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. Last Updated: 07/27/2016

BOJ Zero Interest May Be Harming Economy




TOKYO -- Japan's zero interest rates, which the central bank argues are needed to stave off deflation, are doing more harm than good and causing a misapplication of funds in the economy, analysts say.


"The worst impact is that the zero rate policy has disabled the key function of monetary policy - that is, to distribute funds effectively throughout the economy," said Masao Susaki, professor of economics at Senshu University in Tokyo.


The Bank of Japan must restore this key function, said Susaki, who along with other economists argues that the 14-month policy of keeping interest rates at virtually zero must be dumped soon to enable a genuine recovery from recession. The Bank of Japan adopted the policy of pushing the key call rate virtually to zero in February last year amid Japan's struggle to emerge from its worst recession of the postwar era.


Ultra-low interest rates have already caused anguish among managers of corporate pension funds, insurers and trust banks, as well as pensioners reliant on investment income.


Even under the zero rate climate, many smaller firms are having difficulty in raising money, and their needs have been met not by banks, but by non-bank finance firms that charge high interest rates.


Japan's 6,000 non-bank money lenders, or so-called shoko, which specialize in making loans to small businesses with extraordinarily high interest rates, have been making trillions of yen worth of loans to smaller enterprises without collateral, analysts say.


"This is clear evidence that what really matters is not the level of interest rates but the availability of funds," Susaki said.


Banks, though, have traditionally demanded collateral for loans to smaller firms. But the bursting of the economic bubble and subsequent collapse of asset prices virtually choked collateral-backed lending to riskier borrowers.


Japanese banks' loans to smaller firms in December fell 8.7 percent year-on-year, the largest fall since June 1979.


The zero rate policy is also depressing loan demand by bigger firms to which banks have no problem extending loans, experts say.


"Bigger firms have been in no hurry to secure money as the very prospect that the zero rate policy will continue for a while discourages them from raising funds now," said Shin Nagai, vice president treasurer in the treasury department of ABN Amro Bank.


"Ironically, the zero rate policy is keeping the economy from getting back on a normal cycle. In this sense, it is apparently causing a moral hazard," Nagai said.


Lack of borrowing by firms translates into limited capital spending and little increase in profits, which generates a sluggish outlook for business and the whole economy, he added.


"The biggest proven effect of it [the zero rate policy] is to take vigor out of the economy," Nagai said. Low interest rates in theory stimulate spending. But in Japan, abnormally low rates have depressed consumer sentiment and led consumers to save harder instead, Nagai said.


Since the advent of modern market economies, the Bank of Japan has tightened credit only twice - in the post oil-shock era of the late 1970s and in the aftermath of the bubble economy of the late 1980s.


Economists say monetary policy must be more flexible to allocate capital effectively.


"It would be a policy mistake to let uncompetitive firms survive with the aid of an abnormally low interest rate because it would hinder structural reform in Japan," said Susaki.