Photographer: Tomohiro Ohsumi/Bloomberg

Japan Central Bank's ETF Shopping Spree Is Becoming a Worry

  • Sustainability is said to be a key concern for some at the BOJ
  • No changes are likely at the policy board’s meeting this week

Some officials at the Bank of Japan are increasingly concerned about the sustainability of the BOJ’s purchases of exchange-traded funds, according to people familiar with discussions at the central bank. But the chances of any change at this week’s policy meeting are low, they said, with no need for an immediate change to the program.

Concerns include the risk that the central bank could end up owning such large amounts of the free-floating shares of some listed companies in the Nikkei-225 Stock Average that it could seriously distort the market, according to the people, who declined to be identified because the talks are private. Still, they say it’s unlikely the matter will be discussed in detail at the two-day policy meeting ending July 20.

If the BOJ were to make a change sometime down the road, it could increase the proportion of purchases in the broader Topix stock index while cutting back on the Nikkei, said the people, rather than reducing the overall quantity of purchases. The timing of any such change would depend on a range of conditions, including the state of the economy and inflation, and possibly the extent of public criticism of its ETF buying, they said.

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The Financial Services Agency, which regulates banks and securities trading, is also paying close attention to the way the central bank is accumulating ETFs, according to a senior FSA official. The FSA is watching the BOJ’s emergence as a large, passive owner of stocks at a time when financial regulators are focused on getting shareholders to play an active role in improving corporate governance, said the official, who asked not to be named.

Some BOJ officials also share this concern, according to the people with knowledge of talks inside the central bank. According to other officials at the BOJ, the use of private investment trust banks to buy ETFs provides monitoring of corporate behavior.

Stimulus Risks

Not all BOJ officials are concerned about the sustainability of ETF purchases, reasoning that the previous shift toward Topix buying should prevent problems with sustainability for the foreseeable future, said people with knowledge of the matter.

Still, the growing focus on the risks associated with the BOJ’s monetary stimulus program -- which includes enormous asset purchases, particularly of Japanese government bonds, as well as negative interest rates and yield curve control -- comes as its inflation target remains elusive. With no end to its program in sight, the BOJ is under increasing pressure to mitigate risks and explain its thinking about an eventual exit. 

Its ETF buying, now targeted at around 6 trillion yen ($53 billion) annually, is the subject of continued questioning. The concern inside the BOJ coincides with its growing presence in the market. The BOJ owned about 71 percent of all shares in Japan-listed ETFs at the end of June, according to a Bloomberg analysis of data from the central bank and Japan’s Investment Trusts Association.

The NLI Research Institute has forecast that the BOJ could own almost three quarters of the free-floating shares of Fast Retailing Co., the most heavily weighted company on the Nikkei, by March of next year, and almost all of them within three years. Fast Retailing’s free float is relatively small compared to its outstanding shares because of the large amount of shares held by the family of the company’s founder.

Japan’s Nikkei 225 Stock Average dropped 0.6 percent in the morning session on Tuesday, with the Topix index also falling. The yen was trading at 112.13 against the dollar as of 11:53 a.m. in Tokyo, up 0.4 percent against the dollar.

Nobuyuki Nakahara, a mentor to Prime Minister Shinzo Abe, told Bloomberg in an interview late last month that the BOJ’s ETF purchases are driving an “artificial rise in stock prices,” and that it was unclear how this would help inflation rise to its 2 percent target. “They can’t keep holding ETFs forever,” he said.

Banking Industry

Nobuyuki Hirano, the chairman of the Japanese Bankers Association and head of Mitsubishi UFJ Financial Group Inc., Japan’s biggest bank, told reporters last week that there are issues with the size of the BOJ’s ETF holdings, including the impact on stock prices and corporate governance. 

Governor Haruhiko Kuroda said after last month’s policy meeting that it is "possible in theory" to reduce the BOJ’s ETF purchases before inflation reaches the target. But it was "generally unthinkable" that the BOJ would remove a part of its easing program, and had no intention of treating ETF purchases differently from the other elements of the program, Kuroda said.

Some BOJ officials think the ETF buying will probably need to be adjusted again in the future, but feel that reducing the purchases is an unlikely way to go because it’s a key element of the stimulus program, according to the people familiar with central bank discussions.

The BOJ altered its ETF buying in September last year, allocating a greater percentage to ETFs tracking the Topix index as part of a broad change in its policy framework meant to maximize sustainability. The move followed growing criticism that its focus on the Nikkei, which has fewer companies, was distorting prices and could lead to it becoming the dominant shareholder in many firms.

Policy Survey

None of the 43 analysts surveyed by Bloomberg expect a change to BOJ policy this week. That leaves the focus on whether there will be any adjustments to forecasts for economic growth and consumer prices.

The BOJ board will discuss whether it needs to revise its forecast for the timing of reaching the 2 percent price target from around fiscal 2018, with some of the view that it can be maintained while others leaning toward an adjustment to reflect the current price weakness, according to people familiar with the central bank’s discussions.

Separate to the 2 percent goal, the BOJ is gaining confidence that inflation expectations are showing signs of bottoming out and the output gap is turning positive, according to the people.

— With assistance by Yuji Nakamura, and James Mayger

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