Japan’s Monetary Easing ‘Buys Time but no Panacea’, says Fitch

The Bank of Japan’s (BoJ)
expansion of monetary easing
, announced on 4 April can buy Japan additional time to resolve its long-term structural economic and fiscal challenges by reducing pressure on the public finances and potentially boosting economic output in the short to medium term, according to Fitch Ratings.

However, the credit ratings agency (CRA) says that without efforts to address these deeper issues, the benefits will probably prove temporary. Last week’s announcement of “a new phase of monetary easing both in terms of quantity and quality” has already pushed down both the yen and Japanese government bond yields. This shows how the BoJ’s ability to issue one of the world’s reserve currencies remains a powerful asset, helping to keep sovereign debt servicing costs low and potentially boosting Japanese exports through a weaker currency.

Experience in other major advanced economies shows that quantitative easing (QE) is not in itself an economic panacea, adds Fitch. QE cannot be extended indefinitely. However, in the short-to- medium-term, it can buy time to tackle other issues by holding down the government’s debt servicing costs and by giving a broader fillip to activity.

Therefore, developing and implementing a credible fiscal strategy over the medium term, and enacting structural reforms to raise the real economic growth rate remain central issues for Japan and its sovereign credit rating.

Having announced a ¥10 trillion stimulus in January, prime minister, Shinzo Abe, has indicated that he will outline his government’s medium-term fiscal policy in June. Fitch says that will assess this in due course as part of its review of the new government’s fiscal and economic strategy as a whole.

The credit rating agency’s (CRA) downgrade of Japan to A+ last May 2012 and the negative outlook on the rating, already reflect the risk posed by high and rising general government debt ratios. Fitch said at the time that a lack of new fiscal policy measures aimed at stabilising public finances amid further rises in general government debt ratios could lead to a downgrade.

The BoJ will increase purchases of government bonds to ¥7. 5trillion per month out to 2014 and extend purchases to longer-dated government bonds and other assets. The purchases will double the monetary base in two years as the BoJ aims to hit the 2% inflation target agreed with Abe.

By extending its government bond purchases out along the yield curve and including other assets such as exchange traded funds (ETFs), the BoJ may be more effective in boosting the supply of credit to the domestic economy than it has achieved so far. However, given the persistent weaknesses in the Japanese economy after a protracted period of deflation, Fitch doubts that inflation will be close to or exceed 2% for a sustained period over the next two years.

The CRA expects an important channel for Japan’s quantitative easing will be through depreciating the exchange rate to boost export competitiveness. While global partners have tolerated a weaker yen so far, if that changed, Japan could come under pressure to moderate its policy stance.

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