The problem of how the fiscally constrained government would be able to purchase the BOJ’s ETF holdings is best addressed by decomposing it into two components: the purchase itself and what happens afterwards. The two tend to be conflated but they qualitatively differ completely from each other.

A clear-cut solution to the first problem has been proposed by Hitotsubashi University professor and former BOJ official Tomoyuki Shimoda in an article published last August¹. Shimoda’s proposal, expressly made in his capacity as a private citizen, went viral among financial market participants following its publication. His article is likely still widely remembered among those who read it.

Shimoda proposed a four-step plan to extricate the BOJ from its ETF holdings. First, the government would establish a 100% state-owned institution to serve as a repository for the ETFs. Second, the institution would purchase the BOJ’s ETF holdings at book value. Third, the institution would redeem the ETFs for their underlying cash equities and repackage the equities into index ETFs. Fourth, the repackaged ETFs would be sold to institutional investors (but not retail investors) at the index’s average intraday price on the sale date. In this installment, I focus on the first two steps, which pertain to the funding problem.

In step two, Shimoda proposes that the repository institution’s acquisition of the BOJ’s ETF holdings be funded by borrowing the requisite funds from the BOJ or exchanging newly issued subsidy JGBs for the ETFs. Subsidy JGBs are a type of bond issued in lieu of cash to, e.g., recipients of certain government benefits but, unlike regular JGBs, their issuance does not generate cash proceeds and is therefore not accretive to the fiscal deficit until their recipients redeem them.

In addition to subsidy JGBs, the MOF has previously issued JGBs as in-kind contributions to the IMF and other international institutions to which Japan belongs and to capitalize the Development Bank of Japan and Nuclear Damage Compensation and Decommissioning Facilitation Corporation. Shimoda’s proposal to issue subsidy JGBs to the repository institution to be exchanged for the BOJ’s ETF holdings is thus a workable idea. I likewise proposed using subsidy JGBs in BOJ exit discussions missing the forest for the trees (lakyara vol. 336, March 2021), but Shimoda’s plan to combine subsidy JGBs issuance with a new institution dedicated to acquiring and divesting the ETFs is more fleshed out than my proposal.

Shimoda’s other funding proposal is to borrow the ETFs’ acquisition price from the BOJ. Under such an arrangement, the repository institution’s acquisition of the BOJ’s ETF holdings would involve only the institution and BOJ. In essence, such a transaction would convert the ETF holdings into a loan receivable from the repository institution on the asset side of the BOJ’s balance sheet. Meanwhile, the repository institution would end up with the ETFs on the asset side of its balance sheet and a loan payable to the BOJ on the liability side.

Irrespective of which of the two funding methods were used, the crucial point from the government’s standpoint is that the fiscal deficit would not increase as a result. The Shimoda proposal dispels doubts about how the government would be able to fund the purchase of the BOJ’s ETF holdings despite its dire fiscal condition. The text of Shimoda’s article did not explicitly say that his proposed funding arrangements were intended to circumvent the government’s fiscal constraints (though a table in the article did). Shimoda may have omitted this point because he felt it was self-evident. Nonetheless, I believe Shimoda’s proposal has made a major contribution with its concrete solution to the funding problem that many worried was a deal killer.

In Part 3, I will discuss the remainder of the Shimoda proposal, namely how the repository institution would ultimately dispose of the ETFs purchased from the BOJ. (To be continued)

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  The article, titled Aratamete Kangaeru Nichigin ETF Kaiire no Igi to Deguchi Senryaku, appeared in the August 17 edition of Shukan Kinyu Zaisei Jijo.

• Katsutoshi Takehana

  Group Manager

  Financial Market & Digital Business Research Department