Following is the transcript of a CNBC interview with Haruhiko Kuroda, Governor of the Bank of Japan. The interview was broadcast on CNBC on 5 May 2017.
All references must be sourced to a "CNBC Interview".
Interviewed by Martin Soong, Anchor, CNBC.
Martin Soong: I know this is a question more for your finance minister Taro Aso. We are also obliged to ask because we have the privilege of speaking with you today.
So let me ask you directly. The level of the yen right now. Are you comfortable with it?
Haruhiko Kuroda: As you know, in Japan, exchange rate policy is done by the Ministry of Finance, rather than the Bank of Japan. So I should refrain from making any specific comment on the situation regarding the foreign exchange market. But I think it is a well-established and well agreed principle of G7 or G20 countries that exchange rate should reflect the economic fundamentals, rather than the speculative movements. And I think that is clearly stated principle of major economies.
Martin: So at 110-ish, does the yen accurately reflect Japan's economic fundamentals?
Kuroda: Again, that is a question to be raised to finance minister (laughs).
Martin: I had to try.
Let's get more into your ambit at the central bank as central bank governor. A lot of people are wondering, they have many questions of course, the most immediate of which is the new policy or the most recent policy of the yield curve control or YCC, trying to pin the 10 year JGB yield at or near zero. How long can you maintain this? And what will have to happen for you to adjust that target rate, up to let's say, plus-minus one percent?
Kuroda: I don't know. We introduced this yield curve control last September. And since then, we've been able to manage this yield curve control system quite well. Of course markets tend to experience ups and downs. And in particular, since long-term interest rates have been, rising in the international markets. Despite this situation, 10 year JGB rate, has been around zero - that is our target for yield curve control at this stage. And by maintaining this stable, long-term interest rates, I'm quite sure that the real economy has been benefitting from stable, long term interest rates.
As you know, shown by the fact that in the last four quarters, particularly in the last two quarters, Japanese economy showed stronger recovery trend. We expect about 1.5 percent economic growth this year and next year. 1.5 percent is not great. But, in Japan, it is well above medium term potential growth rate. Meaning output gap continues to shrink, becoming positive, and labor market continues to tighten, so wages and prices would eventually rise to achieve the two percent inflation target (both laugh) around fiscal 2018…The point is that the yield curve control has been functioning quite well.
And of course, if this zero percent, around zero percent 10 year JGB rate target could, should be changed. Of course, at every monetary policy committee meeting, policy board will decide and discuss and decide whether it should be adjusted upward or downward. But I feel that since the economy is likely to grow at around 1.5 percent, and wages and prices will start to accelerate in coming months and years, I think we should for the time being maintain this zero percent operational target for 10 year JGBs.
Martin: Let's talk about conditions under which that target would have to be raised to let's say plus minus one percent. A lot of it will probably have to do with what the Federal Reserve in the U.S. may or may not do. They've been very consistent with communication and telegraphing to the market for 2017, two more hikes, two more hikes. The market, is about, last I checked 70 percent priced for the next hike to come in June. If though, because of the fundamentals of the U.S. economy or because of Trump policy, the Fed is forced to become much more aggressive or raise sooner and faster, that would have to force the BOJ's hand to raise that target to plus minus one percent, wouldn't it?
Kuroda: Not really, because our monetary policy is directed toward achieving the two percent price stability target at the earliest possible time. So our mandate is to achieve price stability target and like Federal Reserve or ECB monetary policies, our policy is based on domestic mandate. And so, international long-term interest rates may go up in coming months but that does not necessarily mean BOJ should or have to adjust 10 year JGB rate upward. It will only be adjusted reflecting Japanese economic situation, particularly price front.
Martin: Ok let's talk about that, the Japanese domestic economic situation. The two percent target 2018 is the latest target date. What exactly is going on? Do you view the conditions as too little inflationary impulse or too much deflationary pressures?
Kuroda: I think deflation by definition means continuous downward movement of prices. That situation has gone already. We are not in a deflationary situation anymore. However headline inflation has been quite slow to adjust upward, partly because oil prices declined quite sharply in the last two years.
Now it's recovering, but still not very much. More importantly, Japanese people, business, as well as labour unions are accustomed to deflationary situation for 15 years, from 1998 through to 2013, just before we started quantitative and qualitative monetary easing. So the mindset is still quite cautious about inflation expectations.
But I'm quite sure that with continuous accommodative monetary policy supported by fiscal policy, we'd be able to eventually raise wages and prices significantly
Martin: We'll leave the fiscal side and the Abe government and what they could and could not do for later. But the monetary side, I'm wondering, is it fair to say the BOJ has reached or is reaching the limits of monetary policy in terms of its ability to try and push prices up? Because we've seen Japanese corporates, they've benefited handsomely from the weaker yen. That has not pushed on to higher wages, or salaries or consumption which is the end goal of Abenomics. In other words, demand-pull inflation is not there anymore. You say it's a psychology problem of animal spirits. What is it going to take to get to that two percent target?
Kuroda: Because basically, core inflation rate is determined by two factors - one is output gap and the other is inflation expectations. Now output gap has shrunk already and it's now positive. That would have a pressure on prices and wages to go up.
Inflation expectation in Japan is largely adaptive. That means that when actual inflation rate decelerates, inflation expectations also decelerate. Unlike in the U.S. where inflation expectations are well anchored around two percent inflation target. So when oil prices started to decline quite sharply, actual inflation rate in Japan also declined quite sharply, then after some time lag, inflation expectations also declined. But now oil prices have stabilised and are picking up slightly. And as I said, output gap has shrunk and is now positive and we will continue to increase in the positive range, that would increase pressure on prices and wages to rise.
So once prices, actual inflation rate, start to significantly rise, that would also, in an adaptive way, raise inflation expectations as well. So two factors - output gap, inflation expectations - both of them would converge and contribute to raising wages and prices. But it takes time. So our latest forecast is sometime around fiscal 2018.
Martin: Let's talk about something a little easier to understand, would be the Japanese labor market. Because of demographics, we know the workforce is already shrinking. Theoretically, that should mean inflationary pressure and higher wages. But structurally we both know the workforce – 40 percent of it is full time, part time, etc. These are not the kind of people who'd get big increments in the year. They work for literally, minimum wage. There are two schools of thought on this. One school which is more optimistic thinks okay, 40 percent is full time, part time. They don't benefit from higher annual increments. At the same time, the mass, the critical mass of these people, that will be enough to push consumption higher. Do you side with this school of thought? Or the other school of thought which says this just ain't gonna work because the labor force is like that, you can't change it?
Kuroda: I think I tend to belong to the more optimistic group. First of all, this year, now famous Shinto - spring offensive - is likely to result in base pay increase, almost comparable to the base pay increase last year. You may say 'oh only comparable to last year'. But, in Japan, spring offensive is annual wage increase negotiations between business and labor. And since its annual pay increase negotiation, they tend to forecast past the 12 month inflation rate, to settle the wage increase or pay rise. And in the last 12 months, as I said, inflation rate was down, and basically in negative territory. And yet, they agreed to base pay increase, almost comparable to last year's pay rise. That means that business and labor have become, to take into account, future inflation rate, in negotiating base pay increase, probably for the first time in the last several decades
And second, this time, small and medium sized enterprises, agreed to much larger pay increase done last year. This is quite significant. Because for small and medium sized enterprises, they face really tight labor market conditions, and more importantly, part time workers, contract workers - their pay, hourly wages, have been rising about 2.5 percent, quite significantly higher than pay increase of regular workers in large companies.
So all of this makes our contention more reasonable. In the sense that labor market tightness has been affecting, initially part time workers and irregular workers. But now regular workers in small and medium sized enterprises are also experiencing higher pay increase.
Martin: This is fascinating. Tell me about what has changed between business and labor. Because historically we both know, whenever Japanese corporates enjoy the benefits of weaker yen, and they do very well in terms of profits etc, they are not always likely to pass it on to the Japanese worker. What has changed?
Kuroda: First of all, the Japanese corporate sector now enjoys historic high level of profit, better than ever, even better than during the bubble period. They have huge profit, huge cash to spend. So Japanese corporate sector has been increasing capital investment, and now, somewhat belatedly, started to increase wages.
So I think if we continue our fiscal and monetary policy in coming years, if labor market continues to tighten - at this stage, unemployment rate is 2.8 percent. 2.8 percent unemployment rate, is, even in Japan, full employment situation.
And if this situation continues, eventually, tight labor market conditions would force wages to rise significantly.
Martin: Final question for you Governor, what do you think the Abe government on the fiscal side could or should do to support what you are trying to do? And I'm thinking specifically for corporates to enable them to be more let's say generous with the record profit they've been earning because of the weaker yen.
The quid pro quo for many months now was thought to be, look the government says alright we'll give you a tax break, we'll lower tax rate, and hopefully you'll use that wisely and give back to your workers. What is the state of play on this corporate tax cut?
Kuroda: I think first of all the government has been encouraging business and labour to settle higher wage increase for the last four years, and certainly successfully raised wages significantly, although if further wage increase is done it's better.
Second, the government has been reducing corporate tax burden significantly despite a fairly difficult fiscal situation, particularly encouraging small medium sized enterprises to increase CAPEX and also to increase wages.
And thirdly, I think the government has managed fiscal policy quite flexibly - when needed they introduced significant fiscal stimulus, but in the medium-term perspective, they continued to gradual, gradual sort of fiscal consolidation. Compared with four years ago, just before the Abe government was hopeful the fiscal deficit has almost halved.
But that doesn't mean the Abe government can provide austerity or anything like that, because actually the government introduced fiscal stimulus measures in a timely manner, and now of course fiscal policies is stimulative.
But in the last four years the deficit was halved, and the government still predicted that particularly primary deficit should be eliminated by the time of fiscal 2020. And so I think the government has been employing the structural reforms, tax reforms and fiscal policy and...
Martin: There's not any more they could or should do?
Kuroda: I think the there are some further structural reform agendas, particularly labour market reform and social security reform. They are certainly politically challenging, but I think these two - labour market reform and social security reform - are absolutely needed for the Japanese economy to achieve higher medium-term growth while consolidating the fiscal position.
Martin: Very quickly back to CAPEX though, does it concern you that more likely than not Japanese corporates are going to invest that CAPEX, if they do in more plant, equipment, machinery and even jobs outside Japan? As opposed to at home? And what can be done about it?
Kuroda: You see, nowadays large manufacturing companies not just auto makers but electronics makers - for them, outside market is larger than domestic market, so that bulk of their profit comes from outside of Japan rather than inside of Japan.
So they naturally continue to invest hugely outside of Japan, but even inside of Japan, they have started already to increase CAPEX, physical investment as well as R&D investment, particularly R&D. So as far as CAPEX is concerned, I'm much more confident that this would contribute to higher economic growth in coming years. What I'm still a bit…
Martin: And higher wages and inflation.
Kuroda: Yes higher wages, but I think in the medium-run wages and prices would rise.
Martin: Last one - a lot of people think it's way too early for the BOJ to start talking about or communicating about an exit strategy. Although the big worry is once you begin exit, you could be faced with massive balance sheet, losses because of the monstrous size of your holdings of JGBs, even in equities. Is the BOJ starting now, as we speak to plan for exit?
Kuroda: I think it's still premature to discuss in concrete terms about exit strategy. As you know, Federal Reserve after 2008, Lehman crisis, embarked on quantitative easing in three stages - QE1, QE2, and QE3. And even during those periods of quantitative easing, they mentioned about exit strategy. Now they are implementing exit strategy.
But current exit strategy they are implementing is completely different from exit strategy they mentioned years ago. That means that even for the Federal Reserve, exit strategy must be tailor-made so to speak, to the real economy, and financial situation of the time when actually exit strategy is implemented. And if you make some premature statement, that could destabilize rather than stabilize the market…
Martin: But you have a dream team - Takeshi Kato, Masayoshi Amamiya. This is the pair who were responsible for how Japan coped with the surging yen in the aftermath of GFC, then the aftermath of 3-11 disaster. Aren't these two men working on, if not exit, at least normalization right now?
Kuroda: I have full trust in those two gentlemen, also other senior staff, I have full trust. But at the same time, I have to say that as I said, exit strategy, discussing it in premature way, does not help…
Martin: But are they working on it?
Kuroda: Inside the bank, of course we have various simulations of potential exit strategies and so on and so forth. But as I said, it's premature to openly discuss exit strategy at this moment when inflation rate is still close to zero, although improving. And we expect inflation, price target to be met sometime around fiscal 2018.
But there could be downside as well as upside risks. And we have to be flexible. And at this moment, it's certainly premature to speak, in concrete terms, about exit strategy.
Martin: Compositional changes on the nine member BOJ board, recent ones, have meant that the last of the perceived hawks are gone, and now you are working with all doves – accommodationists. Does that make you more comfortable?
Kuroda: The nine policy board members, they act independently, even governor and two deputy governors, under the current BOJ law, as far as monetary policy is concerned, they have to discuss and decide independently. And of course six members from outside, they are also independent, from the bank's staff. So nine members of the policy board freely discuss economic, financial situations and decide monetary policy up to the next policy board meeting. There are various views, and there are many different views at any time.
Martin: But there must be less dissention now?
Kuroda: As far as two new likely members of the policy board are concerned, of course at this stage I can't make any comment, government has not yet appointed them. Because appointment requires confirmation by the upper house and lower house of the Diet.