Since 2013, the Bank of Japan (BOJ) has purchased a large number of exchange-traded funds (ETFs) linked to TOPIX, Nikkei 225, and other broad Japanese equity indexes. By July 2018, BOJ owned an estimated 75% of ETFs listed on the Tokyo Stock Exchange (TSE), despite a ¥6 trillion ceiling on annual purchases since 2016. Market participants have grown increasingly critical of the BOJ's policy.

Yasuyuki Kuratsu, a former dealer at major banks and a well-known financial and capital markets commentator, shared his take on BOJ's ETF buying binge and proposed creating a social wealth fund instead.

Investment
Japan (IJ):

Since beginning its policy of extraordinary quantitative easing, BOJ has purchased huge volumes of ETFs and other assets including, needless to say, Japanese government bonds (JGBs). Governor Haruhiko Kuroda has stated the ETF purchasing program was intended to reduce risk premiums in the stock market. Do you think the program has worked as intended?

Kuratsu:

We, players in the capital market, can observe the risk premium directly in the spread over risk-free rates for corporate bonds and commercial paper, but that's not the case with equities. Stock market participants usually look at fluctuations in equity prices themselves, not the risk premium. So, it's fairly useless for BOJ to target the equity risk premium. People recognize that the BOJ is really just trying to prevent drops in the equity market.

There is little evidence that the BOJ's activities have in fact contributed to a lower risk premium in equities for the past six years. The Japanese market is still undervalued. Also, Kuroda's explanation that the BOJ's equity operation is aimed at achieving an inflation target is equally without merit. There is no correlation between the risk premium and inflation. Kuroda has said that expectations are important, but people have been losing confidence in the BOJ itself due to his failure. It's a very annoying situation.

IJ:

The BOJ's ETF buying program has been criticized by many as producing distortions in Japan's equity market. What is your opinion?

Kuratsu:

BOJ's operation produced distortions in the JGB market, which is the basis of all capital markets, including equities, in Japan. The primary source of market distortion has been the artificial manipulation of yields and the yield curve. Moreover, BOJ's equity buying is causing further distortion in the equity market. The current monetary policy is one of the worst I have ever seen. There is clearly distortion in the equity market between stocks that have been selected for purchase by BOJ and those that have not. BOJ's ETF adventure may also weaken corporate governance, which is an even more serious issue than distortion, I think.

IJ:

At what point should the BOJ stop purchasing ETFs? There's growing speculation the Bank may already be secretly scaling back its ETF program, possibly beginning last summer, when the buying pace slowed. Since October, however, BOJ's buying has rebounded and this year's ¥6 trillion purchase ceiling has been reached.

Kuratsu:

BOJ should slowly taper the operation, but it would be risky to announce such a plan officially. The market expects BOJ to continue on course.

IJ:

Any idea how to exit the ETF purchase program without damaging the market?

Kuratsu:

I hate this operation, but BOJ cannot liquidate their holdings so quickly. I want to propose a constitutional shift from BOJ's holdings to a social wealth fund*, as opposed to a sovereign wealth fund. This kind of fund serves three purposes. First, it's a resource for the basic income system, which may be necessary in the coming age of artificial intelligence (AI). Second, it is a source of compensation for the distortion in the public pension system, which mainly harms the younger generation. Third, it is an additional fund for JGB redemption.

IJ:

Thank you very much.

* The idea for a social wealth fund was originally developed at the People's Policy Project (3P) think tank by founder Matt Bruenig, a lawyer, blogger, and policy analyst in the United States.

Yasuyuki Kuratsu
Yasuyuki Kuratsu

President, Research and Pricing Technologies Inc.

Director, The San-in Godo Bank, Ltd.

Executive Director, Industrial & Infrastructure Fund Investment Corp.

He has expertise in many areas of international finance, including foreign exchange, fixed income bonds, derivatives, and risk management.