[Opinion] Japan's Distorted Financial Policy and the Challenges of the Bank of Japan

Published 18 Apr.2023 11:10(KST)

Newly appointed Bank of Japan Governor Kazuo Ueda took office on the 9th. Whether the new leadership of the Bank of Japan will change the policies of the previous administration is attracting attention not only in Japan but also overseas. The Bank of Japan introduced the Yield Curve Control (YCC) policy, which manipulates short- and long-term interest rates, in September 2016 during the tenure of former Governor Haruhiko Kuroda. To control long-term interest rates, the yield on the 10-year government bond, a key long-term interest rate indicator, was kept artificially low, generally around 0%.

Since Governor Kuroda began quantitative and qualitative monetary easing, the Bank of Japan has purchased Japanese government bonds worth 465 trillion yen, lowering interest rates and distorting the government bond market unprecedentedly. The problem is that due to this extreme quantitative easing policy, Japanese funds amounting to 3.4 trillion dollars have left Japan in search of higher returns overseas. Overseas investments exceeded two-thirds of Japan’s economic scale. This changed the flow of the global financial market. Japanese investors became the largest foreign holders of U.S. Treasury bonds and held about 10% of Australian and Dutch bonds. They also held 8% of New Zealand bonds and 7% of Brazilian bonds. Since April 2013, Japanese investors have invested 54.1 trillion yen in global stock markets, representing 1-2% of the U.S., Dutch, Singaporean, and British stock markets.

With the new leadership at the Bank of Japan, the international financial community is closely watching whether Japan’s era of ultra-low interest rates will come to an end. The repatriation of funds is already underway. Anticipating the Bank of Japan’s move toward normalizing monetary policy, Japanese investors sold a net 23.7872 trillion yen of foreign medium- to long-term bonds in 2022, the largest scale since 1996. The outflow was particularly large from Australia. On the other hand, 30.3 trillion yen flowed into the Japanese government bond market. If the Bank of Japan changes its interest rate policy, an additional approximately 2 trillion dollars of foreign bonds held by Japanese investors could become potential sale targets.

Having suffered significant losses in last year’s global bond market, Japanese investors have a stronger reason to repatriate their investments to Japan. If the Bank of Japan raises interest rates, large Japanese life insurance companies and pension funds will have an opportunity to accelerate capital repatriation. However, if Japanese interest rates rise, the global bond market, already shaken by the U.S. Federal Reserve’s aggressive rate hikes and credit contraction threats over the past year, could face further instability. While Governor Ueda may end the monetary easing experiment, the risks are very high. Conscious of this, Governor Ueda stated at a press conference after his inauguration that continuing yield curve control is appropriate, showing a cautious approach. Tobias Adrian, Director of the Financial and Capital Markets Department at the IMF, pointed out that sufficient communication is important to avoid expected market turmoil when the Bank of Japan changes its monetary policy.

However, it seems unlikely that Governor Ueda will simply follow former Governor Kuroda’s path. It is highly probable that changes will be made gradually over time. The side effects of long-term large-scale monetary easing policies are very significant. One such side effect is that the Bank of Japan holds more than 52% of Japan’s government bond balance of 1,051 trillion yen. Additionally, the Bank of Japan holds about 50 trillion yen in stocks. It remains to be seen whether Governor Ueda can overcome the dark legacy of Abenomics implemented during the Kuroda era.

Kim Dong-gi, author of 'The Power of Geopolitics'