Japan's Low-Rate Policy May Be Coming to an End

Japan has maintained its interest rates below zero since 2016, even as other major central banks have increased their own. This has been the case throughout the entirety of this year.

Japan is currently facing a difficult situation. Inflation is increasing, the yen is decreasing, and some economists and business leaders are pointing to the negative rate policy as the cause of weakened competitiveness and excessive government spending. This has caused the Bank of Japan to consider raising rates.

For the past thirty years, Tokyo has been attempting to bolster its stagnant economy and combat deflation through extensive deficit spending. This has caused the government debt to reach the highest level among major economies. If interest rates were to increase, the cost of servicing the debt would also rise, potentially leading to a vicious cycle of more borrowing at higher rates, which could cause market instability, according to some economists.

The gap between Japanese and foreign interest rates has caused the yen to drop by 20% this year, reaching levels not seen since the late 1990s. This has increased the cost of imports and decreased the value of Japanese wages compared to foreign wages, leading to unexpected results.

Travel companies are encouraging Japanese youth to take advantage of the "Working Holiday" visa program in Australia, where the minimum wage is double what it is in Japan. This is especially beneficial due to the recent decline in the value of the yen, which has made it difficult for farms and factories to keep workers from Southeast Asia, who were already earning low salaries in Japan.

Apple Inc. experienced a decrease in net sales in Japan, the only major market where this occurred in the year ending September. Analysts believe this is partially due to the devaluation of the yen, which has made iPhones more costly.

Adam Posen, president of the Peterson Institute for International Economics in Washington, believes that if the currency continues to remain down by 30%, and if talented workers choose to leave the country, the Bank of Japan will have to permit higher interest rates in order to keep the government functioning. He further stated that Japan does not need to be growing faster than the rest of the world, but it should not be rapidly shrinking either.

Hiromichi Shirakawa, chief Japan economist for Credit Suisse, believes that the yen's current lack of strength is due to a combination of the interest-rate differential and the structural decline of Japan's economy, particularly the decreased competitiveness of Japanese manufacturers.

The Bank of Japan has not yet yielded to any demands to alter its current policy; it is anticipated that the minus 0.1% target for short-term rates will remain unchanged at its upcoming meeting.

In October, Japan's consumer price inflation rate excluding fresh-food prices reached a 40-year peak of 3.6%. When food and energy prices were excluded, the underlying inflation rate was 1.5%. The Bank of Japan has long been aiming for an inflation target of 2%, and wage growth has only recently increased to 2% from 1%.

Haruhiko Kuroda, Governor of the Bank of Japan, expressed his concern about the potential for a negative cycle of wage and price increases in the U.S. and Europe during a news conference on November 14th. He noted that the situation in Japan is quite different.

It is anticipated that Mr. Kuroda will resign from his position by April after a decade of service. Economists are split on whether the Bank of Japan will implement a tighter policy after his departure. Many anticipate a moderate rate hike in either the second or third quarter, citing the rising cost of imports and the new leadership as the cause of inflation.

Gene Park, a political scientist from Loyola Marymount University who has researched Japanese economic policy, believes that the bank is unlikely to make a drastic change due to worries about the effect of higher rates on homeowners, most of whom have adjustable-rate mortgages, as well as on small businesses.

The potential danger of higher interest rates is not only to the public, but to the government as well. In 2013, when Mr. Kuroda became governor, the bank began to buy a large amount of government bonds and other riskier assets, which was referred to as "Kuroda's bazooka."

In 2016, the central bank of the country declared its first ever negative interest-rate policy. This was followed by the implementation of yield-curve control, which is a measure to keep the 10-year government bond yield at 0% by buying the securities when the yield goes above the set range.

The government has been able to borrow large amounts of money to fund economic stimulus and the increasing costs of caring for the elderly without causing bond yields or interest rates to rise.

Japan's general government debt to gross domestic product ratio has seen a dramatic increase from around 60% in 1990 to 263% in 2021, largely due to the country's expansive fiscal spending during the pandemic. According to the International Monetary Fund, pension expenditures and healthcare and long-term care expenditures have been the main contributors to the 200-point rise in the debt ratio over the past three decades, accounting for 96 and 82 percentage points respectively.

The International Monetary Fund (IMF) reported that Japan's debt level in 2021 was the highest among advanced economies, with a ratio of 200% compared to Greece, 151% for Italy, and 128% for the United States. Despite this, Japan only pays 1.5% of its Gross Domestic Product (GDP) in interest on its debt due to its low interest rates. If these rates were to increase, the interest burden would also rise significantly.

The United Kingdom's recent economic struggles have raised questions about Japan's stability. When Prime Minister Liz Truss implemented her ill-fated fiscal policy package in October, it caused alarm about the government's financial standing, leading to a surge in government bond yields and her eventual resignation. This has left Japan's debt at 104%.

Economists have mixed opinions on the risk Japan faces due to its government debt. Cem Karacadag, head of Barings' emerging markets sovereign debt group, believes that if investors are willing to finance a country, then much higher levels of debt can be sustained. He stated, "There are countries in the world that can't sustain 10%, 20%, 30% of GDP in debt. But if people are willing to finance you, much, much higher levels of debt are sustainable."

Takeshi Niinami, CEO of Suntory Holdings Ltd., expressed his concern about the potential consequences of printing Japanese yen. He warned that the same thing that happened in the U.K. could happen in Japan. Despite this, Mr. Niinami believes that higher interest rates, when implemented at the right time, can create a healthy economy.