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A small hike makes big news

Last Friday's decision of the Japanese authorities to raise interest rates for the first time in six years has important messages for the rest of the world too. The actual increase in the benchmark overnight lending rate might be a mere 0.25 percentage point but it is still extremely significant for at least two reasons. It marks the end of the zero interest rate policy that the Bank of Japan has been pursuing for a greater part of the past six years. Despite being highly unorthodox, the zero interest rate policy came to be viewed as the centrepiece of an unprecedented monetary initiative to help the world's second largest economy get out of a recession that was in evidence during most of the 1990s and early part of this decade. Secondly, the move is the strongest indication yet that the monetary authorities are seized of the vastly improved economic situation and are ready to use the traditional monetary instruments to keep the resurgent economy on track. According to recent surveys, business confidence in Japan is at a record high. Companies have their order books full and many of them are reporting huge profits. An interest rate hike should normally dampen economic growth but the magnitude of the rise and, even more significantly, the announcement by the Bank of Japan that it will moderate future increases have been well received both in Japan and outside. The strength of the Japanese economy is seen in its ability to keep inflation well under control even in the face of the runaway petroleum prices. All these are a far cry from the crises caused by the bursting of the twin bubbles of stocks and property prices of the late 1980s. The economy was actually deflating with very low demand and a contraction in the price levels.

With the increase in interest rate, Japan has fallen in line with other major countries. The U.S. Federal Reserve has raised its benchmark rate 17 times since 2004 and it stands currently at 5.25 per cent. Interest rates in the Euro Zone and in the U.K. are much higher than in Japan. The recent action of the Bank of Japan will have a significant impact on India too. The Reserve Bank of India, which had recently raised the reverse repo and repo rates to 5.75 and 6.75 per cent respectively, might hike them again soon to temper inflation expectations. In the exchange markets, the Japanese yen is expected to strengthen in the wake of the interest rate change but in these early days geopolitical factors — the North Korean missile tests and the West Asian crisis for instance — rather than economic fundamentals seem to be the key determinants of currency equations in the short run. Japanese investors have recently been investing in the Indian stock markets and it is still not clear whether they will change course and pull back. There is a larger and wholesome message for India and other developing countries: a resurgent Japanese economy is altogether good news for the global economy.

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