Japan and Interest rates.

It was the "gharm mroe pardesia" moment when the Bank of Japan finally increased their interest rates, increasing borrowing costs for fellow Japanese businesses and citizens, and not being the odd man out. The Bank of Japan started its negative interest rate policy in 2016 to prevent a stronger yen from damaging the export-oriented economy and to fight deflation. A stronger currency is not good from the perspective of exports because it increases the import cost, leading to a fall in demand. Depreciating currency is lucrative for a growing economy to boost its exports. Deflation is a situation when the prices of goods are decreasing. It is the opposite of inflation. Deflation is a favorable scenario for consumers because they are able to buy more goods with the same amount of money. It is not a win-win situation, though. I know there's a lot of financial jargon in the beginning itself, but bear with me. By the end of this blog, you will be able to initiate a small talk about Japan's situation and sound smart too. So, let's dive into Japan and their love story of negative interest rates. 

As a prerequisite, you need to get familiar with inflation, deflation, and the way they are combated using monetary policy. As mentioned earlier, inflation is a steady rise in the prices of goods and services. The most prominent way to treat inflation is by increasing interest rates. Imagine this: you are driving from Pune to Mumbai at 100 km/h. Once you cross Thane, you take a quick break to freshen up and to let your vehicle cool a bit. This break is nothing but monetary policy. When inflation is rising, the central bank increases its lending rates, making it more expensive for banks to borrow, subsequently transferring that high cost to retail borrowers. When interest rates are increased, aggregate demand decreases, resulting in a decrease in price. On the contrary, when the economy is facing subdued demand, the central bank lowers the interest rate, making it cheaper for banks and retailers to borrow money and buy the things that you have been lusting for a long. 

What was happening in Japan was beyond traditional economics. The central banks usually decrease the interest by 2-3% which gives a sufficient boost to the economy. Obviously, a 2% reduction in borrowing cost for a corporation like Samsung or Toyota can save tens of thousands of crores in interest cost, which can be further utilized for either capex or dividends. It all started after the crash of 2008. I have already covered the crash in a previous blog. You can read about it by clicking on this link. 

https://economicsunbiased.blogspot.com/2023/04/seth-klarman-forgotten-lessons-of-2008.html

After the Lehman Brothers collapsed, taking America with them, the central banks across the world started cutting interest rates in anticipation of a decrease in demand. The US FED kept its policy rates in the 0%–0.25% range from late 2008 until the end of 2015, while other central banks decided to cut interest rates below 0% because of concerns that deflation could push their economies into recession. Japanese stock prices reached a recent peak in the summer of 2007 and, with the outbreak of the US subprime loan crisis, began a gradual but substantial decline through the fall of 2008. The decline in stock prices placed a strain on the balance sheet and capital adequacy ratios of commercial banks and, as a result, limited their willingness to lend by the summer of 2008. The Lehman crash further aggravated the strain on Japanese commercial banks. Bank of Japan data indicate that new loans for equipment funds declined 10%. This, coupled with the lagged impact of the negative terms of trade shock (rise in oil prices and other commodities), may to some extent explain the sluggishness of industrial activity in some sectors starting in the summer of 2008. 

Production of electronic parts and devices as well as transportation equipment was intact, but overall manufacturing activity had taken a hit. The downward movement of industrial production closely followed the downward movement of exports. Japanese exports fell by 40%, subsequently falling as low as 50%. The situation was pretty complicated. Interest rates had decreased, the private players were doubtful about production, the commodity prices had crashed, consumers were spending on things that were necessities, and the major economies were collapsing like the house of cards. To spice things up, Japan had already gone through the "lost decade." Japan's economy rose meteorically in the decades following World War II, peaking in the 1980s with the largest per-capita GNP in the world. Japan's export-led growth during this period attracted capital and helped drive a trade surplus with the US. 

During the 1990s, Japan's GDP averaged 1.3%, significantly lower as compared to other G-7 countries. Household savings increased. But this increase did not translate into demand, resulting in deflation for the economy. In the following decade, Japan's GDP growth averaged only 0.5% per year, as sustained slow growth carried over right up until the global financial crisis. As a result, many refer to the period between 1991 and 2010 as the lost decade, or the lost 20 years. These events had collectively hammered the Japanese demand. As a response, the Japanese central bank lowered their interest rates, falling below the 0% mark. Under negative interest rates, the lender pays borrower for holding debt. This means that someone gets paid interest for holding a loan, such as a mortgage or a personal loan. As such, banks lose out while borrower's benefit. Savers, on the other hand, lose out. That's because it costs them money to store their cash at the bank. This means that they don't earn any interest on their deposits. Instead, they pay their bank interest to hold their savings. 

This 17-year journey of holding negative interest rates finally came to an end on March 20, when the Bank of Japan increased its interest rates. This decision to finally hike rates hinged on the country's major corporations increasing wages for their workers to help them cope with the rising cost of living. Earlier this month, Japan's biggest companies agreed to raise salaries by 5.28%, the biggest wage hike in more than three decades. Wages in the country have flatlined since the late 1990s as consumer prices rose very slowly or even fell. Inflation came in as a blessing for Japan. 

In February, Japan's main stock index, the Nikkei 225, hit an all-time closing high, surpassing the previous record set 34 years ago. On the contrary, the Nifty is on steroids, reaching a new high every month. This month, Japan avoided falling into a technical recession after its official economic growth figures were revised. The revised data showed GDP was 0.4% higher in the last three months of 2023 compared to a year earlier. I personally believe that Japan has reached a level where it would be hard for them to consistently show rising GDP growth rates. It will be a mixed economy, with some aftereffects of deflation, hopefully inflation, a pinch of loose monetary policy, and some stagnancy. What's bad for them is good for us. It will be easier for India to become the third-largest economy. 2030, here we come.