The samurai central bank strikes

SINGAPORE: It was not quite an act of financial harakiri, but the Bank of Japan Monetary Policy Committee's decision last week to end its zero-interest-rate policy came close.

The Japanese government virtually begged the bank not to raise rates. The International Monetary Fund weighed in with warnings that Japan's economic recovery was "under-powered and uneven", and urged the retention of the zero-rate policy.

But BoJ Governor Masaru Hayami was adamant. Flooding the money market with sufficient liquidity to keep the overnight rate near zero was perverse, he said, implying there was something shameful about the policy.

Dismissing concerns that ending the zero policy just now may threaten the recovery, he argued that the obverse was true. Signs of recovery were widespread, he insisted, so it was time the bank reversed course. He was also dismissive of concerns that a premature rate hike may accelerate deflationary pressures. "The economy has reached the stage where deflationary concern has been dispelled," he declared.

The BoJ's confidence is misplaced. Contrary to Hayami's assertions, signs of recovery are far from widespread, consumer confidence remains wobbly, and deflation is by no means dead. Retail prices have actually been falling by about 1 percent in the past few months, and the BoJ itself admits this is probably an under-estimation.

Though last week's hike was modest -- the unsecured overnight rate will now rise to just 0.25 percent -- the bias in favor of higher rates may have unintended consequences. If it led to a stronger currency, not only will exports become less competitive, imports will become cheaper as well, and cause domestic prices to fall further.

Hayami suggested that this might be countered by people spending more as a result of higher rates, but that is doubtful. People dependent on interest income may have slightly more to spend, but the more likely effect of higher rates would be to encourage Japan's famously prudent households to save more.

The suggestion that higher rates will encourage corporations to restructure was similarly tendentious. Cheap loans do tend to encourage bad loans, but rising rates will punish efficient companies just as much as they will inefficient ones.

Indeed, in Japan's case, efficient companies will probably be punished more, since it is precisely the inefficient ones which tend to have cozy relations with financial institutions. As it is, despite the zero policy, bankruptcies have been increasing at an alarming rate.

The latest figures show these rose by 21 percent year-on-year in July, with total debts of the companies concerned rising three-fold to a post-war high of 4.2 trillion yen. Significantly, politically-connected construction companies, the chief recipients of government largesse, are not among those filing for bankruptcy.

On the contrary, debt-waiver schemes are already afoot to save some troubled construction companies. The BoJ's rate hike will not stop such schemes, but it may encourage banks to pull the plug on struggling new companies.

The central bank took the decision that it did for no other reason than to prove its independence. "This is just the kind of occasion," said Hayami, "on which the bank should exercise its power." The law gives the power to BoJ to make monetary decisions, so it "felt it needed to exercise that power this time", he explained.

Given the pressure that Japanese politicians have tried to exert on the BoJ, it is understandable that it should want to signal its independence. It has chosen the wrong occasion, and the wrong time, to do so.

-- The Straits Times/Asia News Network