Japan: Fukui May Linger Past His Sell-by Date

Key message

The 2008 recession call made by our US economics team is becoming the consensus, and the market view on Japan’s economy, where we moved early to cut our forecasts sharply, now also appears to be becoming more downbeat. In this context, the market is starting to become sensitive to the possibility that there will be a rate cut in Japan too. However, political turmoil due to the upper and lower house stand-off has thrown succession plans for the BoJ’s leadership into confusion, and it is now possible that incumbent governor Toshihiko Fukui’s influence will linger some time beyond his expiration date of March 19, as a result of political compromise. If so, delays in moving to a new leadership would probably mean that even if there is a rate cut, it will not come so quickly.

What’s new

The terms of the current governor and deputy governors are approaching expiration, but the chances of an uncontested selection process for their successors are slim, and our originally whimsical scenario that these seats may be left vacant is becoming more realistic. Some elements of the Democratic Party of Japan (DPJ) are already saying that the selection should be a matter for the next cabinet, and that therefore the reshuffle should be postponed to beyond a general election. This opens the possibility that Fukui will either be reappointed for a time, or retain a role in policy enforcement as an executive director even if he steps down. Our reasons are outlined below. Scenarios differ depending on whether the Diet is in session or not when the term of office expires on March 19.

First, if the lower house is dissolved and the Diet closes down, in the event that agreement of both houses cannot be obtained, the cabinet could appoint a governor and deputy governors without the approval of the Diet. But then if these appointments are not endorsed by the new Diet after the general election, the cabinet would have to axe these appointees swiftly (according to the BoJ Law, article 23, clause 5-6). It is easy to imagine that no strong candidates would be willing to put their names forward with this threat hanging over them, in which case a natural outcome would be to reappoint the current leadership provisionally. Also, if the next leadership team is decided and the Diet gives approval, there is the possibility that the incumbents could step down voluntarily before their terms expire, falling on their swords in traditional Japanese manner.

What would happen if there is a vacuum at the BoJ even though the Diet is in session? Here the procedures are somewhat involved. Since the current BoJ Law makes no provision for this eventuality, nifty moves would be needed to keep the policy board functioning. This might take the form of the current governors stepping down, and then taking up positions as executive directors. (Another possibility is the policy board member being elected from the six standing executive directors.) Diet approval would not be needed to become an executive director, and the Minster of Finance could make such appointments based on the recommendation of the policy board (BoJ Law, article 23, clause 3). The newly appointed directors could then be co-opted onto the policy board in the normal line of business. These proceedings were characterized as the view of the Cabinet Legislation Bureau in the House of Councillors Financial Affairs Committee last November as “a theoretical possibility that is not ruled out” (source: Bloomberg). The BoJ Law provides that the executive directors may take the governor’s duty when the governorship is vacant (article 22, clause 5). (The process differs legally when pertaining to ‘vacancies’ and ‘unable to perform duties’. The latter indicates cases where the board chairperson becomes unable to carry out his/her duties, including from overseas business. The Board chose Miyako Suda under such an ‘unable to perform’. However, the leadership chairperson is chosen by other board members when the top position is a ‘vacancy’.)

The policy board chairperson is chosen by the other members (BoJ Law, article 16, clause 3). In this case, it should be theoretically possible to elect a newly added executive director as the chairperson of the policy board, and so Fukui could carry on in this role even after stepping down as governor by becoming an executive director until the governor’s post is filled. This is simply a theoretical possibility, and not a stratagem that the government would be likely to embrace eagerly, but is worth keeping in mind should a vacancy in the governorship leave the policy board chair open. It would nevertheless be a global embarrassment for Japan if it cannot find a governor to attend major international get-togethers such as G7 meetings which can only be attended by the MoF Minister, Vice Minister and Governor of the BoJ. A G7 meeting in Washington is coming up in late April, for example. As one market participant, we are eager to see a swift appointment of a new governor and deputy governors, as a delay raises uncertainty about policy scenarios.

Where we differ

The risk of an impasse for the BoJ reshuffle is already widely recognized in the markets, but these two scenarios above, though imperfect, are possible ways around the problem. They would mean, however, that Governor Fukui retains influence for a time even after stepping down, either as the provisional governor or cloaked as an executive director.

Next catalysts

To divine the future course of policy, we hone in on the interim assessment of last year’s October Outlook Report, due in the January Monthly Report (January 22). This is likely to indicate that the economy is trending less robustly than the BoJ forecast made in October. This tenor is already observable in the downgrading of the basic outlook in the December BoJ Monthly, and in the cautious wording of Deputy Governor Toshiro Muto’s speech on January 10. If a new governor is decided by April, it is even possible that in the next Outlook Report in April the basic scenario for the economy and prices and the policy approach of normalization of policy rates will be revised according to the new broom’s policy leanings. We cannot push this possibility very hard at this moment, however, given the demands of character and initiative that would be required of a new governor willing to jump straight in and revise the Outlook Report in April, especially amid the current uncertainty over the personnel issue.

Policy implications

The economic outlook at home and abroad is getting bleaker, but it is still likely that monetary policy would remain gridlocked should Governor Fukui continue to wield influence until a new governor is decided after a general election. This means that in a situation which calls for lower interest rates, there might be delays in making the necessary moves because of a reluctance to depart from the path towards normalized interest rates that Governor Fukui has embarked upon. The framework for basing policy on ‘two pillars’ may also need to be reviewed flexibly according to the condition of the economy and asset markets, and we also see a need to rethink the positioning of the ‘understanding of price stability’ as a policy tool, which has become obscure. If the handover to new BoJ leadership is delayed, however, any departure from the current framework, if any, could well be delayed beyond the middle of the year.

Risks

If the general election is advanced to February, the likelihood that the handover process will stall diminishes. Also, if the DPJ agrees to the elevation of the presumptive successor Deputy Governor Muto, there would be no vacuum. We rate both as unlikely, however. In the former case, the critical importance of time-limited budget-related bills (sunset bills) could lead to political trading between the government and opposition parties that brings forward the dissolution of the lower house to around the end of the fiscal year, but the general election would probably slip into April. There could be a leadership vacuum at the BoJ for nearly two months if this happens. In the latter case, the decision would probably rest with DPJ honcho Ichiro Ozawa. He will not commit himself on the governorship question, but the DPJ opposed the deputy governor Muto and Iwata’s nomination five years ago and is unlikely to meekly accept the appointment of a former top MoF bureaucrat.

By Takehiro Sato Tokyo
Morgan Stanley
January 14, 2008