Two cheers for the end of free money in Japan

The end of Japan’s experiment in ultralow interest rates may be less of a shock to the system than feared.

Corporations are better prepared for more expensive money than they were in the past, with strong balance sheets and a better understanding of risk, while piles of savings will start to generate significant income as rates increase.

And the government, although heavily in debt, has some time to get its fiscal house in order given the average maturities of the bonds it has sold.

Since the Bank of Japan ended its negative rate policy in March and upped rates for the first time since 2007, the yield on Japan's benchmark 10-year government bond has been rising. Last week, it climbed to the 1% level for the first time in 11 years and on Thursday rallied to a 13-year high of 1.1%.

With the BOJ looking to normalize monetary policy, market expectations suggest that the central bank will likely shift to a more hawkish stance in the coming years.

A steady and paced rise in interest rates would not inflict heavy damage on businesses overall, according to Tomohisa Ishikawa, chief economist at the Japan Research Institute, which predicts the central bank increasing rates by 25 basis points every six months for the time being.

“One thing is that Japanese firms tend to be timid about getting loans after the burst of the asset bubble,” he said, referring to Japan's so-called bubble economy, which came crashing down in the 1990s.

Data compiled by the Japan Research Institute show that a 1-percentage-point rate increase reduced corporate capital expenditure by 3.5% in the 1980s and 1990s. Between 2000 and 2019, a 1-percentage-point rise in rates resulted in a 2% fall in capital expenditure.

Another factor that will possibly soften the impact is that Japanese companies have been willing to invest in IT and software to improve efficiency in recent years.

Digitalization and incorporating new systems amid severe labor shortages is key to survive competition, so capital expenditures for such purposes will not really be swayed by an increase in borrowing costs, Ishikawa said.

He cautions that financially weak small and midsized enterprises will likely be more hesitant to make such investments, which could pose a risk to their competitiveness.

A rise in rates would lower the productivity of those companies, and a number of them may not survive competition, he said.

Households and savers in general could find some comfort in rising rates.

The Japan Research Institute expects the central bank to increase rates by 25 basis points every six months for the time being. | REUTERS

The low-rate policy has been seen as a major factor in the weakening of the yen, which has pushed up import costs and prices on a wide range of daily goods.

“Short-term interest rates are extremely low, in real terms, and that is causing some side effects, some negative impacts to the economy,” said Takahide Kiuchi, executive economist at Nomura Research Institute.

“Increases in short-term interest rates could reduce this kind of side effect and contribute to the stability of the economy in the long term,” he said.

As of last December, Japanese household financial assets stood at ¥2.141 quadrillion ($13.6 trillion) while debts totaled ¥388 trillion.

Based on a simulation by Mizuho Research & Technologies in which the central bank’s policy target rate would reach 2.75% by the end of 2026, households would on average have an additional ¥178,000 in annual financial asset income in fiscal 2026.

But those with housing loans would have an additional burden of ¥101,000 a year in the same simulation.

Economists warn that higher rates could possibly widen disparity between rich seniors and young, lower-income households. Extra income from financial assets due to higher interest rates would be higher for older households, as they tend to have more assets, Japan Research Institute's Ishikawa said.

“The impact of rising interest rates is expected to be polarized by age and wealth holding,” he said.

Since the BOJ ended its negative rate policy, calls for the Japanese government to strengthen its fiscal discipline have been growing. The country is haunted by public debt that is about twice the size of the gross domestic product.

Economists argue that interest rate increases will not dramatically elevate the government’s debt-servicing costs in the short term because the average maturity of Japanese government bonds is about nine years.

But they are calling for action.

“Improving the fiscal balance with an eye on the risk of rising interest rates is a matter that cannot wait,” Saisuke Sakai, a senior economist at Mizuho Research & Technologies, warned in a report released last month.

If interest rates keep rising, Japan’s long-term rates could top its nominal growth rates in the medium to long term. In that case, debt-servicing costs would be larger than the increase in tax revenue, so the country’s fiscal health would deteriorate further, Sakai said.

Ishikawa also said Japan should ramp up efforts to brace for possible increases in borrowing costs while there is still time.

“The country seriously needs to discuss and come up with measures for fiscal reconstruction in the next four to five years,” he said.