Bank of Japan governor Kazuo Ueda attending a press conference
A poorly managed exit could undermine the BoJ’s inflation objective © Kim Kyung-Hoon/Reuters

The writer is an FT contributing editor

The Bank of Japan has, over 14 years, acquired exchange traded funds containing stocks equivalent to about 7 per cent of listed Japanese companies. In March, BoJ governor Kazuo Ueda called time on this aspect of the central bank’s extraordinary monetary easing programme. The bank has yet to announce what it will do with its half-a-trillion-dollar stock portfolio.

With about a quarter of stock market gains during the Abenomics period connected to their stock buying, a poorly managed exit could sink the Japanese equity market. It could also undermine the BoJ’s inflation objective.

Why exit at all? After all, in a world of gaping losses from quantitative easing programmes by central banks to support economies, the BoJ’s ETF portfolio has delivered a rare profit. The ¥37tn of cumulative stock purchases have ballooned in value to be worth an estimated ¥77tn today, according to some estimates. Criticism that individual stock prices were being distorted has largely faded since the BoJ reduced the cost of stock borrowing. And, as Naohiko Baba, head of Japan research at Barclays, notes, the roughly ¥1.2tn in dividends that they bring come in handy. It is enough to defray the cost of policy normalisation of its monetary policy, offsetting the cost of interest on reserves held at the bank on a policy rate up to at least 0.25 per cent.

But the bank is not a natural holder of stock. Its accounting framework is penal. Unrealised stock losses must be provisioned, but unrealised gains are never recognised. As such the balance sheet has an asymmetric vulnerability to stock price volatility.

So what are Ueda’s possible exit ramps? First up, the BoJ itself has form. Ahead of, and during, the global financial crisis the bank bought about ¥2.4tn in shares held by financial institutions. After initial abortive attempts, these have been in steady liquidation since 2016.

The market impact has gone almost unnoticed, but the pace has been glacial. The BoJ could apply the same softly-softly practice to ETF sales. But this would take roughly two-and-a-half centuries to complete at the same pace. Ueda has indicated he is in no hurry but this may be stretching things.

The second widely discussed option is an off-market transaction. One obvious recipient would be Japan’s Government Pension Investment Fund, the largest pension fund in the world. But the bank’s holdings of locally listed stocks now exceed GPIF’s making them hard to absorb without losing any pretence of independence. Elsewhere, the government has shown a willingness to endow new entities to promote policy priorities outside an increasingly testing fiscal environment. The Japan University Fund was set up in 2022 and now has a ¥10tn fund to promote research activities. The bank’s ETF portfolio would make for a sizeable endowment in any policy area.

Third, the BoJ could look to the Hong Kong Monetary Authority’s experience. In 1998, hedge funds launched an attempt to break the territory’s currency peg to the dollar. They had gone short on both Hong Kong dollars and stocks. But in a series of daring interventions, the HKMA short-circuited the attack by purchasing 6 per cent of the stock market, forcing losses on the hedgies and squeezing them out of their positions.

The following year the central bank shifted its stocks into a huge ETF — the Tracker Fund of Hong Kong — which it sold off in stages to retail and institutional investors with a discount of more than 5 per cent. There are many things for the BoJ to like here. The HKMA emerged having defended the financial system and making a tidy sum. A comparable move by the BoJ could, if well structured, not only de-risk its balance sheet and net it a handsome profit but also broaden stock ownership among households — a government objective.

As Shigeto Nagai, a former director-general of the Bank of Japan’s International Department now at Oxford Economics, tells me, “selling the ETFs without disrupting markets is not a realistic choice”. The HKMA playbook would achieve many policy goals.

Transferring holdings to a new sovereign wealth fund could be a good intermediate step. It would de-risk the BoJ’s balance sheet. It would also warehouse risk until a broader plan to either sell to the public or endow a policy area is delivered. And given the book cost accounting, a sovereign wealth fund could acquire the BoJ holdings for a fraction of market value without putting a dent in the central bank’s balance sheet. The programme’s mammoth profits give Ueda some time. He must now use it to co-ordinate a plan with the government.

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