The Hindu Business Line : The BoJ jolt

The Bank of Japan (BoJ) has raised interest rates for the first time in six years, bringing it out of a unique monetary policy experiment of maintaining "zero interest rates". The BoJ Governor pointedly said that they do not intend raising rates at consecutive meetings but left the door open for gradual increases. The hike, of 0.25 percentage point, is not something that should jolt markets, especially when the second largest economy in the world has been behind the curve, as it were. The rest of the world has been on an interest rate-hiking spree. Witness the US Federal Reserve Board going for 17 straight hikes to take the rate to 5.25 per cent, while the European Central Bank maintained its rate at 2.75 per cent. Closer home, the Reserve Bank of India moved its reverse repo rates up by nearly one percentage point over the past year.

In itself, a 0.25 percentage point increase in interest rate may not seem large to the real economy nor would it blunt the competitiveness of Japanese manufacturers. But it could be significant in the context of the flow of Japanese funds coming into the Indian market. Anecdotal information points to a phenomenon of foreign institutional investors borrowing cheap in the Japanese currency and investing in the Indian market for better returns. That the Indian market was until recently generating handsome profits made the case that much more compelling. All that could change. The higher cost of funds in Japan will render the `yen carry trade'— the euphemism for Japanese funds finding their round about way into the Indian stock market — less attractive. Should the rise in interest rates be sustained, Japanese investors would start to think they would be better off keeping their monies on shore. That prospect is bound to inject an additional element of volatility to Indian stock prices, buffeted as they already are by such factors as an uncertain internal security environment or political instability. Then there is the minor aspect of borrowing costs going up for listed Indian companies (they raised about $15 billion last fiscal through external commercial borrowings) as the Japanese interest rate environment is bound to harden the sentiment for interest rates globally.

Intended to help revive the Japanese economy, the `zero-rate' policy was outliving its utility given the improved growth prospects in Japan. Continuing to make cheap money available when the economy has broken into a brisk growth would only lead to inflation or investment excesses. On the other hand, the Japanese Government is saddled with a huge public debt and rolling that over at higher interest rates is not going to be an easy decision for the policy-makers. The global financial situation has just been endowed with another element of uncertainty.

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