Japan's big stock-buy may signal deeper economic woes

On Wednesday, the Bank of Japan said it will buy $66 billion in stock to boost the economy.

Japan's central bank stunned observers Wednesday by announcing plans to buy stock from 10 to 20 commercial and regional banks. That drastic proposal – unprecedented among major industrialized nations – pumped up shares prices in Tokyo by 2 percent yesterday, even as equities were falling around the world.

But as a reversal of central governor Masaru Hayami's previous declaration that the Bank of Japan had done all it could to stabilize the financial system – through zero-interest rates and an ultra-loose monetary policy – it left many analysts wondering whether the country's financial woes were more urgent than suspected.

"For a developed country's central bank to jump out and buy equities is completely bizarre," said Garry Evans, strategist of HSBC Securities. "Reading between the lines, the Bank of Japan sees some sort of crisis looming."

Some analysts in the US cheered the move. "The Bank of Japan is doing the right thing," says economist Dan Ryan with DRI-WEFA Inc., a consulting firm based in Lexington, Mass. "It is a way of pumping more money into the economy."

Japan's economy, the second largest in the world, has been suffering from deflation, and its banking system has been on the verge of collapse for almost a decade. Hit by a 1,400 trillion yen ($11.6 trillion) plunge in assets since the 1989 collapse of the bubble economy, nonperforming loans have accumulated faster than banks have been able to write them off.

Now the bank has indicated it might buy as many as $66 billion of the $207 billion the commercial banks hold in stock – a move that could not only stimulate the economy, but also prop up its imperiled banks.

Yet David Malpass, an economist in New York with Bear Stearns, a brokerage house, suspects the central bank will "sterilize" its stock purchases – a way of neutralizing its impact on monetary policy.

The Japanese government is expected to approve the bank's decision. As part of its effort to end deflation, the Bank of Japan, indirectly, has been purchasing about 40 percent of the new debt issued by the government. This has helped swell the nation's money supply to a level about 50 percent of national output, twice what it was a decade ago. Mr. Ryan is convinced that at some point Japanese banks and consumers will start using that extra money, lifting the economy out of its doldrums.

The settlement of accounts in March and September has become a half-yearly trauma for banks worried that a late slide in stock prices could erode what is left of their capital bases. The usual method has been for the government to talk up share prices with promises of new economic packages, tax breaks, or – as was the case in March – restrictions on short-selling.

This September looked to be following the familiar pattern. Stock prices dropped close to 19-year lows, the banks are nervous, and the government has again hinted at a new antideflation package, which could be announced as early as today. Then, without warning, came the Bank of Japan's proposal to purchase stock – a radical move for a bank and a central governor usually considered arch-conservatives.

The most recent comparison occurred in Hong Kong during the height of the Asian financial crisis, when the territory's central bank bought equities to prevent a meltdown in stock prices. That proved effective and made a tidy profit for the taxpayers because the bank bought at the bottom of the market.

But the Bank of Japan is not – on the surface, at least – faced by anything like the same degree of peril. The economy is showing signs of a weak recovery, stock prices have improved slightly in the past week, and business confidence is picking up.

Analysts are still trying to work out why it is taking such a step now. One theory is that the bank and the government have put aside their differences to face problems in he banking system, following President Bush's advice to Japanese Prime Minister Junichiro Koizumi last week that Tokyo must accelerate the clear up of bad loans.

Whether that is the case should be clear when the government announces its latest economic package. But if there are such plans, they have been kept secret from the economics minister, Heizo Takenaka, who admitted that even he does not understand the Bank of Japan's decision to buy shares.

"This has taken everyone by surprise," said Frank Packer of Nikko Solomon Smith Barney. "It shows that the Bank of Japan is ready to do everything within its means to prevent a financial system implosion."

• David Francis in Boston contributed to this report.