BOJ left behind by normalization moves at other central banks

The Bank of Japan, as expected, decided to forego any changes to monetary policy at the December 16-17 Policy Board meeting. Amid numerous policy rate hikes and moves to normalize policy by key Western central banks, the Board opted to leave policy on hold in view of Japan’s largely stable prices and an inflation rate that remains far below the target level.

There were, however, some indications of a shift toward normalization, including a decision to partially wind down the BOJ’s special COVID-19 funding program. This was probably intended to reduce the risk that perceived delays in normalizing policy relative to other central banks would lead to a weaker yen, raise import prices, and weigh on corporate and household activity, and also to fend off criticism of the Bank itself. 

Bank ends special pandemic measures for large corporations

The BOJ has been implementing the Special Program to Support Financing in Response to the Novel Coronavirus, which has two components: (1) a measure that allows increased central bank purchases of commercial paper and corporate bonds and (2) operations to supply funds to banks. The program is set to expire at the end of next March, but the Policy Board decided to extend it until end-September 2022.

In view of the healthy market for issuance of commercial paper and corporate bonds, the Bank opted to end its special support for large corporations. Specifically, it will discontinue the higher JPY20 trillion cap on these assets at the end of March and will gradually reduce its holdings to the pre-pandemic level of JPY2 trillion for commercial paper and JPY3 trillion for corporate bonds. It will also stop providing funds against collateral of private-sector debt, which has consisted mostly of the debt of large corporations and residential mortgages, in March 2022.

As small and medium-sized enterprises continue to face some difficulties obtaining financing, the Bank decided to extend its COVID-19 funding operations for small and medium-sized enterprises by six months, until September 2022. However, “government-supported loans,” which are pandemic-related loans carrying government credit guarantees, are treated differently from “non-government-supported loans,” on which credit risk is borne by the lenders. The former type previously received an incentive in the form of 0.1% bonus interest and an increase in the lender’s macro add-on balance by twice the loan amount. These loans will now be classified as Category III under the Interest Scheme to Promote Lending, which means they will receive no bonus interest, and the lender’s macro add-on balance at the central bank will be augmented only by the amount of the loan. Participation in these operations is therefore expected to decline starting next April.

Non-government-supported loans will remain eligible for the powerful incentives of 0.2% bonus interest (Category I under the Interest Scheme to Promote Lending) and the double addition to banks’ macro add-on balances.

The government already plans to stop accepting applications for new interest-free unsecured loans, so it comes as no surprise that the BOJ is also winding down its operations for government-supported loans, which were launched with the aim of supporting this facility. Meanwhile, the central bank will continue providing substantial incentives for pandemic-related lending when credit risk is borne by the lenders themselves.

Decision highlights rigidity of Japanese monetary policy

With this review of the special COVID-19 funding program, the BOJ has demonstrated its intention to normalize some of the emergency policies adopted in response to the pandemic. However, this clearly pales in comparison to the normalization measures unveiled by Western central banks this week.

The BOJ would probably argue that its policy response should be different given Japan’s vastly different economic and price environment. While that is true enough, the decision has clearly exposed a key problem with Japanese monetary policy—namely, that an insistence on achieving a price target that is too high for Japan (2%) has tied policymakers’ hands and left monetary policy rigid and inflexible.

If Japan’s different approach to monetary policy prompts further weakness in the yen, fears that the resulting rise in import prices will squeeze corporate earnings and lower households’ standard of living could escalate criticism of BOJ policies. It might also lead to speculation of a normalization of those policies.

However, the BOJ is unlikely to undertake full-fledged normalization efforts anytime soon. Instead, we think the Bank may tacitly acknowledge expectations that policy will be returned to normal after Governor Kuroda retires in April 2023 and use that as part of a strategy aimed at keeping yen weakness in check.

• Takahide Kiuchi
  

  Executive Economist