Central banks across the world may be running low on ammunition, but the Bank of Japan has shown it may still have a few bullets left in its belts. BOJ Gov. Haruhiko Kuroda surprised markets again on Jan. 29 by pushing the deposit rate into negative territory. Few had expected such a dramatic step of charging financial institutions 0.1% for a portion of reserves they hold with the central bank.
After swamping financial markets with liquidity through its bond purchases, Japan's central bank changed tactics and switched its focus to interest rates. As the assets available for the BOJ to buy are becoming ever scarcer, this shift opens up the prospect of even greater easing. Interest rates, after all, can be readily cut further below zero -- the European Central Bank, for example, charges financial institutions 0.3% for their deposits. Central banks in Switzerland, Denmark and Sweden also apply negative interest rates.
Whether this will be the trick that revives growth in Japan is doubtful. The evidence from Europe is mixed at best. But Kuroda has expanded the Bank of Japan's toolbox, with further action likely as inflation remains stubbornly below target. Even though the immediate implications for the Japanese economy are likely to be limited, the rest of Asia may benefit more.
What ails Japan's economy is that its vast treasure of savings is not properly deployed. Deposits sit idle in banks, which have a large portion of their assets tied up at the BOJ. The problem is the lack of local demand, as companies hold sufficient reserves to finance capital spending for many years without needing to resort to bank funding. Now, negative interest rates will make it even harder for banks to earn a decent return. The solution: Banks have to invest more abroad, thereby deploying capital where they can still earn decent interest rates.
The BOJ's latest move, therefore, could accelerate capital outflows, providing affordable financing to neighboring economies and further afield. This, to be sure, has already happened in recent years. For instance, Japanese bank lending to member countries of the Association of Southeast Asian Nations is at a record high. Japanese investors also snapped up assets abroad, buying bonds from Australia to India. Even Japanese companies have regained some of their earlier swagger, increasing their foreign investments in places like Vietnam and Indonesia, for example, either through mergers and acquisitions or greenfield projects. More funds are now on their way.
This comes at a good time. Last year, emerging markets were rocked by fears over capital outflows as the U.S. Federal Reserve was poised to embark on its tightening cycle. While jitters persist, not least because of worries about China's slowing growth, easing elsewhere should help to partly offset the impact of a rising federal funds rate. The BOJ's surprise move thus may help ease pressure on hard-pressed emerging economies in the region.
GOOD FOR EVERYONE It is true that a large chunk of Japanese portfolio investment still finds its way into the U.S. Treasury market, thus not benefitting neighboring economies directly. But this helps, too: By keeping a lid on benchmark dollar interest rates, it relieves outflow pressures from emerging markets more generally. From this perspective, the BOJ's easing provides a lift everywhere.
In fact, Kuroda's surprise decision to cut interest rates below zero may supercharge the effect of his earlier quantitative easing. Previously, risk-averse financial institutions could content themselves with the fact that their vast reserves at the BOJ earned a tiny, though at least positive, return of up to 0.1%. Now, part of their holdings will be charged at the equivalent rate. Raising the return of other investments, therefore, has become a much more pressing matter. And overseas investments must surely count among the more attractive options.
But what about the exchange rate? Will the BOJ's latest easing weaken the yen and raise competitive pressures on other economies? Perhaps. But only at the margin. For one, Japan maintains a large, and growing, current-account surplus. Greater capital outflows thus merely help to offset the upward pressure on the currency delivered by the country's export surplus.
NO PANACEA In addition, Japan does not compete head-to-head with most of its neighbors. With the possible exception of South Korea and, to some extent, Taiwan, most major Asian economies export goods several rungs lower on the product ladder. True, a weaker yen may reduce the country's purchases from the region, but what matters far more for Asia's economies at the moment is stabilizing financial conditions.
This includes China. The BOJ's easing, and the marginal weakening of the yen after its decision, does not pose a competitive challenge to mainland China. In any event, given the region's intricate supply chains, a weaker yen may actually help to raise the competitiveness of other economies in Asia by pushing down the price of Japanese inputs, especially electronic components.
None of this is to say that the BOJ's latest move amounts to a panacea for the growth malaise in Japan and the wider region. Far from it. It merely cushions the impact of further Fed rate hikes and may marginally help to stabilize financial conditions after excessive volatility in recent quarters. Ultimately, individual economies will have to tackle their structural growth bottlenecks and wean themselves off credit as a fuel for demand. All that Kuroda has offered is a helping hand to economies and investors in dire need of some positive news.
Frederic Neumann is co-head of Asian economics research at HSBC.