While Bank of Japan Gov. Haruhiko Kuroda has underscored how much work still lies ahead, when the central bank does finally hit its inflation target and exits stimulus, it is likely to face huge balance sheet losses.
Kuroda has brushed off the need to discuss the details of what happens when his unprecedented asset-purchase program comes to an end, but economists are already debating the matter.
Adding to the uncertainty, there is no provision in the central bank law for the government to inject funds to repair its finances, if it should come to that, as some suggest. Less dire scenarios see the BOJ running down its reserves and capital, and largely operating as normal while taking years to pull its balance sheet back into the black.
According to new estimates by former central bank official Hiroshi Fujiki, the BOJ may have a paper loss of ¥9.7 trillion in fiscal 2021 as it starts to exit quantitative easing, and the red ink will continue to run until 2039.
The BOJ is already sustaining losses on the value of the assets it holds, with a ¥200 billion hit in the six months through September. This came after exchange-rate movements reduced the value of foreign assets, it wrote down the worth of bond holdings and set aside more money to cover potential future losses on the government debt it’s purchased.
Fujiki, who now teaches at Chuo University, is focused less on the value of assets and more on the BOJ’s annual income and expenses. He’s concerned that the central bank will have to steadily increase the interest it pays commercial lenders on the funds they park at the BOJ, which currently total ¥328 trillion. This implies the central bank would need to fork out more than ¥3 trillion on a sum this size once interest rates reach 1 percent.
Former Federal Reserve chair Ben Bernanke is among those who view the balance sheet as of secondary importance. He said in 2003 that “the Bank of Japan is not a private commercial bank. It cannot go bankrupt in the sense that a private firm can.”
Nobel laureate Christopher Sims is in agreement. He said in a recent interview that “it’s very hard to devise a scenario in which the capital losses from increases in interest rates actually create a problem so bad that it requires a capital injection.”
The BOJ and other central banks around world, which have run up enormous balance sheets since the global financial crisis, hold an ace in their hands: seigniorage. Put simply, they have a monopoly on minting money, and the difference between the value of money and what it costs them to produce it brings an almost certain profit.
All this isn’t enough to quell the debate in Japan. If the Ministry of Finance did get called on to come to the rescue of the BOJ one day, it would mean expanding a government debt load that’s already the heaviest of any major economy, at 250 percent the size of gross domestic product.
Takahide Kiuchi, a BOJ board member who has consistently dissented against Kuroda’s stimulus program, estimated in 2015 that the BOJ could at some point face a ¥7 trillion loss in a single year. Kiuchi calculated about ¥1 trillion in income versus ¥8 trillion in interest that the BOJ would have to pay financial institutions for the assets they park at the central bank.
Keio University’s Mitsuhiro Fukao estimates that if the BOJ was to exit after 2018 and raise rates to 2 percent, it would suffer cumulative losses over decades of ¥84 trillion.
Fukao, who is also a former BOJ official, calculates that if the BOJ is able to keep its losses to ¥30 trillion to ¥40 trillion, and could stop paying any money back to the national treasury, it might be able to repair its balance sheet with seigniorage over several decades.
Kuroda, at a news conference after the policy decision on Thursday, said the BOJ’s goal is the stability of prices and the financial system, not generating profits. The central bank could face smaller profits at the exit from its current stimulus program, he said, while adding that he couldn’t envisage any need for an injection of funds from the Ministry of Finance.