Is Monetary Policy The Only Way Forward For Japan's Economy?

| About: iShares MSCI (EWJ)

Summary

We saw the status quo in the BoJ announcement.

Stimulus packages are the need of the hour.

The outlook is positive for the short term.

In this article, I will analyze the recent monetary policy of the Bank of Japan (BoJ) and its effect on the MSCI Japan ETF (NYSEARCA:EWJ) and other regional players.

The BoJ expanded the program of buying ETFs worth 2.7 trillion yen ($26 billion) along with an increase in dollar-lending operations, but the decision fell short of market expectations. This is because the market was expecting something unusual from Kuroda; however, he took the previous approach by expanding the ETF purchases in order to avoid a sudden backlash from the market. Furthermore, he kept the monetary base at 80 trillion yen. In this way, he is urging the government to focus more on fiscal reforms.

Although Kuroda did not supplement the government's expansionary policy by further cutting interest rates, he did signal further easing if the targets are not met. In my view, the decision was prudent on the part of Kuroda as he resisted in giving away "unlimited fiscal stimulus."

In my view, a strong fiscal stimulus -- which includes tax cuts together with strong infrastructural spending -- could get the economy back on track. Nonetheless, it is pertinent to mention that the Japanese government has announced 4.6 trillion yen ($45 billion) extra spending in the current fiscal year. However, the central bank's decision not to expand financial asset purchases raises eyebrows as to how the government would finance its fiscal stimulus packages.

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Briefly, on the reforms front, the government needs to address the problems in the labor market by raising wages, coupled with increasing the participation of older workers, women, and foreigners.

Measures and Their Effects

The increase in ETF purchases would increase the liquidity and confidence in equity markets by stabilizing the overall capital market. This would bode well for the EWJ ETF. Furthermore, the doubling of the dollar-lending limit would help corporate sector funding. However, the resultant stronger yen would prove negative for exports.

In my view, the actions of the BoJ have shown financial experts and economists the limits of monetary policy. Thus, there can only be a fiscal stimulus coupled with structure reforms that could save Japan from years of stagnant growth together with deflation. Furthermore, according to my analysis, no matter how much quantitative easing measure are undertaken by the BoJ, it would be very difficult for Japan's central bank to achieve a CPI target of 2% -- unless the above-mentioned actions are not taken by the government.

Recommendation to Investors

In the short run (until September 2016), I am bullish on the EWJ ETF. However, looking out to the long-term time horizon, uncertainty still looms as Japan faces the fundamental problem of demographics. The younger working population is dwindling compared to the rising older population, resulting in lower labor productivity.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.