Japan: BOJ and Fiscal Stimulus Plans

Published on May 31, 2016

Key Takeaways:

We believe the Bank of Japan will provide additional monetary policy stimulus at either its upcoming Monetary Policy Meeting on June 15-16 or at its subsequent meeting on July 28-29.

We lean towards July as that latter meeting will include a new Outlook Report, and allow the BOJ additional time to assess Fed policy, dollar/yen, and government plans for additional fiscal stimulus.

That easing is likely to take the shape of an “all of the above” package to ensure maximum effectiveness, including we expect some help for the banks.

On the fiscal policy front, we expect the Abe administration to announce a supplemental budget of around 5 trillion yen in addition to the expected announcement of another delay in the consumption tax hike.

The supplemental budget will include consumption vouchers, first introduced in the Fiscal Year 2014 budget, but we expect this time they will be larger in size.

Since stepping in as the Governor of the Bank of Japan in March of 2013, Haruhiko Kuroda has confound analysts and his fellow policymakers alike on numerous occasions, staying the bank’s hand when action has been expected, while delivering unexpected and aggressive policy actions when not.

And so in the run up to the June 15-16 and July 28-29 Monetary Policy Meetings expectations in the markets are high for action, yet still uncertainty and confusion reign over exactly when and what.

*** The recently stronger dollar/weaker yen on the prospects of a Federal Reserve summer rate hike, the prospects for a delay in the planned consumption sales tax hike by Prime Minster Shinzo Abe, and the likelihood of a supplemental fiscal stimulus package will take some pressure off the BOJ to act. But we expect the central bank to step in nevertheless at one of its next two meetings – more likely in July – to reverse weak inflation expectations and protect its elusive second half of FY 2017 target for hitting its 2% inflation target. ***

*** The guiding principle for Kuroda’s BOJ when easing is to ensure the actions taken are as effective as possible. So in this case, an easing will likely take the form of an “all of the above” combination of an increase in bond purchases, ETFs and other assets, and even a cut in deposit rates further into negative territory. The latter we believe would be accompanied by a mechanism to offer loans at negative rates to banks in order to offset the contractionary impact of the policy action on bank lending and profits. That measure was rumored to have been under consideration before the April BOJ meeting, but was not adopted at the time. ***

*** On the fiscal policy front, we expect the Abe administration to announce a supplemental budget of around 5 trillion yen in addition to the expected announcement of a delay in the consumption tax hike from 8 to 10%, scheduled for 2017, by two and a half years. Most interestingly, the stimulus will include consumption vouchers, first introduced in the 2014 budget, but in larger size. We expect those vouchers to provide a boost in consumption of a minimum of 0.2% and by as much as 0.5% of total private consumption. ***

Controlling the Message

Just hours before the Bank of Japan surprised markets by cutting rates into negative territory for the first time on January 29 — despite Kuroda having just testified to the Japanese Diet that such a move was not under consideration — a Nikkei newswire report appeared suggesting the BOJ was in the process of deliberating exactly such a move.

That leak – suspected to have come from the Ministry of Finance observer at the meeting – triggered an internal BOJ investigation and a parliamentary and media grilling of Kuroda that was lost only in the shadow of the disastrous market meltdown especially in bank stocks that ensued after the shock rate cut decision.

It would be no small surprise therefore to hear that Kuroda was similarly angry at a leak before the April BOJ meeting in a newswire that the central bank was considering extending credit — possibly under its standing “Stimulating Bank Lending Facility” — at negative rates to Japanese banks in order to alleviate pressure from a potential further reduction in the deposit rate into negative territory and to stimulate bank lending into the economy.

Such a facility was not adopted or discussed at the subsequent meeting, at which the BOJ chose to remain on hold.

But we believe it will come under consideration again, and is likely to be resuscitated from the trash heap at one of the next BOJ meetings assuming, as we do, the central bank decides to go ahead and cut rates further below the 0.1% negative deposit rate.

Indeed, it should come as no surprise that the Bank of Japan maintains a dialogue with the European Central Bank as with other major central banks, in the former case to share notes especially on the ECB experience with negative rates, including in its recent roll out of the TLTRO-2 program designed to extend funding to banks that meet certain lending criteria at negative rates.

All of the Above Policy Mix

More broadly speaking, if and when the BOJ were to decide to move, it is our sense it will look to put together a package that will be as effective as possible, and shy away from piecemeal actions.

We believe that will include a step up in asset purchases under the QQE program, as well as a further reduction in rates.

BOJ officials believe the bond and asset purchases to date have indeed been effective in pushing real rates lower, estimating the QQE program to have helped push real yields in the 10 year sector down by 35-40 basis points already. And they maintain they can still do more.

Markets and analysts have raised concerns over the extent of the BOJ’s purchases and ownership of the Japanese Government Bond markets – the BOJ is currently purchasing almost the entirety of new JGB issuance by the government.

But BOJ officials note that behind the primary market there is a vast stock of JGBs being held in the secondary market including by pension funds and insurers that the BOJ can buy.

Of course these institutions may not want to part with these, having faced a tough job of Asset/Liability Management in such a low rate environment already. But if the BOJ were indeed to be successful in driving inflation higher, perhaps some sales at the current nosebleed prices may even prove fortuitous for the Japanese financial sector in the long run.

And as if to underscore that point, the BOJ is said to be quietly preparing contingency planning if it were to be forced to take capital losses at some point in the not too distant future on its books.

Vouchers from Heaven

Having said all that, there is no question the focus in the halls of Nagata-cho has shifted from monetary policy to additional stimulus that may be required on the fiscal side as well now to offset increasing signs of lackluster consumption and weak economic sentiment.

The first step on the fiscal side is to delay the second installment of the consumption tax hike, from 8 to 10%, beyond its scheduled Fiscal Year 2017 start date. As widely expected, Abe is very likely, on the heels of the just concluded G7 meeting last week, to announce a two and a half year delay to the scheduled tax hike.

While less obvious, Abe will also push ahead with a supplementary budget – in addition to the 778 billion yen just allocated in response to the Kyushu earthquakes – that we believe will be in the 5 trillion yen range.

Some prominent “reflationists” of the ruling Liberal Democratic Party such as Kozo Yamamoto have called for stimulus sending of as high as 10 trillion yen. But Abe and Finance Minister Taro Aso have pushed back on those numbers, still seeking to balance additional stimulus with their pledge to hit a primary balance budget by Fiscal Year 2020 – for what that’s worth.

So it is unlikely the administration will agree to a “shock and awe” stimulus number, but they will roll out a relatively decent stimulus package in two tranches – focusing for one on specific industry support such as in fintech, automatic drive, drones and such, and then on projects such as a magnetic high speed train from Osaka to Nagoya, public works, child care subsidies, and consumption vouchers.

The consumption vouchers, of course, are designed to ensure that stimulus hits the economy directly and does not go into savings (see SGH 4/22/16, “Japan: Monetary and Fiscal Stimulus Two-Step”). The idea was first introduced by the LDP’s coalition Komei party in FY 2014, and has been proposed again by Komei.

At the time, Komei estimated the multiplier on consumption from the vouchers would be approximately 1.2 to 3.9 times the premium spent — i.e., government expenditure — depending on locality.

The premiums spent in 2014 were 254 billion yen, which translated roughly into 630 billion yen in additional private consumption, or a 0.2% boost of the 292 trillion yen in total private consumption, assuming a roughly 2.5x midpoint multiplier.

This time around, we expect a larger premium that the government will be willing to subsidize. That increase may not translate into an increase on the upper end of our estimates above 0.5% in private consumption, but it could nevertheless be enough to make a dent in the current economy, and provide a badly needed tailwind to consumer psychology, as well as to growth.

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