After ten years as the head of the Bank of Japan, Haruhiko Kuroda will transfer his position to Kazuo Ueda on 8 April. This brilliant 71-year-old university professor is no stranger to the world of central bankers. He previously worked at the Bank of Japan from 1998 to 2005. But having been out of monetary decisions for almost 20 years, he was not expected to take over the reins of the Japanese central bank.
The favourite for the position was the current deputy governor, but he refused the job. A great architect of the highly accommodative policy that had been in place for over a decade, the Deputy Governor felt he was not the right person to end a singular monetary policy in more than one capacity.
Despite inflation at 4%, the Bank of Japan keeps its key interest rate at -0.10%. It also buys massive public debt to keep 10-year interest rates near zero. But these policies are increasingly creating financial and economic tensions.
It is impossible to stop what has been in place for more than ten years overnight. Therefore, we should not expect a monetary revolution in Japan in the coming months.
The future Governor has never hidden his opposition to controlling interest rates on bond markets. He should therefore follow the path initiated by his predecessor in December. Two months ago, the band of fluctuation tolerated by the monetary authorities for 10-year interest rates was widened from 0.25% to 0.50%.
By gradually increasing the accepted margin around zero, the Bank of Japan will allow Japanese interest rates to rise to their appropriate level.
This will be a long process to prevent Japanese public debt holders from incurring significant losses on their bond portfolio. The goal is also to allow borrowers to adapt to the end of free money or almost. This aspect is all the more important as Japan’s public debt is huge, at over 260% of GDP.
Is a storm in sight for the public debt?
Public debt financing is acceptable today thanks to the Bank of Japan's intervention, which massively buys public bonds. The decrease in these purchases does not, however, herald a financial crisis in Japan.
The Japanese public debt is almost entirely financed by local actors, the central bank, the pension funds, and banks that place in the public bonds the money that the Japanese entrust to them massively. This is the paradox of Japan.
The Government is in debt like no other, but the country is prosperous. It is even the biggest creditor vis-à-vis the rest of the world.
Even without the Bank of Japan’s intervention, interest rates will remain contained thanks to the significant domestic savings. However, this would increase the debt burden of about 2% of GDP, which is mainly sustainable for public finances, especially since public taxes are low in Japan, at 36.5% of GDP against 46.5% in the European Union.
So there are tax margins in the archipelago to increase revenues.
The end of the stock market rebound?
The highly accommodative monetary policy allowed the Japanese stock market to rebound. The weakening of the yen favoured exports and, above all, mechanically inflated foreign earnings once they were converted into national currency.
But today, these advantages are few compared to the adverse effects of an extremely low yen. As a result, Japanese firms have moved production of low-value-added products abroad, and a weak yen is no longer necessary. On the other hand, the currency’s weakness increases the price of imports and causes production costs in the Archipelago to boom.
Moreover, by distributing the money massively and free of charge, the Bank of Japan keeps zombie companies alive with no future. To the detriment of future innovative companies, these monopolise market shares and labour in a country where domestic demand is low, and the staff shortage is an increasingly pressing problem. This penalises the country’s productivity and economic dynamism.
The end of the highly accommodative monetary policy will generate some turbulence but will not cause a financial crisis in Japan. On the other hand, it will give new colours to the yen, which is now highly undervalued and will allow the Japanese currency to regain its role as a haven, lost in recent times because of the immobility of the Japanese bank.
Reducing the overall risk of a portfolio and allowing a significant gain in the exchange rate, Japanese debt is unavoidable. With historically extremely low volatility, the Japanese equity market could experience a slightly more turbulent period with the change in monetary course.
But while the non-standard policy currently being pursued by the Bank of Japan has more disadvantages than advantages for Japanese companies, the end of the zero rate policy will ultimately be beneficial.
Therefore, we keep 5% Japanese equities and 5% Japanese bonds as part of our portfolio.