Bank of Japan Dilemma: When to quit from QE By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

June 23, 2015 | Posted by bobbysrinivasan << back to blog

The current Japanese inflation rate is running around 0%. The government is fighting the deflationary trend by pumping its large sums of money into the economy with the desire to reflate the economy. As of now, it has not achieved the desired result. Why? One of the reasons is that the current price of imported oil is stagnating around 60 dollars a barrel and is not helping to push the inflation rate up. It is unlikely that the oil price may move up in the near term because the oil producing countries annual budget depends on the oil revenue and hence they need to produce more oil to sell. The Abenomics is a policy committed to upping the inflation rate to atleast 2% before they can withdraw the quantitative easing scheme. The Japanese economy has a stagnant growth over the last 20 years.

Japan, in its effort to push up the inflation rate to 2% is putting money into the economy, buying assets at a pace of 80 trillion yen a year. For example, if Japan wants to raise interest rates to say to 3%, the bonds that they have bought with near zero yield will drop in value and so the value of the assets that they hold in treasury could drop several trillion yen of operating losses.

Now the question is, when will Japan call off its bond purchasing program? Haruhiko Kuroda, their Central Bank governor is tight lipped about the entire issue. Any misinterpreted announcement of his could create severe doubt about their resolve to push up the inflation to 2%. He said in a bank conference and I quote, “I think it is premature to discuss concrete details of the exit from qualitative and quantitative easing”.

Do central banks need capital? After all they create money and so they cannot run out of cash and even if there is a temporary short fall they can always set it right by using future profits. However central bankers are concerned about their credibility which could be threatened by capital deficit and also protecting their independence from the government. Japanese government carries huge government debt exceeding 270% of GDP, probably one of the highest in the world.

So the Japanese government dilemma will continue for some time. There are suggestions from among the Japanese central bank board members that they should wait till the middle of 2016 before any concrete steps should be taken.

What are the implications of this policy dilemma? The uncertainty is reflected in the Yen value against the dollar. Currently it has drifted down to 124-125 to a dollar. It was as high as 78 to a US dollar two years ago. If all projections turn out to be true the value of Yen will drift lower and lower perhaps touching 140 to the dollar. Of course, the Japanese government is happy about this currency downward drift since it will help them boost their exports thus pushing their GDP.

Why is this relevant for India? China, Japan and many other countries are slowly engaging in competitive devaluation strategies. With the global trade shrinking in volume this is the only way they can make sure of their market share of exports. For India, exports minus imports (X – I) carries a huge deficit. Our currency is managed by RBI. Sooner or later they will realise that our market share of exports is declining because of the competitive devaluation. Of course they could count on the FII’s money to reduce the current account deficit. This will depend upon how long will the prosperity continue in our stock market. Any major FIIs withdrawal will definitely drive the value of our currency down significantly. Let us wait and see how long Japan will continue with their QE plans.

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