Japan is quietly drawing up contingency plans to protect its economy and financial markets in case this weekend's Greek elections ignite fresh turmoil in the eurozone and a flight of capital from the bloc.
Central bankers and government officials are drawing up the plans using the experience of the financial tsunami unleashed in 2008 by the collapse of Lehman Brothers, which prompted credit markets to seize up globally and investor to pounce on the yen as a haven of safety.
"There's a deep sense of irritation that in Europe, the time bought wasn't used effectively," said a senior Japanese policymaker involved in international negotiations. He was referring to loans by the European Central Bank, which helped ease pressure on markets early this year.
The Bank of Japan started a two-day policy review on Thursday and is widely expected to leave its settings unchanged to save its financial firepower in case the Greek election ignites fresh market turmoil.
Japan is not alone in Asia in preparing contingency plans.
"There are different crisis management groups within the government to deal with such a possible scenario," Kaushik Basu, chief economic adviser to India's finance minister, said of India's efforts.
In China, key agencies including the central bank, have been asked to come up with similar plans, sources said last week. Measures may include keeping the yuan steady and stepping up policies to stabilize the economy, they said.
Tokyo's worst fear is not that Sunday's national elections may lay the path for Greece to leave the euro area, but that it could rekindle a financing crunch for Spain and Italy, already under pressure from markets.
A fiscal meltdown in the bloc's third and fourth biggest economies could spark a global stock market selloff and a credit crunch as banks, weakened from the 2008/2009 crisis, stop lending.
The euro area is set to dominate a G20 summit in Mexico early next week.
To be sure, many Japanese policymakers still believe a disorderly Greek exit from the eurozone is unlikely. They are counting on European policymakers - long criticized for dragging their feet - to take action and prevent global contagion.
But with the shock of the 2008/2009 crisis still fresh in their minds, they are not taking any chances. Indeed, many of the policies adopted in 2008/2009 are still in place, such as near zero central bank interest rates and easier collateral terms for short-term funding operations.
The Bank of Japan and other central banks still have a Lehman-legacy dollar-swap arrangement with the U.S. Federal Reserve. The latest extension of the deal, which allows the BOJ to tap unlimited amounts of dollars, runs to February 2013.
Capital Controls, Currency Cap Ruled Out
The most probable scenario policymakers are looking at is a flood of money rushing into yen assets, according to several interviews in the past week with central bank and government officials who craft economic policy.
They declined to be identified because they are not authorized to speak with the media.
Money has flowed into the yen fairly persistently since the euro area crisis erupted in late 2009 and the currency hit a record high of 75.31 yen per dollar in October.
Pressure on the record level would spark fresh currency intervention by authorities, especially after the IMF said this week such a measure was an option to ease volatility. The BOJ could also ease policy by increasing the spending limit on its main tool - a 40 trillion yen ($504 billion) asset buying fund.
However, the ability to reduce the attraction of the yen may be limited longer term given the options available for investors. They are likely to steer clear of the struggling euro area, where the policy rate is just 1 percent, and markets are increasingly concerned about how Washington will deal with its own debt problems and the economic impact later this year of the scheduled expiration of lower tax rates.
"Europe's debt problems are the biggest risk to the global and Japanese economies," BOJ Governor Masaaki Shirakawa told parliament this week. "A loss of market stability will lead to a
severe economic slump, as we experienced during the Lehman crisis."
Under a more severe scenario that includes falling stock markets, Japan would lean on a number of measures already in place, the sources said.
Naked short selling is banned in Tokyo's $3.2 trillion equity market.
The central bank also has measures in place to buy commercial paper and corporate bonds using its main policy tool, the asset-buying fund. It would simply speed up its purchases if markets come under stress, sources familiar with the central bank's thinking say.
"The BOJ's priority is to ensure market stability," a source said.
The BOJ could also buy shares from financial institutions if stock falls threaten Japan's banking system, like it did during the 2008/2009 crisis and through to April 2010. But this would require fresh BOJ board approval and the sources said a share-buying fund is not part of policymakers' thinking right now.
There are some measures, the sources said, that have been ruled out. One is capital controls and the other is following in the footsteps of Switzerland, which last September set a cap on the franc's exchange rate at 1.2 per euro after the currency was buffeted by a surge in safe-haven buying.
Since the yen is also a favored safe-haven, financial markets have speculated that Tokyo might follow suit. But officials argue the sheer size of Japan's $5 trillion economy, which is about 10 times bigger's than Switzerland's, and the yen's huge trading volumes make such moves unrealistic.
Japan's economy is expected to outperform most of its Group of Seven peers this year with growth of about 2 percent, partly helped by reconstruction spending following the 2011 earthquake and tsunami.
A soaring yen could derail the recovery, hitting exports already vulnerable because of slowing emerging economies and a relatively high yen.
"The priority for policymakers would be to put a stop to any sharp yen rise," said Mitsumaru Kumagai, chief economist at Daiwa Institute of Research in Tokyo. "If the finance ministry alone cannot stop yen rises, the BOJ has room to ease further."
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