The Bank of Japan. Picture: REUTERS
The Bank of Japan. Picture: REUTERS

MORIOKA — The global economy could be hurt if the withdrawal of funds from emerging markets picks up ahead of an expected reduction in the US Federal Reserve’s monetary stimulus, a Bank of Japan (BoJ) director said on Thursday.

Yoshihisa Morimoto also signalled that Japan’s government needed to proceed with a planned two-stage hike in the sales tax as part of efforts to fix its tattered finances, or face a severe market backlash.

He shrugged off the need to loosen monetary policy again to ease the pain from the tax hikes.

The former utility executive stuck to the BoJ’s assessment that Japan’s economy was headed for a moderate recovery, but noted challenges such as geopolitical risks in the Middle East and market volatility caused by expectations the Fed could start tapering its bond-buying programme as soon as next month.

"Market participants are withdrawing funds from emerging and resource-rich nations on expectations (of Fed’s tapering) and may continue to do so," Mr Morimoto said in a speech to business leaders in Morioka, northeastern Japan.

"The global economic recovery remains fragile, so there’s huge uncertainty on how a sharp outflow of funds could affect financial markets and global growth," he said, in the starkest warning to date by a BoJ official on the potential risk for a bigger capital withdrawal from emerging economies.

The Indian rupee and Turkish lira have both hit record lows against the dollar, the Indonesian rupiah has fallen to four-year lows, and other currencies have fallen sharply as investor sentiment has soured on emerging markets.

Exacerbating the move has been a rush to safe-haven currencies such as the yen as investors worry about the risk of US launching air strikes on Syria.

"We expect the global economy to resume a moderate recovery. But with emerging economies struggling, the pace of recovery will be moderate," Mr Morimoto said.

Maintain trust

The BoJ unleashed an intense burst of monetary stimulus in April to end chronic deflation and achieve its 2% inflation target in roughly two years. Last month, its raised its assessment to say the economy was "starting to recover moderately".

Mr Morimoto, in his first public comments since the April easing, said exports, output and capital expenditure would increase moderately as overseas growth picked up.

But he said he wanted to wait for more data showing that companies were indeed increasing wages and capital spending, before raising the BoJ’s assessment again to say convincingly the economy was recovering.

While more firms are increasing summer bonuses, they remain reluctant to raise monthly salaries. Data released earlier on Thursday showed retail sales fell 0.3% in the year to July, a sign consumer spending may be losing some momentum before household income rises sustainably.

Still, he shrugged off the need to offer additional monetary stimulus and reiterated the BoJ position that the sales tax rise was needed to help improve its tattered finances.

"Japan’s fiscal condition is in a severe state. If trust in the country’s finances is lost, we may see a rise in long-term interest rates inconsistent with economic and price moves," Mr Morimoto said.

"The economy is moving in line with our forecasts," he told reporters after the meeting, dismissing market speculation that if the government proceeded with the planned tax hike, the BoJ would ease again to cushion the damage to the economy.

The BoJ is hoping global growth will pick up in time to make up for any downturn in domestic demand if the tax is increased as planned from April next year.

The government is holding hearings with economists, business leaders and consumer advocates this week that may help determine Prime Minister Shinzo Abe’s decision on the tax rise.

Some legislators and Mr Abe’s aides have called for delaying the tax hikes or seeking a more moderate increase, worried that the rising burden on taxpayers may hurt a budding economic recovery.

The BoJ says the tax increase will not derail the recovery.