Not an old story that Japan has
been a deflationary economy for over 15 years, but markets were taken aback
last week after the Bank of Japan’s new governor Haruhiko Kuroda announced an unexpected
measure to pull the country out of deflation. Following the principles and
policies of the Prime Minister Shinzo Abe, Kuroda announced a massive
quantitative easing program that will double the country’s money supply in two
years, from US $1.43 trillion to US $2.86 trillion. Shinzo Abe’s economics –
also called as ‘Abenomics’ – is to
increase money supply in the economy to elevate inflation.
This decision of infusing money
supply comes alongside tax breaks from the government aimed at encouraging
firms to raise wages, in the hope that consumers will respond by increasing
spending, and allow prices to rise, too. At the same time, in a bid to make
exports more competitive, the government is looking to depreciate its currency.
By doing so, imports will become costlier which will help in bringing about
inflation and also reduce the trade and current account deficit of the country.
Under the announced plan, Bank of
Japan has decided to buy long term government bonds worth $70 billion every
month for the remaining part of this year and the whole of next year.
Given that the US Fed Reserve is infusing
$85 billion every month by buying government bonds and Japan being only 1/3rd
of the size of the US economy, spending $70 billion every month looks very huge
and unsustainable. Plus, it is said that BoJ’s balance sheet will increase by
around 1% per year whereas the Fed’s balance sheet is growing by about 0.54%
per year. This raises a question whether the Japanese economy will be able to absorb
such massive levels of liquidity infusion.
The backdrop is that inflation in
Japan has remained either flat or negative since the collapse of the country’s
stock market and real estate bubble at the beginning of the 1990s.
Theoretically, when an economy is in
deflation, it simply means that prices are falling y-o-y. Needless to say, falling
prices make people happy but in anticipation of prices falling in the future,
they postpone their consumption decisions. This impacts businesses and their
earnings remain flat or fall. This affects the economic growth of the country
as a whole. Thus, it is proved and well received, that inflation, at comfortable
levels, should persist in an economy.
Was this announcement less in itself to excite the market
that Mr. Kuroda has gone to the extent of saying that if prices did not rise as
expected, the bank ‘would not hesitate’
to increase its easing program?
Well, we must, with open arms, appreciate
the bold decision taken by Mr. Kuroda but we should also not sideline and
ignore the issues which may become a hurdle in achieving the objectives
outlined.
One issue is that regardless of
the increasing liquidity in the economy, money is not trickling down to all levels
in the economy, more specifically to the bottom of the pyramid. This does not
support the success of the quantitative easing program. Secondly, majority of
the population of the country is in the age range 60-65 years. With this proportion
expected to rise in the future, it continues to remain a deterrent even going
ahead. At this stage the country wants its people to borrow and spend but the
ageing population, out of its tendency to save, may not spend. Economic
instability along with fiscal deficit remaining at above 9% levels, government
debt remaining at above 200% of GDP and trade balance moving into deficit will also
remain a concern going forward.
These structural issues, I
assume, are enough to convince investors to keep their sums of money out of
Japan, thus defying the basic purpose of introducing the quantitative easing
program.
