Japan’s Monetary Policy Surprise | Aranca Articles and Publications

``Japan’s Monetary Policy Surprise
December 30, 2014
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P a g e | 1
Running out of arrows in the quiver
The Japanese economy witnessed sluggish growth for more than two decades since the early 1990s when Japan’s real estate and
stock market bubble burst. A stimulus was needed to boost the economy. In December 2012, Japan’s Liberal Democratic Party won the
elections and Shinzo Abe took over as the prime minister (also served from 2006-07). Shinzo Abe’s economic policies (referred to as
‘Abenomics’) were designed to revive the economy using ‘three arrows’: fiscal consolidation, expansionary monetary policy (in
coordination with Bank of Japan) and structural reforms to improve competitiveness.
Since April 2013, the Bank of Japan (BOJ) has been engaged in quantitative and qualitative easing involving increasing monetary base
through the purchase of government bonds, ETFs, J-REITs, and other investments to achieve the CPI inflation target of 2%. The
program doubled the monetary base from JPY130.9trn to JPY262.7trn between January 2013 and October 2014. However, BOJ
surprised the markets and analysts on October 31 when it announced further expansion in its quantitative and qualitative easing
(QQE2) program from the annual pace of JPY60–70trn to JPY80trn. The expansion involves an increase in the annual purchase of
Japanese Government Bonds (JGBs) from JYP50trn to JPY80trn, ETFs from JPY1trn to JPY3trn, and J-REITs from JPY30bn to
JPY90bn. Apart from this, BOJ would increase the average maturity of JGB holdings from seven years to 7–10 years.
The expansion announcement was also accompanied with the Government Pension Investment Fund (GPIF)’s decision to diversify its
investment portfolio toward more risky assets. The GPIF, which manages total assets worth JPY130trn, would cut the share of JGB
holdings to 35% from 60% over the next five years and increase domestic equity holdings to 25% from 12%. Foreign equity allocation
would increase to 25% from 12% and bond allocation would rise to 15% from 11%.
BOJ’s Pace of QE and GPIF Asset Allocation
Source: Government Pension Investment Fund, Japan
Disinflationary trend prevails as consumer spending slows down amid falling oil prices
Japan’s core inflation (after tax hike adjustment) fell to a 13-month low of 0.9% Y-o-Y in October 2014. The additional stimulus was
announced to keep up inflation expectations; however, according to the expectations survey, one-year inflation expectation has
declined to 1.4% from 1.5% in the previous quarter, whereas that for three years and five years has been stable. BOJ started its first
round of easing in April 2013 with an aim to extend credit to businesses and industry and encourage consumption, thereby boosting
inflation. The QQE was considered to be working as a stable inflation trend was emerging within the economy. However, since the tax
hike in April 2014 which pushed the economy into recession, consumption expenditure of households has continuously been in the
negative territory; the overall household spending declined for seven months in a row to 4.0% Y-o-Y in October 2014.
Although lower oil prices should boost growth, weak domestic demand is eroding inflation, nullifying the impact of a weaker currency.
Thus, lower oil prices and weak demand are increasing the possibility of Japanese consumers’ disinflationary or worse, deflationary
sentiments to persist for longer than what the BOJ may have expected earlier.
0
10
20
30
40
50
60
70
80
90
Old New
JPY trillion
BOJ's Pace of QE
JGBs ETFs & J-REITs Others
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Old New
GPIF Asset Allocation
Others Foreign Stocks Foreign Bonds
Domestic Stocks Domestic Bonds

December 30, 2014
P a g e | 2
Japan’s Core Inflation (%)
Source: Bank of Japan, Financial Times
Japan’s Household Income And Consumption Expenditure Growth (in real terms)
Source: Statistics Bureau Japan
Banks playing hardball
Banks continue to accrue cash reserves instead of lending as the outstanding balance of current deposits at BOJ by all financial
institutions also increased by JPY104.1trn during the same period. Bank lending (excluding lending by local shinkin credit banks which
are cooperative regional financial institutions providing services to small and medium enterprises and local residents) rose an
unexpected 2.8% Y-o-Y in November, the fastest pace since May 2009. Japan’s monetary base, which has already expanded by
JPY60trn in 2013, is likely to expand further by JPY70trn in 2014 on account of the QQE program. Therefore, boosting the base by
JPY80trn represents a small increase of JPY10trn. BOJ increased its holding of government securities by JPY117.4trn since the launch
of its QQE program in April 2013 until November 2014.
-0.3
-0.5
0.0
0.4 0.4
0.7 0.8 0.7
0.9
1.2 1.3 1.3 1.3 1.3
1.5 1.4 1.3 1.3
1.1 1.0 0.9
3.2
3.4 3.3 3.3
3.1 3.0 2.9
-1
0
1
2
3
4
Feb-13 Apr-13 Jun-13 Aug-13 Oct-13 Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 Oct-14
Core inflation (tax impact adjusted) Core inflation
-10
-5
0
5
10
Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Aug-13 Oct-13 Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 Oct-14
Income (% Y-o-Y) Consumption expenditure (% Y-o-Y)

December 30, 2014
P a g e | 3
BOJ Current Deposits (JPY Trn) and Incremental Bank Lending (JPY Trn, %Y-o-Y)
Source: Bank of Japan
Pace of Quantitative Easing and BOJ Assets: Govt. Securities (JPY Trn)
Source: Bank of Japan
Rising corporate cash stockpile takes the sheen of earnings growth
A major effect of the stimulus was seen on the yen, which has depreciated about 27% since April 2013, when the stimulus began.
However, the continuing trade deficit shows that the depreciation has had a limited impact on exports. A weaker yen makes Japanese
goods more competitive in the international market. With weak domestic consumption, which was hurt further by the consumption tax
levied earlier this year, exports were expected to drive economic growth. Although exports have grown, the volume has been lower than
expected. Additionally, although the total value of exports increased 7% Y-o-Y to JPY6.4trn in November 2014, the volume declined
1.6% Y-o-Y.
The depreciation of the yen in the last two years has failed to lift export volumes, possibly due to structural factors such as a high rate of
overseas manufacturing by Japanese companies and the continued shifting of their manufacturing activities to emerging economies.
Although Japanese companies recorded the highest profits in September, mainly as a weaker yen increased the value of earnings,
firms continue to hoard cash, increasing cash and deposits by 4.2% Y-o-Y to JPY233trn at the end of September.
0
20
40
60
80
100
120
140
160
180
Jan-09 Feb-10 Apr-11 Jun-12 Aug-13 Oct-14
BOJ: Current Deposits
0%
100%
200%
300%
400%
500%
600%
0
2
4
6
8
10
12
14
Apr-13 Oct-13 Apr-14 Oct-14
Incremental Bank Lending
Incremental lending % Y-o-Y Growth (RHS)
0
50
100
150
200
250
300
2009 2010 2011 2012 2013 2014
Pace of QE
0
50
100
150
200
250
300
2009 2010 2011 2012 2013 2014
BOJ Assets: Govt. Securities

December 30, 2014
P a g e | 4
Cash and Deposits (JPY Trn) and Corporate Earnings (JPY)
Source: Bloomberg, Bank of Japan
Exports Growth % Y-o-Y (in Quantity and Value Terms)
Source: Trade Statistics of Japan
Expansion of monetary base to have a limited impact on yen
While an increasing gap between the monetary base of Japan and the US indicates towards depreciation of the yen versus the dollar;
however, for the monetary base expansion to have a further impact on the currency, an interest rate decline is required. But bond yields
across the curve are already extremely low in Japan, which could limit the impact of easing. The spreads between the long-term US
Treasury and Japanese Government Bond (JGB) yields have mostly remained unchanged since the BOJ’s easing. Therefore, going
forward, any widening in the spread is expected to be driven by an increase in the US Treasury yields than by a decline in the JGB
yields.
0
50
100
150
200
250
Q1
2009
Q4
2009
Q3
2010
Q2
2011
Q1
2012
Q4
2012
Q3
2013
Q2
2014
Cash and Deposits
Private Non-Financial Insitutions
-300
-200
-100
0
100
200
300
Q1
2009
Q4
2009
Q3
2010
Q2
2011
Q1
2012
Q4
2012
Q3
2013
Q2
2014
Corporate Earnings
Nikkei 225 Earnings (EPS)
-20.0%
-10.0%
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
Jan-10 Jul-10 Jan-11 Aug-11 Feb-12 Sep-12 Mar-13 Sep-13 Apr-14 Oct-14
Quantity terms Value terms

December 30, 2014
P a g e | 5
USD/JPY Exchange Rate and US Treasury & JGB Yields
Source: Bloomberg
Abenomics 2.0 and beyond: Time to push through his ‘third arrow’
Huge victory in Japan’s December elections for PM Shinzo Abe and a weaker yen offer Abe more room to go for fiscal expansion in the
near term, which could boost GDP growth, thereby reducing the probability of more QQE. However, the true test of Abenomics would
be his ability to fire the “third arrow” which is bold economic and social reforms.
Based on the experience in 2013, impact of additional easing is likely to be short-lived as a weaker yen and rising equity markets can
boost export revenues and consumer sentiment in the short term. But structural headwinds along with fiscal constraints continue to
weigh on the Japanese economy. Real GDP growth continued to decline from 6% Q-o-Q in Q1 2013 to contract 1.5% Q-o-Q in Q4
2013.
Abenomics 1.0 made some notable headway in temporally fighting deflationary pressures in 2013 as inflation in Japan rose to 0.4%
from 0.0% in 2012. Increased government spending, with a focus on infrastructure development and social services, improved
economic activity during 2013. However, no key structural reforms were implemented to increase productivity and competitiveness
amid declining workforce and translate the monetary and fiscal stimulus to achieve sustainable growth trajectory. The slowdown in the
economy as a consequence of the tax hike in April further indicates the need for bold reforms to improve productivity, enhance
workforce, and open up of some of the domestic sectors such as agriculture for greater competition in order to realize long-term gains
from the fiscal and monetary stimulus; otherwise, the results of these measure are likely to be short-lived, as witnessed in the recent
times.
70
80
90
100
110
120
130
Jan-09 Mar-10 Apr-11 Jun-12 Aug-13 Oct-14
USD/JPY
0%
1%
2%
3%
4%
Jan-09 Mar-10 Apr-11 Jun-12 Aug-13 Oct-14
Yields
10-year JGB Yield US Treasury 10-year

December 30, 2014
P a g e | 6
Research Note by: Vaibhav Tandon, Research Analyst
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