BOJ Independence Challenged as Japan Deflation Continues

Increasing risks to Japan’s recovery prompted what may become the biggest threat yet to the Bank of Japan’s independence as politicians seek to redress its failure to end the deflation entrenched in the economy since 1998.

Your Party, an opposition group, plans to submit a bill in the Diet session running through December that would give the government a greater role in BOJ policymaking. Ichiro Ozawa, a former challenger to Prime Minister Naoto Kan whose calls for currency intervention and enlarged fiscal stimulus have been adopted by Kan, made a similar proposal last month.

The debate comes after BOJ Governor Masaaki Shirakawa refused to expand monthly purchases of government bonds this year even as deflation persisted. The bank today instead created a 5 trillion yen ($60 billion) fund to buy bonds and other assets, and pledged to keep its benchmark interest rate at “virtually zero” until the end of deflation is in sight.

“Even if the law isn’t revised, advocating the revision alone may have an effect of prodding the central bank to explore more monetary stimulus -- including more bond buying -- which may be the real intention of politicians,” said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co., which oversees the equivalent of more than $100 billion in assets.

Shirakawa’s Concern

Shirakawa, 61, has repeatedly signaled concern that purchases of government debt at some point will be viewed by investors as a central bank effort to finance deficit spending. Japan has the world’s largest public debt, approaching 200 percent of its gross domestic product.

“If government bond purchases by a central bank are regarded as a tool to pay for fiscal expenditure, or an act of debt monetization, that would spur inflation expectations and increase government bond yields,” Shirakawa said at a forum in Kobe, western Japan, on Sept. 26.

The Nikkei reported today that the BOJ may decide to buy securities backed by lending to small and midsize businesses, and it may also decide to increase purchases of long-term Japanese government bonds.

Some board members say the bank should consider exceeding its self-imposed rule that bond holdings be kept below the outstanding balance of banknotes issued, the report said, without citing anyone.

Drop in Prices

Shirakawa’s intransigence has incurred the ire of politicians pressing the bank to boost efforts to end deflation, which erodes corporate profits, makes debt harder to pay back, and enhances the yen’s lure by lifting its purchasing power. The GDP deflator, a gauge of prices across the economy, has fallen 14 percent since 1997, according to data compiled by Bloomberg.

The yen has surged 11 percent against the dollar this year, the best performer among 16 most-traded currencies. It traded at 83.64 yen per dollar at 3:38 p.m. in Tokyo, less than 1 percent from the 15-year high of 82.88 reached on Sept. 15, which prompted Kan’s government to sell the currency in a step unseen for six years.

“Japan is the only industrialized country which has had consumer price changes of minus or zero over the past decade,” Keiichiro Asao, head of policy research at Your Party, said in an Oct. 1 interview in Tokyo. “If the central bank is a guardian of stable prices, it shouldn’t allow price declines.”

A financial crisis in 1997-98 precipitated by bad loans on Japanese lenders’ balance sheets stemming from burst land and stock-price bubbles of the early 1990s set off Japan’s deflation. Property prices have slumped for 17 of the past 19 years, and stocks remain 76 percent off of their 1989 peak, according to the Nikkei 225 Stock Average.

1998 Law

The 1998 Bank of Japan Law strengthened its independence by ending the government’s authority to dismiss the BOJ governor and deputy chiefs and the right of supervising BOJ operations. It sets the bank’s mandate as “achieving price stability, thereby contributing to the sound development of the national economy,” and helping avert financial instability.

Kan, as finance minister before taking the government’s helm in June, urged the central bank to set a specific inflation target to help end deflation, calling for a target of as high as 2 percent. Economy Minister Banri Kaieda told reporters last month that it’s difficult to interpret the current BOJ law as incorporating maximum employment as a goal, signaling he may favor reexamining the legislation.

Seeking Support

Asao said his party is seeking support from members of the ruling Democratic Party of Japan and other opposition groups for its proposal. Your Party was formed last year and came third in the upper house elections in July; it lacks sufficient numbers in the lower house to introduce a bill on its own.

Shirakawa has said he hasn’t ruled out any policy options. The case for adding stimulus has grown with economic reports in the past week showing Japan’s large manufacturers growing pessimistic about the outlook, industrial production falling for a third month in August, and wage gains coming to a halt.

“The yen’s rapid increase is damaging exporters and yielding a body-blow over the long-term,” Akio Ogura, chairman of Bando Chemical Industries Ltd. in Kobe, told a Sept. 27 business forum in Osaka that Shirakawa attended. Authorities should try to stabilize the yen at around 90 per dollar, Hidetoshi Yajima, adviser of Shimadzu Corp., a machinery maker in Kyoto, said at the same forum.

Bond Ceiling

The BOJ, which had kept its benchmark interest rate at 0.1 percent since December 2008, now purchases 1.8 trillion a month of government bonds. At the current pace of buying, the bank’s self-imposed ceiling for bond holdings will be reached in 2014, according to Barclays Capital estimates.

The Federal Reserve, by contrast, has eschewed any such ceiling and indicated last month it’s prepared to add to its holdings of U.S. Treasuries. At the same time, the Fed’s balance sheet, at $2.3 trillion, is smaller than Japan’s relative to the size of the economy, at about 16 percent, according to data compiled by Bloomberg. The BOJ holds about $1.5 trillion, or about 26 percent of Japan’s GDP.

Vice Finance Minister Mitsuru Sakurai told reporters last week the BOJ could explore “various” additional measures, including an expansion of its bond purchases.

“The act of pressing the BOJ seems to represent politicians’ performance of appealing to the public that they are trying harder to beat deflation,” said Seiji Shiraishi, chief economist at HSBC Securities in Tokyo.

To contact the reporter on this story: Mayumi Otsuma in Osaka at motsuma@bloomberg.net

To contact the editor responsible for this story: Chris Anstey at canstey@bloomberg.net

Enlarge image

Masaaki Shirakawa, governor of the Bank of Japan

Tomohiro Ohsumi/Bloomberg

Masaaki Shirakawa, governor of the Bank of Japan.

Masaaki Shirakawa, governor of the Bank of Japan. Photographer: Tomohiro Ohsumi/Bloomberg

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Oct. 4 (Bloomberg) -- Susumu Kato, chief economist for Japan in Tokyo at Credit Agricole CIB and CLSA, talks about the outlook for Japan's economy and central bank monetary policy. The Bank of Japan will probably increase its 30-trillion yen ($360 billion) credit program to encourage bank lending and reduce demand for the yen at its two-day meeting ending tomorrow, 14 of 17 economists surveyed by Bloomberg News said. Kato talks with Susan Li on Bloomberg Television's "First Up." (Source: Bloomberg)

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