21 December 2015
<Flash Report>
Surprise Supplementary Measures for QQE Announced— BOJ plays down Concerns over JGB Purchasing Limits?
JCER Financial Research TeamOn 18 December 2015, the Bank of Japan (BOJ) introduced its “SupplementaryMeasures for Quantitative and Qualitative Monetary Easing”, which includes extending theaverage maturity of its long-term government bond holdings that it buys under its monetaryeasing program (Figure 1). The BOJ also announced that it would accept foreign
currency-denominated loans on deeds and financial institutions’ housing loans portfolio as
eligible collateral for the Bank’s provision of credit.
Figure 1. Supplementary Measures for QQE

Facilitating smooth
operation of QQE• Accepting foreign currency bonds and housing loans as collateral,
which enables banks to sell their government bonds more freely.

Extending duration ofbonds and increasing
real estate investment• Buying govenment bonds with a remaining maturity of 7- 12years, compared with the current 7-10 years, from January 2016.
• The maximum amount of each issue of J-REIT to be purchased
shall be increased from the current 5 percent to 10 percent ofthe total amount of that J-REIT issued.

Supporting firms'
investment andcompensation foremployees• Buying shares issued by "firms that are proactively making
investment in physical and human capital" at an annual pace of
300 billion yen. To start with, purchases of ETFs which track theJPX-Nikkei Index 400 will be made from April 2016 onward.

Source: Prepared by authors based on the BOJ's “Introduction of Supplementary Measures for Quantitative and Qualitative
Monetary Easing” attachment to “Statement on Monetary Policy” (18 December 2015)

The JCER Financial Research Team released a report titled “Limits to the BOJ’s
Quantitative and Qualitative Monetary Easing and Issues concerning its Exit Strategy” on
17 December, which pointed out if the BOJ continues buying massive amounts of Japanese
Government Bonds (JGBs) from the market, private financial institutions will soon face ashortage of collateral needed for financial transactions and BOJ’s money market operations.
This will make it difficult for the BOJ to maintain its current scale of JGB purchases.

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Financial Research Team <Flash Report>

21 December 2015

The expansion of eligible collateral included in the BOJ’s Supplementary Measuresannounced on Friday last week will loosen the supply-demand balance of JGB market
indirectly. The BOJ’s Measures also incorporated 1) increasing the maximum amount of eachissue of Japan real estate investment trust (J-REIT) to be purchased, and 2) establishing a newprogram for purchases of exchange-traded funds (ETFs) that comprise companies investing in
fixed or human capital. As the annual target amount of increasing monetary base by 80 trillion
yen was maintained, these Measures were mapped out as merely “supplementary” for QQE.
Governor Haruhiko Kuroda said in a press conference held after monetary policy
meeting that “These supplementary measures are not a response to downside risks for theeconomy. They do not themselves constitute additional easing. The move today is aimed atensuring the smooth implementation of QQE, and to further spread its effect to the realeconomy”. However, the BOJ’s massive JGB purchases seemed to have been in a gridlock.
Although Gov. Kuroda continuously insisted that the BOJ would dodge an incremental
approach i.e. to adopt gradualism, one could argue that the latest supplementary measures
were “incremental.”
CPI Inflation Falls back to pre-QQE Rates
Due to the drop in crude oil prices that started last summer, Japan’s Consumer Price
Index (CPI) has been under downward pressure. The core CPI, excluding fresh food, fell
0.1% from the previous the year in August, dipping into negative territory for the first time in
28 months. Year-on-year rates have turned negative for three consecutive months, falling rightback to pre-QQE rates. In the Outlook for Economic Activity and Prices (“Outlook Report”)
released in October 2015, the BOJ pushed back the time frame for achieving its 2% inflation
target to the second half of fiscal 2016, through March 2017, rather than the first half. The
recent US lifting of the 40-year ban on oil exports could lead to further decline of oil prices.
With the implementation of QQE, the BOJ started buying about 7 trillion yen (US$58billion) worth of JGBs monthly from the secondary market. Since the expansion of QQE
announced in October 2014, it has been purchasing more than 9 trillion yen (US$74 trillion)
of JGBs (Figure 2). Along with this, the volume of JGBs reaching the maturity has been
increasing rapidly. In order to achieve its target of annual increment of JGBs, the BOJ will
have to make a 10 trillion yen’s (US$82 billion) worth purchase in 2016. This may further
tighten the balance between supply and demand of JGB market and increase the risk ofmarket liquidity.

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Financial Research Team <Flash Report>

21 December 2015Figure 2. BOJ makes monthly JGB Purchases of 9 Trillion Yen
12(Year)(Trillion Yen)

Expansion of QQE

QQE
Average Maturity (RHS)

1012108866442

200
13/01

13/04

30Years〜
7〜10Years〜1Year

13/07

13/10

14/01

14/04

14/07

20〜30Years
5〜7Years
Average Maturity (RHS)

14/10

15〜20Years
3〜5Years

15/01

15/04

15/07

15/10
15/11

10〜15Years
1〜3Years

Note 1: The increase in the outstanding amount from the end of the previous month was calculated for each JGB issue andthis was taken as the flow of purchases. However, since adjustment for reduction in the outstanding amount as aresult of redemption, and buyback/retirement is made, the amount of purchases is on a gross basis.
Note 2: Jan 2013 to March 2013 data includes JGBs purchased through the asset purchase fund.
Source: Author’s calculations based on the Bank of Japan's Issue-by-Issue Holdings of JGBs by Amount Outstanding
published by the BOJ and Auction Results for JGBs and Buyback Auction Results published by the Ministry ofFinance.

Expansion of Eligible Collateral signals QQE Limits?
According to our estimation, when considering the supply and demand of JGBs, thereis not much time left for the BOJ. The Bank will be able to purchase 9~10 Trillion Yen’sworth (US$74~82 billion) of JGBs for no longer than one and a half years. Since this timelimit is not long away from the BOJ’s time frame for achieving its 2% inflation target, it may
jeopardize financial stability, especially in JGB market. At the press conference on 18December, Governor Kuroda let slip by saying “I do not think there is a limit to QQE. But
some financial institutions have already sold off all the JGBs they can”.
When eligible collateral for the BOJ’s provision of credit expands, financial
institutions’ foreign currency-denominated loans on deeds and housing loans portfolio will
also be pledged as collateral. This will gear up the BOJ’s purchasing of JGBs which were set
aside as collateral by financial institutions. The amount outstanding of foreign
currency-denominated loans and housing loans held by financial institutions at the end of
September 2015 were 10 trillion yen (US$82 billion) and 130 trillion yen (US$1 trillion)
respectively. The foreign currency-denominated loans are held mainly by large financial
institutions including mega banks, whereas regional banks have been expanding the amountof housing loans in the past several years. The expansion of eligible collateral for the BOJ
could facilitate management of collateral for banks.
Qualitative Easing!
In addition to the expansion of eligible collateral, the BOJ extended the averageremaining maturity of JGB purchases from about 7-10 years to 7-12 years. Since theexpansion of QQE in October 2014, the Bank has been purchasing government bonds with an

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Financial Research Team <Flash Report>

21 December 2015

average remaining maturity of 8.6 years (the line chart of Figure 2), which will further
increase from January 2016. This in fact appears to be a measure of qualitative easing. Whenthe maturity of BOJ’s assets lengthens, the duration mismatch between assets and liabilities
extends. The BOJ, holding long-term JGBs on the asset side of its balance sheet, uses its
current account deposits to pay for purchased JGBs. To put it in different way, both thelong-term JGBs on the asset side, and the excess reserves1 on the liability side have been
expanding since the introduction of QQE. While receiving interest from holding JGBs, theBank pays 0.1% interest for those banks maintaining excess reserves2.
When exiting from the QQE, the BOJ is expected to raise the interest rate on excess
reserves. Consequently, the BOJ’s interest payments will increase and may squeeze its current
account surplus. If the BOJ’s surplus declines, this may also lead to increased public burden
through the decline in national treasury payments.
Furthermore, in FY2004 (ending March 2005), the BOJ changed the long-term JGB
valuation method to the “amortized cost method”3. As a result, even if the market value ofJGB holdings falls due to a rate rise, there is no valuation loss. However, if the BOJ buys
JGBs with the price far exceeding their face values, the amount of amortization may increase,
thereby reducing the Bank’s interest receipt even before the QQE exit. From January 2016,
the BOJ will start buying JGBs with longer remaining maturities, but this may make it moredifficult for Japan to maintain fiscal discipline.

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Japan Center for Economic Research (JCER)
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Phone: +81-3-6256-7710 / FAX: +81-3-6256-7924

1The excess reserve is the bank reserves in excess of a reserve requirement set by a central bank.
Under the supplemental reserve facility, the BOJ pays 0.1% interest on the excess reserves exceeding legal reserve
requirements.
3
Under the amortized cost method, the Bank records the face value of long-term JGBs on the asset side of the balance sheet
and amortizes the difference between the acquisition cost and the face value equally every period until maturity.
2

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