The Bank of Japan’s decision to raise interest rates to 0.75 per cent — the highest in nearly three decades — marks a subtle but consequential shift in global monetary conditions. Though still low by international standards, the move signals the beginning of Japan’s exit from ultra-loose policy, with ripple effects for global capital flows, emerging markets, and Indian companies exposed to yen borrowing.
Japan’s long exit from near-zero interest rates
For decades, Japan stood apart from other major economies by maintaining near-zero or negative interest rates to combat deflation and revive growth. The latest 25 basis point hike by the brings its policy rate to levels last seen in the mid-1990s, formally ending its status as the world’s cheapest source of capital.
While 0.75 per cent remains accommodative, the move is symbolically significant. It indicates that Japanese authorities are no longer willing to indefinitely subsidise global risk-taking through ultra-cheap liquidity, especially as domestic inflation and political pressures mount.
Why the Bank of Japan changed course
The decision reflects a delicate domestic balancing act. Japan has been grappling with a persistent cost-of-living squeeze driven by higher food and energy prices, compounded by a weak yen that inflated import costs. Inflation — once a remote concern in Japan’s deflation-prone economy — has become both economically and politically sensitive.
Under Governor Kazuo Ueda, and the new political leadership, the BoJ has opted for cautious normalisation, mindful that Japan’s massive public debt leaves little room for aggressive rate increases without destabilising government finances.
Understanding the yen carry trade
The global relevance of Japan’s rate hike lies in its impact on the yen carry trade. For years, investors borrowed cheaply in yen and invested the proceeds in higher-yielding assets abroad — from US bonds to emerging market equities.
This strategy thrived on two conditions:
- A large interest rate differential between Japan and the rest of the world
- A stable or weakening yen
The BoJ’s shift threatens both pillars. Higher borrowing costs reduce the appeal of yen-funded positions, while the prospect of yen appreciation raises the risk of currency losses that can quickly erase returns.
Risk of unwinding and global market volatility
As Japan’s monetary stance tightens, some investors may unwind carry trades by selling overseas assets and repurchasing yen to repay loans. Such unwinding, even if partial, can trigger episodic volatility.
Emerging markets are particularly vulnerable because they have benefited disproportionately from carry-driven capital inflows. Sudden reversals can lead to currency depreciation, higher bond yields, and risk-off sentiment across financial markets.
Implications for Indian borrowers and markets
India has direct exposure through companies that borrow in Japanese yen to take advantage of low interest rates and long-tenor funding. Public sector entities such as , and have significant yen-denominated loans, often partially or wholly unhedged.
A strengthening yen raises repayment costs in rupee terms and can lead to mark-to-market losses, affecting earnings, cash flows, and balance sheets. While these losses may be unrealised initially, persistent currency appreciation can translate into real financial stress.
At the macro level, if yen-funded capital retreats globally, India could face intermittent portfolio outflows. Although India’s fundamentals remain relatively strong, it is not immune to global liquidity swings driven by shifts in major central bank policies.
What this signals for the global monetary cycle
Japan’s move underscores a broader transition in the global monetary environment. As the last major outlier begins to normalise policy, the era of abundant, near-costless global liquidity is gradually receding.
For markets, the risk is less of a sudden shock and more of repeated bouts of volatility as investors adjust positions built on the assumption of perpetually cheap yen funding.
What to note for Prelims?
- Role and mandate of the Bank of Japan
- Concept of the yen carry trade
- Meaning of mark-to-market losses
- Foreign currency borrowing risks
What to note for Mains?
- How global monetary tightening affects emerging markets like India
- Risks and benefits of foreign currency borrowing by Indian PSUs
- Linkages between carry trades, capital flows, and financial stability
- India’s vulnerability and resilience to global liquidity shocks
