasizing the
significance of this index, the government has
insisted that Japan is still mired in deflation.
"I cannot say we have overcome deflation," Koizumi
said on Monday. Although the BOJ is exploring the
possibility of ending its ultra-easy monetary
policy as early as next week, some officials of
the government and the LDP still want the central
bank to delay any policy shift until April or
later, if possible.
Still, the government
is poised to let the BOJ decide the timing of any
policy change. In fact, even if the BOJ proposes a
vote on a policy shift at a next meeting of the
Policy Board on March 8-9, the government is
leaning toward letting two government officials -
one from the Finance Ministry and another from the
Cabinet Office, who attend the meeting as
observers - refrain from invoking their rights to
request the postponement of the vote until another
meeting. (The board decision is made by a majority
vote, and the two government observers have no
voting rights.)
The immediate focus of
attention is on exactly when the BOJ's move will
come. The earliest possible date would be during
next week's Policy Board meeting. Prior to that
meeting, the CPI for January will be released this
Friday. Most analysts expect the index to log
another rise of 0.4-0.5% from a year earlier,
further convincing the board members that
deflation has ended in Japan.
It is also
possible that the BOJ will take into consideration
concerns within the government and the LDP and
wait until seeing the CPI data for February, due
on March 31, and the closely watched "tankan"
quarterly survey of corporate sentiment, due on
April 3. In that case, a widely anticipated policy
shift could come at either one of two board
meetings set for next month - one on April 10-11
and the other on April 28.
The BOJ's
next move The BOJ has said repeatedly that
it will keep its zero-interest-rate policy intact
for some time even after ending the ultra-loose
monetary policy. Governor Fukui said in
parliamentary testimony last Thursday that the end
to quantitative easing wouldn't mean an immediate
tightening in policy, but would be a stepping
stone toward a more "normal" monetary policy and
"a return to more neutral interest rates".
Analysts calculate that it will take four
to five months for the BOJ to drain all excess
liquidity from the market after dismantling the
ultra-easy monetary policy, by lowering private
banks' daily reserves at the BOJ to a legally
required level of about 6 trillion yen, from
between 30 trillion and 35 trillion yen at
present. The time required for this step will make
it difficult for the bank to raise interest rates
during this period.
Yet there are concerns
that long-term interest rates could rise sharply
if market players act according to what they think
the central bank will choose to do once it
jettisons its current monetary policy. In fact,
Japanese Government Bond (JGB) prices tumbled and
the yen surged against the US dollar on Fukui's
diet testimony. (As with all bonds, JGB prices and
yields move in the opposite direction.) On the day
of Fukui's testimony, the yield on the newest
benchmark 10-year bonds jumped 0.04 percentage
point to 1.555%, while the dollar weakened to
about 117.20, down more than 1 yen from late the
previous day. Prices of Japanese government bonds
have gyrated since government officials began to
suggest they would no longer stand in the way of
the central bank's move to end its ultra-easy
monetary policy.
There are concerns that a
policy change would send the BOJ into uncharted
territory. Some government officials and LDP
members have proposed setting an inflation target
to raise the price increase rate to a certain
level. However, the BOJ and some experts object to
the idea, raising questions about the
effectiveness of such a target and claiming that
it would become difficult for the central bank to
implement flexible monetary policies. Setting an
inflation target would have the merit of boosting
the transparency of BOJ policy, but at the same
time it would have the demerit of depriving the
central bank of room for flexible policy
implementation.
Amid growing concerns that
the end to the ultra-easy monetary policy could
disturb the financial markets, the BOJ itself
seems to be at pains to devise some new criteria
for implementing its monetary policy, although it
remains adamantly opposed to setting an inflation
target. Instead of adopting specific numerical
goals, the central bank is considering improving
its biannual economic-outlook report and
statements released after every policy-setting
panel meeting to help stabilize market
expectations and boost transparency in monetary
policy. To be sure, the Koizumi government seems
to have raised the white flag in a policy battle
with the BOJ this time. But another round of
policy battle could break out later this year over
how fast the BOJ should move to raise short-term
interest rates.
The government does not
want to see any hasty interest-raise move by the
BOJ for fear of sharp rises in long-term interest
rates, which would lead to a rise in government
debt-servicing costs. Japan's fiscal condition is
the worst among major industrialized countries,
with pubic debts, including those owed by local
governments, expected to reach 775 trillion yen at
the end of fiscal 2006, about 150% of the nation's
GDP. The Finance Ministry estimates that every 1%
rise in long-term interest rates - which are now
around 1.6% - will increase government
debt-servicing costs by at least 1.5 trillion yen.
The fiscal 2006 government budget plan, now
pending in the diet, calls for 18.8 trillion yen
in debt-servicing outlays. Of this amount, 8.6
trillion yen will be used for interest payments.
Under such circumstances, the BOJ is widely
expected to move slowly to raise rates. Some
analysts say that the BOJ will be very cautious
about raising rates because it remains traumatized
by the policy debacle in the summer of 2000 when
it prematurely lifted its zero-interest-rate
policy, triggering a recession.
Many
analysts have suggested in recent days that the
BOJ is likely to raise the unsecured overnight
call rate, the interest rate banks charge one
another, by the end of the year, but only to
0.25%. But the BOJ is now mulling ways to put an
upper limit on an anticipated rise in short- and
long-term rates, not only to cushion the impact of
the policy shift but also to secure the support of
the government and the LDP for terminating the
current policy.
Specifically, the central
bank is expected to ensure that the
uncollateralized overnight call rate does not
exceed 0.1%, effectively keeping the key rate
close to zero. The 0.1% figure is equivalent to
the official discount rate, at which the BOJ
provides funds to financial institutions facing
liquidity constraints. And in a bid to prevent a
sharp rise in long-term interest rates, the BOJ
has indicated it would continue to make outright
purchases of 1.2 trillion yen in long-term
government bonds each month. When the quantitative
easing policy was launched in early 2001, the BOJ
initially purchased 400 billion yen in those bonds
each month. The purchase amount was gradually
increased.
As the BOJ has pumped a massive
amount of liquidity to maintain a balance of 30
trillion to 35 trillion yen of current accounts
held by private banks at the central bank, the
unsecured overnight call rate, which serves as the
money-market benchmark, has stayed at
0.001-0.002%. But the current-account balance is
expected to decline to the legally required level
of about 6 trillion yen in several months. As the
supply of funds tightens, the overnight call rate
could spike.
Meanwhile, the implications
of the BOJ's anticipated policy shift might not be
limited to the Japanese economy alone. Analysts
point out that the process the BOJ is about to
start after more than a decade of near-zero
interest rates and five years of quantitative
easing could ripple through global capital markets
for years to come. If Japanese rates rise,
Japanese capital that has flowed into the US could
start to return home. Foreign investors, who have
already played a leading role in the rally on the
Japanese stock market in the past year or so,
could begin investing more broadly in Japanese
assets. This could push US interest rates higher
and the dollar lower, as Japanese investors shift
away from US assets.
Hisane
Masaki is a Tokyo-based journalist,
commentator and scholar on international politics
and economics. Masaki's e-mail address isyiu45535@nifty.com.
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