The Bank of Japan’s huge monetary expansion programme has raised fears of a flood of Japanese hot money among emerging markets policymakers.

But hold on, says Citigroup in a report. If flows are correctly managed, their effects could be positive: Japanese investment should make it easier for EMs to finance external and fiscal deficits and so allow faster domestic spending growth. Far from destabilising EMs, says Citi, the BoJ could help them rebalance away from exports and in favour of consumption.

It all sounds a bit optimistic. But let’s take a look at Citi’s logic.

The Japanese rush into EM assets hasn’t happened yet; Japanese investors have instead kept their money at home and poured it into Japanese equities, with spectacular results. But the shift will come, says Citi, as do most other banks.

And the effects will be huge, since the BoJ already holds 19 per cent of the assets of the developed world’s main central banks – which also include the US Federal Reserve, the European Central Bank and the Bank of England.

Citi says: “If the Bank of Japan can generate inflation expectations among Japanese savers, the increase in the demand for foreign assets could be very large.”

Meanwhile, EM economic growth has been slowing, not least in China, which this week shocked markets with a first quarter GDP rise of only 7.7 per cent. Also commodity prices have fallen sharply, hitting growth prospects in commodity-exporting countries and reducing inflationary pressures generally in the EM world.

Citi pulls all this together and says the BoJ’s actions could help EM policy makers boost their economies at a difficult time – by providing the necessary funds:

This combination of factors – liquidity-generating BOJ, weak activity and depressed commodity prices – is likely to lean EM towards looser policy. This is already evident in fiscal policy: non-interest public spending has risen as a share of GDP, and we also detect a greater willingness to run up contingent liabilities by making more use of quasi-fiscal policy.

But we also think this will become increasingly evident in monetary policy too. Central banks that have been ambivalent about (further) rate cuts – in Poland, South Africa, Chile, Russia, Korea for example – might lean towards more risk-taking. And policymakers inclined to hike – Brazil, for example – might need to do less than they might have otherwise had to.

And the long-term outlook may also be brighter than it was:

Further out, we believe an additional consequence of all these trends will be to accelerate the shift in [the] EMs’ growth model: domestic spending is increasingly taking over as a driver of GDP, rather than exports, and the EM trade balance should continue to deteriorate. Since a country’s willingness to accept a current account deficit is partly a function of how easy it is to finance that deficit, the BOJ is offering fuel for a change in the composition of GDP growth in EM.

The problem with this argument is that it seems to assume that the Japanese money will flow in an orderly way and be widely spread across EMs. Investors aren’t necessarily so well-behaved. The herd instinct is very powerful: what appeals to one fund manager at any particular time tends to appeal to others.

So there could be a sudden rush for a hot asset, while others are left in the cold. Just look at the Singapore property market, for example. Or the recent appeal of Indonesian bonds. Japanese banks and brokers have, through their marketing, helped in the past to create investment stampedes by Japanese investors – into Brazilian fixed income, for example.

So, while Citi’s argument may be calm and logical, investor behaviour may not.

Related reading:
The BoJ makes its Pearl Harbor decision, David Pilling, FT
Markets Insight: A weak yen is not the solution for Japan
, FT
‘The goal is to give good things back’
, FT

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