Expert Analysis of the Global Macro Events & News affecting the Indian Markets – 1st Nov 2023

WEEKLY SYNOPSIS

As the festive season brightens up our markets with Diwali lights and decorations, and a chill in the air hints at the coming winter (and perhaps some pollution woes if you’re residing in Delhi, like me), the festive cheer is unmistakable. Stores are all decked up for the season, and our spirits are high. Season’s greetings! But before we dive into this week’s newsletter, let’s take a moment to embrace the cherished festive traditions that make this time of the year so special. After all, it’s the season when we slip into our finest festive attire and follow customs passed down through generations. 

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Navigating “Japanification”

Let me start this week’s newsletter with a simple question. What words come to your mind when you hear “Japan?” World’s third-largest economy? 10 years ahead of the world? Technologically Advanced? I won’t deny all these. These are facts. But at the same time, Japan’s aging population, negative cost of borrowing, and deflationary pressures are also facts. 

Everyone who has been to Japan would agree that going there is like being on a time machine to the future. But today we would be keeping our discussion to what is up with Japan’s economy. A brief history of Japan’s negative interest rates and how a prolonged period of deflation is keeping its government on the edge. 

Do Negative Interest Rates even exist?

Let us try to understand the concept first. Imagine you have deposited your money in a bank account to earn some interest. But instead of earning interest you’ll have to pay banks something called a storage charge. Weird, right? Banks are supposed to pay interest on deposits and receive on loans. That’s how banks work, right?

Before starting our discussion with respect to Japan, have a look at this chart. 

      Source- Stockcharts.com         

Source- Bank of Japan

• 1991-2001 was a gloomy period for Japan’s economy. It is often referred to as Japan’s lost decade.
• Following the cut in rates, Japan’s real estate market skyrocketed with prices doubling in mere 2 years. Interesting fact- Did you know that families in Japan even took multigenerational loans to buy a house because they were fed with the assumption that this bubble won’t end.
• To control this, the Bank of Japan (BoJ) started increasing interest rates. And the bull’s eye burst the bubble. 
• This pushed Japan’s economy into a downward spiral. People started pulling money out of the markets. 
• As you can see, the charts above show the performance of Nikkei, Tokyo’s Stock Exchange Index.

Hows and Whys of Negative Interest Rate in Japan.

                                                                          Source- Wolf Street

As Japan faced persistent problems with low inflation and even deflation (below 0 on the chart)  for many years, Its economy struggled to gain momentum as deflationary pressures weighed on growth (See chart above) In response, the Bank of Japan (BOJ) took an unconventional action in 2016 by implementing a Negative Interest Rate Policy (NIRP). 

Under this policy, the BOJ charged commercial banks an interest rate of -0.1% on excess reserves held at the central bank which contributed to a weaker yen, improving competitiveness for Japanese exports. With cheaper borrowing costs, businesses and households increased lending. The policy aimed to make money cheaper, therefore, boosting lending and private investment in the economy.

How effective has it been?

Despite having NIRP for more than 7 years now, deflation was not fully or permanently eliminated from the economy as intended by the BOJ. While bank lending rates decreased, the overall volume of new lending did not significantly increase amongst businesses as much as they hoped. The effectiveness of negative rates is undermined if corporate revenues continue falling due to deflationary pressure.

A look at Charts

       Source- Deloitte Insights

                                                                            Source- Statista

Labor productivity is one determinant of growth in wages of a country. The chart on the top clearly shows that the average wage growth in Japan has been just 2.1% as compared to last year. We always talk about how bad inflation is for the economy and how it triggers interest rate cycles. But have you ever thought of deflation? It’s worse. 

Here’s an interesting economic concept. Deflation is harmful to the economy because it reduces wages and disrupts economic stability. Falling prices exert downward pressure on wages, leading to stagnant or declining real incomes for workers. This, in turn, can reduce consumer spending as people postpone purchases in anticipation of lower prices, negatively impacting businesses. Additionally, deflation can result in increased unemployment and a higher burden of debt for individuals and companies, creating financial distress. Moreover, the negative expectations associated with deflation can discourage investment and spending, further perpetuating the economic downturn, which is evident from their Real GDP growth chart. Domino Effect, yet again!

Bank of Japan- Upcoming meeting

The Bank of Japan is facing pressure to normalize policy as inflation rises. While the BOJ will likely maintain stimulus this week, analysts foresee adjustments in the coming year that could help sustain Japan’s economic recovery. Most expect an end to negative rates in 2024. Central Banks around the world are moving towards normalization post-COVID-19. Finally, an exit from stimulus packages that were introduced during the pandemic would help bring down the soaring inflation. It would bring Japanese monetary policy more in line with inflation targets, supporting stable prices and wages. 

Source- Livemint

A gradual shift following other economies could boost growth. Meanwhile, India is poised to become the third-largest economy globally by 2028 due to strong domestic demand, investment, manufacturing, and a favorable demographic situation supporting continued rapid economic expansion.

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Green Portfolio is a SEBI Registered (SEBI Registration No. INH100008513) Research Analyst Firm. The research and reports express our opinions which we have based upon generally available public information, field research, inferences and deductions through are due diligence and analytical process. To the best our ability and belief, all information contained here is accurate and reliable, and has been obtained from public sources we believe to be accurate and reliable. We make no representation, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results obtained from its use.