Capital is likely to flow out of Japan into foreign markets if Prime Minister Shinzo Abe’s economic reforms succeed, according to IMF deputy managing director Naoyuki Shinohara.
However Shinohara, himself a former Japanese minister, said there were still key elements of “Abenomics” that were missing.
Markets have watched in vain for signs that the Bank of Japan’s massive monetary easing announced in April is producing capital outflows that could help compensate for planned tapering by the US Federal Reserve of its quantitative easing policies.
In an interview with Emerging Markets, Shinohara said that “if Abenomics succeeds, there would be an outflow of capital from Japan but Abenomics itself is still in the initial stages.
“If it succeeds, it will mean that all three [policy] arrows are in place and the Japanese economy will come back with sustainable growth and stable inflation. In that process probably the exchange rate should appreciate a little and capital outflows have to occur.”
Asked how long the process is likely to take, Shinohara said: “We are still waiting for the third arrow — revitalization of the Japanese economy. There are already ideas expressed by the prime minister broadly but we are still waiting for specific measures.”
Japan’s aim is to change the portfolio of Japanese savings from safe, low interest rates assets to more risky assets and diversify the portfolio to foreign currencies, Shinohara noted. “In that process a certain degree of capital outflows should be expected.”
The Bank of Japan is buying large amounts of Japanese Government Bonds – expanding the central bank’s balance sheet – but the funds that banks receive from selling JGBs to the Bank of Japan are redeposited with the central bank.
“So it seems that nothing is changing but what should change is that the money goes out to other areas [of the economy],” said Shinohara. Some of this will find its way into domestic investment but some should also find its way into overseas investment. “That is the process that is necessary in order for Abenomics to work.
“What we need are signature initiatives in such areas as agriculture, services, social security and the labour market. We need a little clearer picture to show the commitment of the government to move forward on the necessary structural reforms.”
If capital outflows from Japan do occur, it is preferable that they should be gradual, said Shinohara, because that would signal orderly portfolio diversification by Japanese investors. “If the outflow becomes rapid [that] will mean a flight from the Japanese yen.”
Rapid outflow could occur if inflation expectations in Japan do not rise as expected and additional monetary and fiscal stimulus is applied in order to raise inflation expectations.
Markets could see this as a sign that the Bank of Japan is financing the government’s budget deficit. “That could lead to a loss of confidence in Japanese finances,” Shinohora added.