TOKYO, Feb 9 (Reuters) – 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 to suspend a consumption tax after her landslide election win.
The focus on the $1.4 trillion stockpile, far larger than the annual state budget, underscores intense pressure on Tokyo to identify alternative funding sources for an estimated 5 trillion yen ($31.99 billion) annual revenue shortfall, a prospect that has unsettled financial markets.
Following Sunday’s decisive election victory, Takaichi pledged to speed up deliberation on suspending the 8% tax on food sales for two years without issuing new debt, saying details would need to be discussed with other parties.
Some government officials, who spoke on condition of anonymity due to the sensitivity of the matter, say 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 in a television interview that 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 last month, with bond yields surging to record highs on concerns over the government’s ability to fund the extra spending in a nation with the heaviest debt burden in the developed world.
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, reflecting income from U.S. Treasuries accumulated during past bouts of dollar-buying intervention.
Assets in the account, invested mainly in Treasuries, are funded through yen-denominated financing bills, with interest costs more than offset by returns thanks to the wide U.S.-Japan interest rate differential.
There are precedents for diverting surplus to fund flagship policies. While budget rules require at least 30% of annual surplus to be retained in the account as a buffer against future losses, that requirement has at times been relaxed, allowing 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 said.
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 ETF holdings into a sovereign wealth fund in search of higher returns.
“The size of the reserves may be a bit excessive in light of the purpose of ensuring currency stability,” opposition lawmaker Isamu Ueda told Reuters.
“While U.S. 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,” he added.
Several government officials privately dismiss the idea as unrealistic, with one noting that large-scale sales of Treasuries could irritate Washington at a time when the U.S. bond market remains sensitive. Japan is the largest holder of U.S. 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 finance minister for international affairs, said in a recent interview.
Fred Neumann, chief Asia economist at HSBC in Hong Kong, concurred, 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.”
($1 = 156.2900 yen)
(Reporting by Makiko Yamazaki, Takahiko Wada, Takaya Yamaguchi, Tamiyuki Kihara and Tom WestbrookEditing by Shri Navaratnam)
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