Japan's latest stimulus: What it means and will it work?

Haruhiko Kuroda Mr Kuroda has unveiled a massive expansion to Japan's money supply in his first meeting a governor of the Bank of Japan

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When the economic history of Japan is written years down the road, Haruhiko Kuroda's first monetary policy meeting as the governor of the country's central bank is most likely to get a prominent mention.

In his first meeting as governor, Mr Kuroda has put the Bank of Japan on a path that many before him had not dared, or chosen, to take.

On Thursday, the Japanese central bank announced a massive expansion to the country's money supply, on a scale that has caught everyone by surprise.

But while the intent of triggering inflation and spurring economic growth is all good, like with everything else, there is a flip side attached to it.

If all goes according to plan, many may recall this meeting as the moment Japan was put back on a growth track.

However, if things unravel in the opposite way, the history books may not be that kind to Mr Kuroda.

What has the bank done?

The central bank has said that it will increase its purchase of government bonds by 50 trillion yen ($520bn; £350bn) per year.

To put that in perspective, it is the equivalent of about 10% of Japan's annual gross domestic product (GDP).

The central bank also said that it would buy relatively riskier assets such as exchange-traded funds and real-estate investment trusts.

Another key move that it made was announcing that it will now buy bonds with maturities of as much as 40 years, which some analysts say is an outright funding of the government by the bank.

Start Quote

The government will have to repay a lot more than it has to now and they are going to have a big problem doing that”

End Quote Takeshi Fujimaki Fujimake Japan

What is it trying to achieve with this?

Well, the main idea behind these bond purchases is to keep long term interest rates low.

This is to try to encourage businesses and consumers to borrow more money.

The hope is that businesses will use the extra cash to fund expansion plans and consumers will utilise the opportunity to use cheap cash to buy assets such as real estate.

The idea here being that with more money sloshing about in the system, and at a cheap rate, more people will have cash to spend and it will drive up consumer demand and eventually consumer prices.

Will this work?

The central bank and the government definitely think so.

If you look at how the markets have reacted - the Nikkei 225 index pared earlier losses to jump 2.2% - investors seem to agree with them.

However, the analysts are somewhat divided on what these moves can achieve.

Some are of the opinion that this will achieve its aims, helping to boost consumer prices, drive up domestic demand and help spur growth.

But others are sceptical - they say that given the sluggish state of the Japanese economy, as well as problems in Japan's key export markets, business and consumers are not too keen to borrow money at this stage.

They say that all this extra cash is likely to sit with the banks and not flow to the real economy.

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So there is a risk that benefits will not flow into the real economy?

The central bank would definitely want the extra money to flow into the real economy, but there is a real risk that some of it may not.

The fear is that if it becomes too cheap to borrow money over the long-term, this will boost what is popularly called the "carry-trade".

This happens when traders around the world borrow yen at very low interest rates and use it to buy currencies to invest in countries where interest rates are higher.

This does not have any impact on real economic growth in Japan.

Simon Grose-Hodge, head of investment advisory at LGT Bank in Singapore, says given the BOJ's move to keep long-term rates low, the yen is likely to become "the funding currency of choice for carry-trades and the like".

However, to be fair, it does help in another way. Such moves help to weaken the yen as traders sell the currency to buy another one.

That is good for Japan's exporters as it makes their goods cheaper to overseas buyers and boosts their profits when they repatriate their foreign earnings back home.

Are there any risks involved?

Yes, there are.

To begin with, some analysts say that the expansion of money supply is not matched with real economic growth it may do more harm than good.

They warn that such a situation may see the policymakers become too reliant on stimulus measures to help spur growth.

At the same time, there are concerns over the impact on such massive bond sales on the government's debt.

At 230% of the GDP, Japan's public debt is already the highest among industrialised nations and Mr Kuroda has previously warned that this is unsustainable.

Some analysts also point out that if the central bank's latest measures work and inflation starts to rise, then interest rates in the country may have to increase as well.

They say that such moves will see Japanese government's interest payments go up substantially, given the size of it debt.

"The government will have to repay a lot more than it has to now and they are going to have a big problem doing that," says Takeshi Fujimaki of Fujimaki Japan.

In a worst case scenario, he warns, the government may not have enough cash to make those payments and will be forced to sell additional bonds to raise money.

That Mr Fujimaki says, would be start of a vicious cycle that Japan may find tough to come out from.

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