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Following is a transcript of a First on CNBC interview with Haruhiko Kuroda, Governor of the Bank of Japan, by CNBC's Steve Sedgwick in Dresden.
Steve Sedwick (SS): Outside of Japan what is your greatest concern coming in to this meeting?
Haruhiko Kuroda (HK): I think world economy is certainly recovering, led by US economy, after that European and Japanese economy. On the other hand, emerging economies, they are quite diverse. China, India, they are going very fast. While many emerging economies - Latin America, Middle East are slowing down. So as far as I can see the world economy is recovering, steadily, but there are some many emerging economies suffering from significant slowdown of economic growth.
SS: Will the slowdown of EM be exacerbated by the first interest rate hike in the US?
HK: I don't think so because when the Fed raises interest rates, that means that the US economic recovery is quite robust and strong. So I think you might think that US monetary policy normalisation, so to speak, could adversely affect EM economies. I don't think so because as I said the fact that Fed will raise interest rates reflect strong economic recovery in the US.
SS: And yet we have a new set of words. Lack of liquidity, tantrums and volatility. They all seem to accompany a rate hike in the US, but you don't seem to fear tantrums and lack of liquidity...
HK: About 3 years ago yes we had so called 'taper tantrum' and that affected EM but then when the Fed started actual tapering, the world financial markets were not very much affected. Yes there was some increase of volatility, particularly interest and exchange rate, starting actually in Europe several months ago and this increase in volatility still remains, but as you can see volatility is not rising continuously. I mean volatility increased and then slightly decreased but at this moment volatility is very stable.
SS: Do you think it's too soon for the US given Q1 to raise rates?
HK: As I said if the Fed raises rates, soon people will see strong recovery of economy so as they say their action is data dependent. So we will have to see how the data shows in coming... I'm reasonably confident that Q1 poor data was caused by bad weather and west coast strike. Both of these have gone so I think from Q2 US economy will steadily recover.
SS: A couple of years ago I was speaking to Mr Aso in Moscow. A lot of talk behind the scenes about currency manipulation about what Japan was doing or not doing to weaken the currency. Spin forward 2 years and we are now at 1:2373 roughly on the dollar/yen. Are you concerned that you will be criticised that Japanese policies are affecting the policy?
HK: I don't think so. Two things: One, like other central banks, the Bank of Japan does not target the exchange rate. We target inflation. We have been trying to achieve the 2% target rate through so-called quantitative and qualitative easing. The economy has been recovering, although the rate has slowed down largely due to falling oil prices. In the meantime exchange rates have been fluctuating but I think exchange rates affected by many factors, not just monetary policies. Although recently the dollar has appreciated against euro and yen our monetary policy has not changed since April 2014 we have been implementing so-called QE faithfully and in the meantime exchange rate fluctuated. As I said the Fed is likely to normalise its monetary policies because the US economy is the strongest among the three economies. While the Euro and Japanese economy but not as strong as US so I think Europe and Japan will continue QE for some time.
SS: Is the yen too weak now?
HK: After the Lehman shock in '08 the yen appreciated against dollar, against euro, and also all Asian currencies. Then in last two years yen fell against dollar, not against euro, but anyway. Now the current level is almost comparable to pre-Lehman. So in that sense, the yen appreciated and depreciated. So although I don't say anything about correct level of exchange rate. Exchange rates reflecting economic fundamentals are the most important and most appropriate. And I really don't think at this moment exchange rate alignment among major currencies does not deviate substantially from the relationship from economic fundamentals. But of course, exchange rate could move, could fluctuate, affected by many factors. Some kind of event and of course the market is a little bit worried about Greece and that could affect the euro and so on and so forth.
SS: But in terms of Japan, is a weakening yen from this level going to start negatively impacting the economy? Higher import costs and negate some of the benefits i.e cheaper oil.
HK: No I don't think so. As I said the yen appreciated and depreciated after Lehman shock and I don't know which direction the yen will move in coming months. Yen might appreciate, might depreciate. But I think exchange rate, including the yen, should move in line with economic fundamentals. And as I said at the moment US economy is most robust economy whilst Europe and Japan, while recovering, are not yet fully recovered.
SS: I'll try one more time, Sir. The government is more optimistic on consumer spending. You are more optimistic CPI. Fundamentals for growth, according to you, are moving in the right direction. Do you think the yen will appreciate from here if those fundamentals continue in the right direction?
HK: I think that it could, yeah. Because as I said, exchange rate could move but as I said in the long run exchange rate could move with fundamentals, but in short run could move right away. So yen could appreciate but yen could depreciate because of various factors. But as far as economic fundamentals are concerned, as you said, if economy grows by 1.5 to 25 in next 2 years as we have been predicting, well then it might appreciate, But I must emphasise that exchange rate is very difficult animal and best policy regarding exchange rate forecasting is not to say anything about exchange rates.
SS: Let me move on. Let me talk about forecasting CPI. You think we will get to target, a bit late. The most recent minutes from BOJ suggest some think 2016 is too optimistic. Some think you should go for a target of 2018 and go for 3% target. Are you being too optimistic?
HK: Two things. One, our target is 2% CPI and is not just touching 2% but inflation should stay at 2% for the coming years. I think 2% target is reasonable. And as you know almost all major central banks aim at 2% inflation target. Second point - we don't think we are too optimistic. Three things: One, output gap is shrinking and could become positive, because economy is likely to grow about 1.5 to 2 percent. Which is well above [...]. Output gap will continue to shrink. And second, inflation expectations have been raised. So shrinking output gap, rising inflation expectation could bring about 2 % inflation rate. And as you know, so-called Shinto wage negotiation in Spring is likely to result in again very significant wager increase. So I think all factors, all economic variables show that we are on track and inflation rate would reach about 2% around the first half of the fiscal 2016.
SS: Someone said to me that Abenomics has a timeline in which it has to work. When does 246% debt to GDP become something that Abenomics cannot ignore?
HK: I think the government itself has clearly committed to consolidation of government fiscal position. 3 stages. First stage is to halve primary deficit by fiscal 2015 and that is achieved. The second most significant target is to eliminate primary deficit by fiscal 2020. Challenging but possible and the government is preparing a clear road maps to achieving primary surplus by 2020. And the 3rd most important is after 2020 the debt GDP ratio should steadily decline. To what extent the government has not specified but certainly 200% is too high. Many economists in Europe saying 100%, 60%.
SS: We don't have same savings as you do sir.
HK: Yes, yes but I think the government has its own fiscal plan and if the government faithfully implements this plan I think there would not be any fiscal crisis. But the most important point is that government must implement plan.
SS: Finally, Mr Amari has been quoted as saying a small bubble is not a problem. He would welcome inflation assets. Do you have any concerns that Japanese policies are creating a bubble in the stock market which is now at a 15 years high?
HK: Of course we are always careful about financial stability because the BoJ's two main objectives are price and financial stability. Whenever we discuss economy and monetary policy not only inflation rate but also financial system, financial stability we carefully monitor. So far we haven't seen any kind of excess, financial excess in the economy. We don't think there is any asset bubble or stock market bubble but we will continue to carefully monitor financial system and like other central banks we wold not allow any financial excess or instability developing in our economy.