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Japan attempts to slay deflation dragon

Published time: April 26, 2013 22:22
Reuters / Kim Kyung Hoon

Reuters / Kim Kyung Hoon

The Bank of Japan's (BOJ) belief it can end 15 years of deflation through drastic monetary easing in just two years has triggered a heated debate on economic policy in the world’s third-largest economy.

Japan’s monetary base will increase at an annual rate of about 60-70 trillion yen, the Policy Board of the BOJ announced on Friday.

Earlier this month, the central bank said it would start buying 60 to 70 trillion yen of longer-term debt and securities annually. The more assets BOJ buys, the more hard cash it is able to circulate in the country. The final goal is to drive up annual inflation to 2 percent. 

Consumer prices are expected to rise 1.9 percent in the fiscal year starting April 2015, according to BOJ Governor Haruhiko Kuroda.

The move is part of an initiative put forward by Prime Minister Shinzo Abe, dubbed “Abenomics,” which calls for robust government spending and drastic monetary easing designed to end 15 years of deflation.

However, the depth of the deflationary problem was highlighted in a separate report that showed consumer prices tumbling 0.5 percent in March, the steepest plunge in two years. The BOJ said that it expects prices to keep falling for “the time being” until its measures take hold.

Tokyo-based Barclays analyst Kyohei Morita said last week in a research report that the price of TVs had dropped 19 percent from a year earlier, and air-conditioners by 18 percent, and that consumer prices will start to increase sometime around July. 

Deflation, or falling prices, can have a disastrous impact on economic growth. In Japan, where the amount of personal savings is one of the highest in the world, consumers have a greater tendency to delay spending, perhaps in the hope that prices will drop even more. 

BoJ Governor Koroda believes all the necessary steps have been taken to assure success of his plan. "Our belief is that we took all necessary steps to achieve the 2 percent inflation target basically in two years," Kuroda said earlier this month. "We'll examine the effect each month but that doesn't mean we will adjust policy every month." 

Critics respond

Kuroda’s plan to spark inflation has run up against predictions of failure. 

“It’s unrealistic, they won’t be able to reach their target in two years, or even in five,” Masaaki Kanno, chief Japan economist at JPMorgan Chase & Co. in Tokyo and a former BOJ official said, as quoted by Bloomberg. Additional easing may be required as early as October, when the BOJ releases new price forecasts, he said. 

BOJ board members themselves are split over the prospects for inflation, with some predicting that consumer prices won’t increase at half the rate set as a target this month. 

Eisuke Sakakibara, an ex-Finance Ministry colleague, believes Kuroda will fall short of achieving the 2 percent inflation goal, and former BOJ board member Atsushi Mizuno sees the central bank running into a “wall of reality” as bond purchases increase risks of a market bubble, Bloomberg reported. 

However, there were reassurances that BOJ will intervene further if its actions do not trigger the desired result.

“We can expect more easing later this year if prices refuse to edge up,” Junko Nishioka, chief economist at Royal Bank of Scotland in Tokyo and a former BOJ official, said prior to the bank releasing its projections. “It’s imperative for the BOJ to clearly communicate its objectives to maintain expectations that prices will rise.” 

Meanwhile, some of the biggest critics of Japan’s move are its neighbors. South Korea, for example, has emphasized the risks to their economy from a weakening yen.

However, finance chiefs from the Group of 20 last week, as well as other financial institutions, including the IMF, have refrained from criticizing Japan over its inflationary measures.

Don’t forget the debt dragon

Thus far, Prime Minister Abe seems to be smooth sailing: Japan stocks are at multi-year highs, his plan has been endorsed by the international financial bodies and Japan has been able to steer clear of charges of manipulating its currency.

Some economists, however, say Japan must do something about its gross public debt, which is projected to hit 230 percent of GDP by 2014.

The Organization for Economic Cooperation and Development, which largely approved of Abenomics in a report on Tuesday, cautioned against runaway debt.

"Stopping and reversing the rise in the debt-to-GDP ratio is crucial," the OECD report said.

The IMF had similar advice: "Japan needs more ambitious plans to bring down debt, plus structural reforms to shift the economy into higher gear," IMF Managing Director Christine Lagarde said last week.

For many years, Japan enjoyed rock-bottom interest rates. Thus, most sovereign debt is held by the Japanese themselves, a lesson that Greece or even the United States could learn something from.

But the country is exposed to risk, especially if interest rates peak.

Japanese policymakers, including Finance Minister Taro Aso, say they are aware of the dangers.

"We are paying attention to that issue, but [Japan] is different than Greece," Aso told CNN last week.

"Given the unprecedented size of its debt ratio and the risk of higher interest rates, Japan needs a detailed and credible medium-term plan of spending cuts and tax increases, accompanied by improvements in the fiscal policy framework," the OECD said.

Some measures suggested by the OECD to tame the debt is bringing social security payments under control, especially with the number of elderly people on the rise in the country; an increase in value-added tax; widen its tax base and eliminate loopholes.

However, given the popularity of ‘Abenomics,’ which opens the door to government spending, it seems that Japan is prepared to forget about the debt dragon and concentrate its efforts in defeating the deflation dragon, which seems to be the graver of the two threats.

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