What is this buzz all about?

 
The Bank of Japan (BOJ) recently took the markets by surprise when they decided to introduce a policy of negative interest rates, but the impact is not certain with regards to any increase in consumption and investment. In fact, whether the policy is another sign showcasing the limited success of the monetary easing operations that the Bank of Japan has pursued over the last couple of years as an integral part of the efforts of the Abe administration to tackle the problem of deflation, is not fully clear. As of now, the bank has announced its decision to charge -0.1% interest rate on the deposits from commercial banks in their current accounts with the Bank of Japan and this is to be levied today. There are speculations that the policy may hit about $100 billion slab of savings. Japan seems to be following the suit of the European Central Bank and Swiss National Bank that have already adopted similar policies with interest rates below zero.
 

The effects and discrete views

 
The first and foremost effect is that the banks are, in turn, expected to increase their lending in preference to paying fees to the central bank. In a way, the banks are led to compensate by charging negative rates on respective deposits. Once the banks are forced to spread their capital across the economy, inflation expectations can be met to an extent. At the same time, negative interest rates can push the corporates, who have excess capital on their balance sheets, to spend more money on capital expenditure and stock buybacks. Banks could thus pass on negative interest rates to large depositors who would be unwilling to be charged to keep money in the bank. This step is also expected to weaken the yen against other currencies.
 

Japan’s Consumer Price Inflation (Source: Thomson Reuters)
 
At the macro level, what we have seen up till now is a split view coming up with some analysts criticizing and arguing that the decision does not seem to be well thought through while others believe that the Bank of Japan has exhausted its other policy options to resurrecting the economy. Another view dictates that negative interest rates would mitigate economic challenges that have been prevailing in Japan for quite some time now. Primarily, the negative interest rates could help in mitigating problems relating to the rise in consumption tax (8% from 5%), which was based on the decision of the Abe government two years ago that refrained spenders to shell out money. Negative interest rates could thus be seen with a potential to bring some stability by investment in the real economy. An effect on the real estate and equity prices is also likely to arise given the otherwise low demand for loans in Japan.So far, the announcement has led toselling of banking and financial industry stocks already. Even, the yield on Japanese government bonds (JGBs) has hit a record low.
 
This negative rate policy may also be misunderstood as limiting the asset purchases by the BOJ who have, however, clarified that the introduction supports the existing program of monetary stimulus with the use of qualitative and quantitative easing. Nonetheless, some believe that proper incentives coupled with the boost to the monetary base to GDP and banking sector may prove fruitful. It is also to be borne in mind that monetary policies may prove more effective when coupled with other requisite reforms such as foreign investment, labour policies and so forth. But, another tricky part is whether the above measure should have been saved for an emergency situation by BOJ.
 

Japan’s Quarterly GDP (Annualized) as Economic Indicator (Source: Thomson Reuters)
 
It is quite notable that Japan’s monetary base has grown since Abenomics has been put into effect in 2012. However, clouds of uncertainties are now prevailing given the current economic situations that has led Japan’s economy to contract at an annualised rate of 1.4% in the fourth quarter of 2015 (as per the latest GDP figures) while above measures have been taken by BOJ. Undoubtedly and in such a scenario, an impact from the negative interest rate would be really tricky to watch.
 

Initial jolts and the move for exemptions

 
What is learnt now is that Japan’s investment industry is taking steps to sail through the effects of the negative interest rates by means of seeking exemptions. The representatives of the investment funds have discussed the same with the governor of the Bank of Japan. This is particularly sought for the savings under the money reserve funds (MRF). Already, investments on the money-managed funds are being rejected by many Japanese asset management companies at the wake of the above policy. However, the acceptance of such an exemption is not expected to come an easy way while heavy outflows are expected from the mutual funds in the near future.
 

Our take

 
The negative interest rate policy announcement has led to a lot of financial turmoil with yields on benchmark 10-year JGBs getting affected badly. There are also speculations doing rounds about the further cut in interest rates. We also understand that the decision to adopt the negative interest rate policy has taken everyone off guard and most of Japan’s banks are not even ready to levy negative interest rates on overnight interbank lending. With this whole gamble put in place, only time would reveal the actual outcome of the policy implementation and any requirement of having supportive reforms set to safeguard interest of those affected. On the flip side, Standard and Poor’s Ratings Services mentioned that an 8% reduction in operating profits on average may be witnessed by the major banks while regional banks might suffer a 15% drop for the current fiscal year to March owing to the impact of negative interest rates.

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