Japan: Monetary and Fiscal Stimulus Two-step

Published on April 22, 2016

With Japan’s inflation readings and expectations drifting lower again, consumption rates still at lackluster levels, and concerns lingering over global risks, all eyes are turning again to the Bank of Japan and Governor Haruhiko Kuroda to see what measures they may introduce at next Thursday’s Monetary Policy Meeting to support flagging economic momentum – and until recently markets – further.

*** We believe the Bank of Japan is likely to undertake a three-part easing at its April 27-28 meeting next week by expanding its annual 80 trillion yen JGB purchase program, raising its limits on purchases of equity ETFs, REITs, and corporate bonds, and expanding its purchases into local government bonds. It is less likely the BOJ will cut its negative deposit rate further from the current -0.1% level, at least at this meeting, but we suspect that option will be kept alive for a future date if needed. ***

*** We fully expect the easing by the BOJ to be followed on the fiscal side with a 5 trillion yen or more supplementary budget and a probable likely postponement of the 2017 consumption tax hike later in the year. In addition, Prime Minister Shinzo Abe’s government is also seriously considering “consumption vouchers” to be included as part of the new stimulus program which, we believe, will be announced before the start of the Japan-hosted G7 meeting on May 26-27. ***

The Debate over Negative Rates

Japanese markets rallied today in response to a trial balloon suggesting the BOJ may consider cutting the rate it charges banks through the “Stimulating Bank Lending Facility” it has had in place since December of 2012 to below zero, the current lending rate, in order to ease the burden on banks if the deposit rate were to be cut deeper.

While that is possible, and banks have certainly been clamoring for some help, we believe it may still be too early for a deeper cut by the BOJ in the deposit rate itself at this meeting.

The BOJ is still reeling from the enormous backlash from the banking sector against its initial cut in the deposit rate to -0.1%, and there is evidence banks are passing the burden, even if in reality minimal, on to clients.

Asset managers and money markets funds are shrinking, and some money market funds have stopped taking deposits altogether. And while banks appear at least to have operationally adapted by now to a new reality of negative rates, the real concern remains the threat to their profitability and, with it, their incentive to lend.

The risk is the real adjustment to come will not be on computer systems and such, but in deeper cuts through labor force restructuring and lost jobs – a disaster both politically and economically in the current environment.

Two-step Money from Heaven

Monetary policy stimulus from the Bank of Japan will almost certainly be accompanied with further fiscal stimulus from the government of Prime Minister Shinzo Abe. Despite his continued refusal to confirm any such intentions, we understand Abe is likely to announce ahead of the G7 meeting on May 26-27 a supplementary budget of at least 5 trillion yen, and probably even more.

The stimulus will be presented as a needed measure to avoid a cliff-like contraction in spending in the second half of the budget year due to the front loading of the budget into the first half. It will be timed to give a boost internationally with the G7 as well as to the ruling LDP party’s prospects in the upcoming Upper House elections in July. It does not appear, however, Abe is ready yet to call early elections for the powerful Lower House at the same time as well, despite some speculation to the contrary.

Little noticed, and perhaps most intriguing in light of all the recent chatter in academic circles over “helicopter money” and the traditional limits of monetary policy, from what we understand the Abe government is also seriously considering issuing vouchers aimed at boosting consumption especially among the younger generation.

These vouchers would take the form, for example, of 1,000 yen coupons that would be redeemable for 1,200 yen of purchases. The point of consumption vouchers instead of a tax cut or other sort of subsidy would be to ensure the government stimulus goes directly into spending, and not into savings — manna from heaven.

And finally, the hike in the consumption tax from 8 to 10% slated for April 2017 is likely to be delayed again.

Tried and True Tactic

Abe has maintained he will go through with the hike unless there is a “Lehman style” disaster or severe economic slowdown. But he is already using clearly stacked panels of outside experts to help make the case for a reversal – a tried and true tactic in Tokyo.

The cabinet will not have to make a commitment on the tax hike until the 2017 budget is put before the Diet for discussion in December, so a decision can wait until November. And there are plenty of ideas already floating around to try and offset the sting of a tax hike with targeted rebates that would avoid a more embarrassing reversal.

But were Abe to change his mind and go for a full delay, there is not a single political party that would dare oppose the postponement of the consumption tax hike.

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