BOJ to Hatoyama: rein in debt

Shirakawa warns against using monetary policy to support the government's finances

by Mayumi Otsuma and Keiko Ujikane

Bloomberg

Bank of Japan Gov. Masaaki Shirakawa escalated pressure on Prime Minister Yukio Hatoyama to contain the world’s largest debt with a warning that investor “trust” won’t be assured in the aftermath of Greece’s budget woes.

“It’s important to gain the trust of financial markets by showing a path for fiscal consolidation,” Shirakawa said in Tokyo on Thursday. He spoke after the BOJ Policy Board kept interest rates, the level of its government-bond purchases, and bank-lending programs unchanged.

Shirakawa’s remarks reflect his concern that increasing the BOJ’s debt purchases risks giving investors the impression that it is willing to fund fiscal expansion.

They also highlight rising tension with political leaders after Finance Minister Naoto Kan this week stepped up heat on the BOJ to fight deflation by saying Japan needs an inflation target.

“Shirakawa wants to give a fresh reminder that Japan will lose trust from the market if the nation uses monetary policy to support the government’s finances,” said Norio Miyagawa, a senior economist at Shinko Research Institute in Tokyo. “Basically, it’s impossible to escape from deflation with monetary policy alone.”

Credit-default swaps tied to Japanese government bonds show an increase in risk. The cost of protecting the debt from default for five years has doubled to 78.8 basis points since the Hatoyama administration started Sept. 16, according to prices from CMA DataVision in New York.

The yield on Japan’s 10-year bond rose one basis point to 1.325 percent, advancing from a three-week low. Kan responded to Shirakawa’s remarks by saying the government will do its part to mend its finances.

“The Bank of Japan and government are basically pointing in the same direction,” Kan told reporters in Tokyo on Friday. “The government will do its part with fiscal and tax policy, while the central bank will use monetary tools.”

As part of its efforts to sustain an economic recovery, the BOJ unveiled a program of lending ¥10 trillion to commercial banks in December. It’s also buying ¥1.8 trillion in government bonds each month, and has kept the benchmark interest rate at 0.1 percent since December 2008.

“Monetary policy isn’t aimed at fiscal funding,” Shirakawa said. “It’s aimed at achieving sustainable growth under stable prices. It’s important that governments respect this stance and markets have faith in it.”

Concerns about the state of public finances in European nations including Greece have roiled global financial markets and weakened the euro.

“Increasingly, attention is being paid to fiscal developments of each country and their impact on markets, as we can see in the case of Greece,” Shirakawa said.

Policy Board member Seiji Nakamura warned this month that the government can’t ignore Greece’s fiscal woes, saying in a speech that the country’s concerns aren’t just a “burning house on the other side of the river.”

Hatoyama’s administration has yet to detail plans to repair its finances since Standard & Poor’s warned last month that it may cut the nation’s AA rating. Kan aims to develop a fiscal strategy by June, and this week he said the government will consider hiking the consumption tax.

Hatoyama later repeated his stance that the government won’t raise the sales tax for at least four years. His Democratic Party of Japan is trying to sustain the recovery as it faces an Upper House election in July.

Economic growth accelerated to a 4.6 percent annual pace in the fourth quarter, led by a trade revival that prompted exporters, from Panasonic Corp. to Nissan Motor Co., to raise their profit forecasts. At the same time, the GDP figures showed deepening price declines that threaten to stunt the rebound.

Kan has been pushing the BOJ to battle deflation as his ability to bolster the recovery is constrained by a public debt that’s approaching twice the size of the economy. Shirakawa says the bank can’t spur prices on its own because adding cash to the economy isn’t enough to drive spending.

Responding to Kan’s suggestion this week of a 1 percent inflation target, Shirakawa said the BOJ has already examined the relative merits of targeting and concluded its current policy framework is the “most appropriate.”

Policy Board members said in December their “understanding” of price stability is increases of up to 2 percent, with a median of 1 percent.

Consumer prices excluding fresh food fell 1.3 percent in December from a year earlier. This week’s GDP report showed the GDP deflator, a broader gauge of prices, tumbled 3 percent in the fourth quarter, the most since records began in 1955.

Shirakawa said putting too much focus on price movements may lead policymakers to overlook distortions accumulating in the economy. Targeting a certain level of prices over the short term may hamper the goal of achieving sustainable economic growth, the governor said.

The BOJ reiterated Thursday that overcoming deflation is a “critical challenge” and it will “aim to maintain the extremely accommodative financial environment.”

“The governor’s comments showed that the BOJ is trying to quietly but adamantly resist” government pressure, said Kyohei Morita, chief economist at Barclays Capital in Tokyo.