BOJ’s Bold Attempt At Reviving Sagging Economy

Bank of Japan joins the race of quantitative easing: Will it create more problems than solving them?

Bank of Japan (BOJ) arrived late at the party of monetary loosening among the developed nations but it arrived with a bang. After the US Federal Reserve and European Central Bank, BOJ loosened its purse strings. Under the new monetary policy, BOJ would try to achieve an inflation target of 2% from the current deflation of 0.3%. 

What really surprised the market was the time frame within which the bank targets to reverse the 15 years of deflation. It has planned the purchase of long-term government debts and financial instruments linked to stock and property market. This will help to prop up the prices of the assets. It is estimated that the bank will have to buy around USD 73 billion worth of bonds every month to achieve its target.

This will constitute 1.4% of the nation’s GDP compared to 0.6% worth of bond buying done by the US Federal Reserve. In addition to this, BOJ will also increase purchases of exchange-traded funds by 1 trillion yen per year and real-estate trust funds by 30 billion yen per year. However, this is not the first attempt by BOJ with quantitative easing. It had tried once in 2001, in a milder form though, but had failed to lift the prices. Nonetheless, this is one of the most aggressive actions taken by any central bank.

The impact of the announcement was felt everywhere. The benchmark 10-year government bond yield witnessed its largest drop in a single day and fell to 0.425%, hitting an all time low. Another impact was visible on the Nikkei Stock Average that was up by 2.2% yesterday after the announcement and 1.58% today. The index is already trading at a multiyear high. Even the Yen depreciated against the US dollar and is currently trading at a three and half year low against the ‘Greenback’. 

A fall in the value of Yen is definitely going to help Japanese exporters who were facing stiff completion in the global market after yen appreciated by 25% during 2009-12. Besides these short-term implications, there are some long-term ramifications that will once again hamper global financial stability, if not handled suitably.

If Haruhiko Kuroda, Governor, Bank of Japan succeeds in achieving his inflation target, it may create other problems. The rise in inflation is certainly going to be followed by a rise in the interest rates. Japan, which already has a dubious distinction of being the highest indebted country among the developed nations, a further increase in debt is going to stress the government finances. 

Currently, interest payment accounts for one fourth of the government’s annual budget and if interest rate rises with a rise in the debt burden, the outcome may be disastrous. It’s not only the government finances that are going to get hurt; banks will also be equally harmed as they carry large amount of government bonds in their balance sheets. Once the bond market starts falling, the implication will be grave for the Japanese Banks who are already operating with razor- thin margins and will dwarf the recent crisis in Europe. 

Regardless, this will have a positive impact on the Indian equity market. In the last 15 months, liquidity has been one of the most important factors that were supporting the market. This monetary easing will definitely spill over and money will pour into the Indian markets and will support them. Moreover, some of the companies like Maruti Suzuki India that make various payments in Yen either for imports or royalty will be positively impacted with the depreciation in Yen.