Japan’s US$1.4 trillion FX reserves under scrutiny as Takaichi hunts for revenue sources

[TOKYO] Japan’s massive foreign currency reserves, a priority war chest for future yen interventions, have come under renewed scrutiny – as Prime Minister Sanae Takaichi scours for funding to bankroll a controversial plan after her landslide election win.

It involves suspending a consumption tax.

The focus on the US$1.4 trillion stockpile, far larger than the annual state Budget, underscores intense pressure on Tokyo to identify alternative funding sources for an estimated five trillion yen (S$40.6 billion) annual revenue shortfall, a prospect that has unsettled financial markets.

Following her decisive election victory on Sunday (Feb 8), Takaichi pledged to speed up deliberation on suspending the 8 per cent tax on food sales for two years without issuing new debt.

She said details would need to be discussed with other parties.

Some government officials, who spoke on the condition of anonymity due to the sensitivity of the matter, said Takaichi may look to tap the surplus from the reserves – after she noted in her campaign speech that Japan’s foreign reserves were a major beneficiary of the weak yen and “performing very well”.

Asked about the possibility, Finance Minister Satsuki Katayama said it was conceivable that the large surplus could be put to use.

“However, this touches on the issue of foreign exchange intervention. From the standpoint of national interest, it is not desirable to disclose all the details of what is available,” she added.

Takaichi’s tax-cut plans and expansionary fiscal agenda sent Japanese markets into a tailspin in January, with bond yields surging to record highs – on concerns regarding the government’s ability to fund the extra spending in a nation with the heaviest debt burden in the developed world.

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Fiscal machine should not rely on FX reserves

In the last fiscal year, Japan posted a record surplus of 5.4 trillion yen from a special government account for currency reserves.

It reflected the accumulated income from US Treasuries during past bouts of US dollar-buying intervention. Assets in the account, invested mainly in US Treasuries, are funded through yen-denominated financing bills. Interest costs are more than offset by returns due to the wide US-Japan interest rate differential.

Precedents exist for diverting surplus to fund flagship policies.

While budgetary rules require at least 30 per cent of annual surplus to be retained in the account as a buffer against future losses, that requirement has at times been relaxed, enabling the entire amount to be transferred to the general account.

“Currency reserves have at times been used for political purposes,” one government official said.

Saisuke Sakai, senior economist at Mizuho Research & Technologies, said: “Foreign currency reserves are, at their core, a safety mechanism to ensure currency stability.”

“Income generated from the reserves is certainly important, but it should not be relied on excessively as a permanent funding source as it fluctuates with markets and interest rates,” he added.

With any additional surplus likely to be small relative to the revenue shortfall, the largest opposition party is calling for more radical measures, proposing to fold Japan’s foreign-currency reserves and the central bank’s exchange-traded fund holdings into a sovereign wealth fund in search of higher returns.

Isamu Ueda, an opposition lawmaker, told Reuters: “The size of the reserves may be a bit excessive in light of the purpose of ensuring currency stability. While US Treasuries are extremely stable assets and do offer a certain level of return, I believe it would be possible to pursue a somewhat more proactive investment approach – without necessarily taking on significantly higher risk.”

Several government officials privately dismissed the idea as unrealistic, with one noting that large-scale sales of US Treasuries could irritate Washington at a time when the US bond market remained sensitive. Japan is the largest holder of US debt.

“Some worry that Japan could be unable to intervene to curb yen weakness, if its foreign currency reserves are insufficient,” Hiroshi Watanabe, a former vice-minister of finance for international affairs, said.

Fred Neumann, chief Asia economist at HSBC in Hong Kong, concurred by saying: “It would be risky to sell reserves primarily for fiscal purposes, and not for exchange-rate management, as this would lower available reserves for possible future intervention.” REUTERS