BOJ policy shift may affect Chinese exports

Source:Global Times Published: 2018/1/21 23:23:40

Illustration: Peter C. Espina/GT

The Bank of Japan (BOJ), the country's central bank, recently cut its purchases of long-term bonds, prompting market speculation that it will join its global peers and begin shrinking its balance sheet as soon as this year.

Data from the BOJ showed in early January that as of the end of 2017, total assets on its balance sheet had declined by 444 billion yen ($3.9 billion) from the end of November 2017 to $521.42 trillion yen. Meanwhile, the Japanese government bonds (JGBs), the largest asset class on the BOJ balance sheet, had fallen by 2.9 trillion yen in the month of December 2017 to 440.76 trillion yen. It seems that the BOJ has started to unload its JGB holdings. While the amount of the decline is relatively small, it is the first monthly decrease in the BOJ assets since Japan implemented its qualitative and quantitative easing under the so-called "Abenomics" introduced in 2012 by Prime Minister Shinzo Abe.

Although many economic indicators already show that the Japanese economy has made some improvements recently, the country has failed to achieve its ambitious 2 percent inflation target. If the central bank really means to start normalizing monetary policy and trim its balance sheet, it would mean that it may have had a rethink about the target, which could turn from a major goal to a secondary one.

The BOJ's recent reduction of its balance sheet comes against the background of relatively good performance by the Japanese economy, which is generally expected to move on to a path to recovery. From an objective viewpoint, recent economic growth may give sufficient confidence to the BOJ for it to give up its easing policy stance.

A number of factors have contributed to the economic pickup in Japan. First of all, the recovering global economy is beneficial to Japan's outward-oriented economic structure. Second, several economic policies have paid off. For instance, thanks to the government efforts to boost tourism, Japan attracted a record 28.69 million tourists in 2017, up 19.3 percent year-on-year. Those overseas tourists drove up domestic demand and consumption, giving a lift to the economy. Third, structural reform, the so-called third arrow of Abenomics, has also played a role. Many companies that were in need of restructuring started investing in new facilities, which also stimulated the economy in the short term. In this sense, Abenomics has helped to lift the economy, even though it has been less effective than expected.

But still some analysts are not bullish on the prospects for structural reform in Japan. Hiromichi Shirakawa, chief Japan economist at Credit Suisse, recently said in an interview with Bloomberg that thanks to the rise in global demand, the Japanese economy is undergoing a cyclical recovery, but added that there is no sign of any structural change yet.

As for the impact of the BOJ balance sheet cut on global markets, Japanese companies may remit their overseas profits back to fill the domestic funding gap, thus leading to capital flows into the country. Also, the financial markets will react to the reduction of liquidity.

Fundamentally speaking, the effect of the BOJ's reduction of its balance sheet could be quite similar to that of the US Federal Reserve's recent tightening. But unlike the US economy, which has a strong worldwide presence, the Japanese economy mainly focuses on Southeast Asia and the Asia-Pacific region, which means there could be a fairly big impact on the regional economy from Japanese tightening. Regarding China, if Japan begins tightening its monetary policy, Japanese companies will face tighter funding and may reduce their overseas investment in neighboring countries. Moreover, Japanese companies may also cut their domestic investment, pointing to lower demand and thus curbing exports from China.

Of course, it should be noted that the specific impact will depend on the extent to which the BOJ shrinks its balance sheet. After all, the central bank hasn't officially announced the beginning of the trimming process, so it is still too early to say whether Japan has decided on a policy shift or not. The balance sheet reduction in December 2017 may just be a correction to the previous ultra-easy monetary policy, or it may be out of consideration for economic security.

In addition, Japan needs to do something to respond to the Fed's downsizing. If Japan continues its quantitative easing against the backdrop of US tightening, it could be suspected of currency manipulation due to the sharp devaluation of the Japanese yen against the dollar that would follow. Such depreciation is not what the US would like to see for the sake of its trade, which may lead to possible criticism and political pressure from the US, thus making it even harder for Japan's future policy arrangements.

The article was compiled based on an interview with Chen Youjun, a senior research fellow at the Institute for World Economy Studies at the Shanghai Institutes for International Studies.

Posted in: INSIDER'S EYE

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