Minutes of the Monetary Policy Meeting

on June 10 and 11, 2003
(English translation prepared by the Bank's staff based on the Japanese original)

The corrections below have been made to reflect the Japanese originals more accurately. The original Japanese text, however, remains entirely unchanged (January 14, 2004).

Item III A, Eligible Assets to Be Purchased (paragraph 3)
(Previous version) firms with capital of 1 billion yen or less
(New version) firms with capital of less than 1 billion yen

Attachment 3, Item 1 (2) , underlying assets (paragraph 2)
(Previous version) enterprises with capital of 1 billion yen or less
(New version) enterprises with capital of less than 1 billion yen

July 18, 2003
Bank of Japan

A Monetary Policy Meeting of the Bank of Japan Policy Board was held in the Head Office of the Bank of Japan in Tokyo on Tuesday, June 10, 2003, from 2:00 p.m. to 3:56 p.m., and on Wednesday, June 11, from 9:00 a.m. to 1:08 p.m.¹

Policy Board Members Present Mr. T. Fukui, Chairman, Governor of the Bank of Japan
Mr. T. Muto, Deputy Governor of the Bank of Japan
Mr. K. Iwata, Deputy Governor of the Bank of Japan
Mr. K. Ueda
Mr. T. Taya
Ms. M. Suda
Mr. S. Nakahara
Mr. H. Haru
Mr. T. Fukuma

Government Representatives Present
Mr. T. Taniguchi, Senior Vice Minister of Finance, Ministry of Finance²
Mr. H. Tsuda, Deputy Vice Minister for Policy Planning and Coordination, Ministry of Finance³
Mr. Y. Kobayashi, Vice Minister for Economic and Fiscal Policy, Cabinet Office

Reporting Staff
Mr. E. Hirano, Executive Director (Assistant Governor)
Mr. M. Shirakawa, Executive Director
Mr. A. Yamamoto, Executive Director
Mr. H. Yamaguchi, Adviser to the Governor, Policy Planning Office
Mr. S. Kushida, Director, Head of Planning Division I, Policy Planning Office
Mr. H. Nakaso, Director-General, Financial Markets Department
Mr. H. Hayakawa, Director-General, Research and Statistics Department
Mr. K. Momma, Director, Head of Economic Research Division, Research and Statistics Department
Mr. A. Horii, Director-General, International Department

Secretariat of the Monetary Policy Meeting
Mr. K. Akiyama, Director-General, Secretariat of the Policy Board
Mr. Y. Nakayama, Adviser to the Governor, Secretariat of the Policy Board
Mr. T. Wada, Adviser to the Governor, Secretariat of the Policy Board, and Budget and Management Office⁴
Mr. N. Yoshioka, Director, Head of Planning Division II, Policy Planning Office⁵
Mr. M. Ohsawa, Director, Head of Money and Capital Markets Division, Financial Markets Department⁵
Mr. H. Onobuchi, Deputy Director, Secretariat of the Policy Board
Mr. S. Shimizu, Senior Economist, Policy Planning Office
Mr. S. Nagai, Senior Economist, Policy Planning Office

The minutes of this meeting were approved by the Policy Board at the Monetary Policy Meeting held on July 14 and 15, 2003 as "a document which contains an outline of the discussion at the meeting" stipulated in Article 20, Paragraph 1 of the Bank of Japan Law of 1997. Those present are referred to by their titles at the time of the meeting.
Mr. Taniguchi was present on June 11.
Mr. Tsuda was present on June 10.
Mr. Wada was present on June 11.
Messrs. Yoshioka and Ohsawa were present on June 11 from 9:00 a.m. to 9:45 a.m.

I. Summary of Staff Reports on Economic and Financial Developments⁶

A. Money Market Operations in the Intermeeting Period

The Bank conducted market operations in accordance with the guideline decided at the previous meeting on May 19 and 20, 2003.⁷ As a result, the outstanding balance of current accounts at the Bank was at around the 28-30 trillion yen level.

As a result of these market operations, the weighted average of the uncollateralized overnight call rate remained at 0.001-0.002 percent. On June 9, 2003, it recorded a historical low of 0.000 percent due to the fact that the volume of transactions with negative interest rates increased.

B. Recent Developments in Financial Markets

Money market rates continued to be stable due to the Bank's provision of more ample liquidity. Three-month Euro-yen rates declined slightly. Yields on three-month financing bills slightly increased temporarily on the days after issuance but stabilized thereafter.

In the Japanese government bond (JGB) market, yields on ten- and 20-year JGBs marked a record low. This was because banks and institutional investors had increased their investment in medium- to long-term JGBs against the background of stronger uncertainty about the economic outlook at home and abroad, thus pushing down the yields on these JGBs. In a situation where the unwinding of their cross-shareholdings had progressed and their risk-taking capacity had recovered slightly, they had no better alternative than to increase their purchases of medium- to long-term JGBs to secure their profits.

Japanese stock prices continued to rise reflecting firmness in stock prices in the United States and Europe and the fact that the appreciation of the yen had come to a halt. The Nikkei 225 Stock Average recovered to the 8,500-9,000 yen level. Another factor contributing to the rise in stock prices was that an improving trend in firms' business performance had been confirmed. For example, the number of firms that revised their corporate profits upward exceeded those that revised downward. A breakdown by type of investor showed that foreign investors had been large net buyers of Japanese stocks.

The trend of appreciation of the yen against the U.S. dollar came to a halt due partly to the heightening of market participants' concern about a possible intervention and to the improvement in some U.S. economic indicators. The euro marked a record high against the U.S. dollar in late May, but depreciated slightly thereafter.

C. Overseas Economic and Financial Developments

The U.S. economy had stayed on a modest recovery trend, but the momentum for an increase in production and income was weakening. Regarding developments in U.S. final demand, private consumption remained on a moderate upward trend as evidenced by firm sales of automobiles in May. Consumer confidence was improving slightly as geopolitical risks had decreased. The unemployment rate for May was high at 6.1 percent, and private nonfarm payroll employment remained slightly weak in April and May. The recovery in production continued to be weak, and developments in business fixed investment continued to lack momentum due to the persistence of uncertainties about the economic outlook and corporate profits.

In U.S. financial markets, stock prices were on an uptrend reflecting expectations for a policy stimulus. Long-term interest rates declined further, due to speculation that the Federal Reserve would increase purchases of Treasury bonds and notes as it was concerned about declines in the inflation rate. Judging from developments in federal funds rate futures, market participants had factored in a cut in the target for the federal funds rate of 25 basis points at the meeting of the Federal Open Market Committee (FOMC) scheduled to be held in late June 2003.

In the euro area, the economy was decelerating, especially in Germany, since domestic demand components, such as private consumption and business fixed investment, remained sluggish and exports were slowing. Leading indicators of production such as the Purchasing Managers' Index (PMI) were weak. In addition, the employment situation continued to deteriorate at a moderate pace, and consumer confidence continued to be weak.

Against this background, the European Central Bank (ECB) cut interest rates by 50 basis points on June 5, 2003.

In NIEs and ASEAN economies, the pace of economic recovery was decreasing slightly, as seen in the fact that the rate of increase in exports was slowing in the area and that private consumption and business fixed investment in some economies, such as South Korea, was decelerating slightly. In economies such as Hong Kong, Taiwan, and Singapore, the spread of severe acute respiratory syndrome (SARS) was thought to be having negative effects, for example in private consumption, although this had not been clearly confirmed in the statistics so far.

Financial markets in emerging economies were regaining stability. In Argentina and Brazil, the peso and the real were appreciating and stock prices were rising partly because market participants' confidence in the governments' economic policy measures had been restored.

D. Economic and Financial Developments in Japan

1. Economic developments

Real exports decreased marginally in the January-March quarter of 2003 from the previous quarter, the first decline in five quarters, and they inched down again in April from the monthly average of the previous quarter. By region, exports to the United States, particularly automobiles, continued to decrease, and those to East Asia, which had continued to record high growth until the January-March quarter, dropped in April. The decline in exports to East Asia seemed to be partly due to the deceleration of domestic demand in South Korea, and the materialization of possible effects of SARS on these exports from May onward also required attention.

With respect to domestic demand, housing investment remained sluggish, and public investment was on a declining trend. Business fixed investment remained on a gradual recovery trend according to anecdotal information and other surveys, although shipments of capital goods declined in April. As for the outlook for business fixed investment, given that there had been a certain degree of recovery in corporate profits to date due partly to firms' restructuring efforts, an uptrend would be established once exports and production increased clearly again. However, given structural factors and uncertainty about the outlook for overseas economies, the momentum for recovery in business fixed investment was likely to remain very weak.

As for private consumption, various sales statistics declined in April, but in May passenger-car sales recovered and sales at department stores in Tokyo also seemed to have been recovering to some extent. Overall, there was no distinct change in the weak trend of private consumption. Private consumption was likely to remain weak on the whole, given that indicators for consumer sentiment were weak and the employment and income situation was expected to remain severe for the time being.

Production declined by 1.6 percent in April from the monthly average of the January-March quarter, which had shown a quarter-on-quarter rise of 0.3 percent. However, production could be considered to have continued to be basically level, since shipments had been level and indices of production forecasts had increased.

As for the employment and income situation, the number of employees, which covered various types of employees including non-regular employees such as temporary workers, appeared to be declining at a slower pace. However, the increase in overtime hours worked and number of new job offers had come to a halt. In addition, the number of regular employees and wages continued to decrease, reflecting firms' stance of continuously reducing personnel expenses. As a result, the employment and income situation overall remained severe, with household income continuing to decrease.

On the price front, import prices and domestic corporate goods prices turned to decline in May, mainly reflecting the fall in crude oil prices since early spring. The decline in corporate services prices expanded in April on a year-on-year basis. This was partly due to irregular factors at sampled firms causing a fall in prices of information services. The rate of decline in consumer prices had diminished in April on a year-on-year basis, due mainly to the rise in the cost of medical treatment caused by the reform of the medical care insurance system.

2. Financial environment

With regard to credit aggregates, private banks' lending continued to decline by 2.0-2.5 percent on a year-on-year basis. The amount outstanding of funds raised through issuance of CP and corporate bonds was at around the previous year's level. Thus, the total amount of funds raised by the private sector continued to follow a downtrend.

As for monetary aggregates, the year-on-year growth rate of the monetary base for May rose to around 15 percent, mainly because the growth rate of the outstanding balance of current accounts held at the Bank increased. The year-on-year growth rate of the money stock for May rose slightly to around 1.5 percent, as funds arising from sales of stocks by corporate pension funds, which were returning funds entrusted to them in order to discontinue acting on behalf of public pension funds, flowed into banks' liquid deposits. On the other hand, the year-on-year growth rate of broadly-defined liquidity fell significantly in April and May. This was because financial assets held by the Postal Life Insurance Welfare Corporation were excluded from the money stock statistics, since the assets of the corporation were transferred to Japan Post due to the dissolution of the corporation. However, excluding the above factor, the growth rate of broadly-defined liquidity had been generally steady from March through May.

In corporate finance, credit demand in the private sector continued to follow a downtrend mainly because business fixed investment was at low levels and firms were continuously reducing their debts.

Private banks remained cautious in extending loans to firms with high credit risk while on the other hand they continued to be more active in extending loans to blue-chip firms. Recently, their lending attitude seemed to be becoming slightly more accommodative in areas such as setting of interest margins. Firms' perception of the lending attitude of financial institutions and of their own financial position suggested that the fund-raising environment, particularly for small firms, continued to be severe on the whole, but it had recently been easing slightly.

As for the issuing environment for corporate bonds and CP, investors were becoming more inclined to purchase corporate bonds and CP in the face of limited investment opportunities. Credit spreads at issuance on corporate bonds and CP, including those issued by firms with relatively low credit ratings, such as corporate bonds with a single A rating and CP with an a-2 rating, returned to almost the levels of the July-September quarter of 2001, the period before the bankruptcy of Enron when the issuing environment was favorable.

In sum, the financial environment seemed to be easing further. Financial markets continued to be stable, long-term interest rates declined further, stock prices had been recovering, and the issuing environment of corporate bonds and CP continued to improve. As for the outlook, however, the financial environment continued to require attention, particularly financial market developments such as stock prices and also the sustainability of the current change in the lending stance of financial institutions and the extent to which it might spread.

6Reports were made based on information available at the time of the meeting.
7The guideline was as follows:
The Bank of Japan will conduct money market operations, aiming at the outstanding balance of current accounts held at the Bank at around 27 to 30 trillion yen.
Should there be a risk of financial market instability, such as a surge in liquidity demand, the Bank will provide more liquidity irrespective of the above target.

II. Amendments to Principal Terms and Conditions for the Purchase of CP with Repurchase Agreements and Related Rules

A. Staff Proposal

The staff proposed that the Bank expand the range of assets eligible for CP purchasing operations with repurchase agreements and include dematerialized CP and dematerialized asset-backed commercial paper (ABCP) to facilitate the Bank's money market operations. Therefore, it was appropriate to amend accordingly the Principal Terms and Conditions for the Purchase of Commercial Paper with Repurchase Agreements, the procedure for selection of eligible counterparties for CP purchasing operations with repurchase agreements, and the rules for conducting the Bank's business.

Prior to this, the Bank had decided to accept dematerialized CP and dematerialized ABCP as eligible collateral at the end of March 2003 in line with the start of operation of the book-entry system for dematerialized CP and ABCP by the Japan Securities Depository Center, Inc.

B. Members' Discussion and Vote

Members voted unanimously to approve the proposal and agreed that the decision should be made public.

III. Explanation by the Staff concerning Purchases of Asset-Backed Securities (ABSs)

The staff explained the outline of the proposed scheme for outright purchases of ABSs which they had formulated taking into consideration the comments received from market participants.

A. Eligible Assets to Be Purchased

The staff said that it was appropriate that the types of assets eligible for the Bank's purchase be publicly-offered ABSs, publicly-offered synthetic-type securities (credit-linked notes), and ABCP including dematerialized CP. Eligible ABSs and synthetic-type securities would be limited to those publicly offered as the purchase prices would be decided based on market prices in order to avoid distortion of the market mechanism, and purchase prices at public offering were the only objectively reliable market prices in the current situation. In addition, regarding synthetic collateralized loan obligations, the Bank would only purchase credit-linked notes because assets eligible for the Bank's purchases were restricted to bills and bonds under the Bank of Japan Law.

The Bank had received requests from market participants to purchase trust beneficiary rights, but the Bank would not include them in assets eligible for purchase because they were privately placed, thus lacking the transparency of pricing required of securities to be purchased by the central bank, and also because they were not eligible for purchase under the Bank of Japan Law.

With regard to underlying assets, the staff took into account comments received from market participants and said that eligible assets would not be limited to loans or receivables, and a wide range of underlying assets that were deemed to contribute to smooth financing of small and medium-sized firms would be eligible. Such underlying assets would need to fulfill the following criteria. First, 50 percent or more of the value of underlying assets would be composed of assets related to small and medium-sized firms (i.e., firms with capital of less than 1 billion yen). Second, when the underlying assets were pools of bank loans, the borrowers would be those classified as "normal," based on the Financial Services Agency's (FSA's) examination manual, in banks' self-assessment of their loan portfolios.

As for the creditworthiness of eligible ABSs, the staff took into consideration market participants' comments that there were hardly any investors purchasing ABSs and synthetic-type securities with a BB rating or below and therefore the Bank needed to purchase these securities to foster the development of the ABS market. Thus, the staff proposed the appropriate criteria for creditworthiness of eligible securities as follows. First, the securities would be rated BB or higher by all rating agencies (minimum of two ratings). Second, original maturities would be up to three years. Third, proceeds raised through the issuance of synthetic-type securities would be invested in pools of financial assets deemed appropriate by the Bank in terms of their marketability and creditworthiness, for example, JGBs.

The appropriate criteria for creditworthiness of eligible ABCP were as follows. First, CP would be rated a-1 by at least two rating agencies. Second, original maturities would be up to one year. Third, ABCP fully supported by a financial institution that had a current account with the Bank was also eligible (as prescribed in the temporary rules for eligible collateral).

B. Purchasing Procedures

For purchases of ABSs and synthetic-type securities, the staff proposed that, after the initial public offering was closed, the Bank purchase them at the request of the selected counterparties to the amount requested. Purchase prices would be decided based on the public offering. This was because, from the viewpoint of avoiding distortion of the market mechanism, the purchase prices at the public offering would be the only objectively reliable market prices in the current situation. Eligible counterparties would be selected in advance from financial institutions that had current accounts with the Bank's Head Office, mainly based on their creditworthiness.

For purchases of ABCP, the staff proposed that the Bank purchase eligible CP through competitive auctions, since there was a sufficiently large volume of ABCP transactions in the secondary market. Eligible counterparties would be selected in advance from those for CP purchasing operations with repurchase agreements.

C. Maximum Amount of Purchases and Other Issues

Although in the current situation it was still difficult to forecast both the amount of the issuance and the actual amount the Bank would purchase, the maximum amount outstanding of the Bank's purchases would be 1 trillion yen for the time being, as the Bank's financial condition should be secured but at the same time it was appropriate that the Bank set a sufficiently large amount outstanding for the purchases. For ABSs and synthetic-type securities, the amount purchased by the Bank would not exceed 50 percent of each tranche of an issue, in order to avoid distorting the market pricing.

The staff said that it was appropriate that purchases of ABSs by the Bank be a temporary measure terminating at the end of March 2006, since the ABS purchasing scheme was unprecedented for a central bank. The outline mentioned above, including the range of ABSs to be purchased, the purchasing procedures, and the maximum amount of purchases, should be reviewed and changed, if necessary, depending on factors such as development of the ABS market as well as the financial soundness of the Bank.

IV. Summary of Discussions by the Policy Board on Economic and Financial Developments

A. Economic Developments

On the current state of Japan's economy, members agreed that it was not necessary to change the basic assessment that economic activity remained virtually flat as a whole because, although exports were currently showing some weakness, this was a partial materialization of developments which had already been expected, as mentioned in May's assessment that "there is greater uncertainty about the economic outlook."

Most members expressed the view that exports continued to require close monitoring because, although the underlying trend remained flat, they were slightly weak in April, as in the January-March quarter.

Many members commented on the factors behind the decrease in April of Japanese exports to East Asia, which had been showing high growth. One member pointed out the possibility that the U.S. economic slowdown was having an indirect negative effect on Japanese exports to NIEs, and said that close monitoring was required of whether East Asian economies would still be able to maintain self-sustained economic growth even if the U.S. economy slowed. Many members pointed out that the recent gradual materialization of the effect of SARS on East Asian economies could also be having a negative effect on Japanese exports to East Asia.

Many members were concerned to some extent about the decrease in production in April. However, they generally agreed that the assessment of production as continuing to be basically level was appropriate, given the increase in the indices of production forecasts for May and June and as suggested by anecdotal information.

Some members expressed the view that corporate profits continued to be on an uptrend, due partly to progress in corporate restructuring. One member, however, said that the situation of firms with regard to corporate profits was becoming more polarized. Business performance was improving and the break-even point was declining among manufacturers, especially exporting firms, while neither improvement was much in evidence among nonmanufacturers and small firms.

Members generally agreed that business fixed investment continued to be on a gradual recovery trend, although shipments of capital goods declined in April. One member pointed out that large business fixed investment plans had been announced in the IT-related assembly industry, and in addition in materials, the steel industry had already increased business fixed investment. The member also noted that the capacity utilization ratio in other industries had reached the level where business fixed investment would be stimulated. A different member said that exports and production would need to resume their uptrend for the improvement in corporate profits to lead to an increase in business fixed investment.

On the other hand, a different member pointed out that the figures for business fixed investment in the Financial Statements Statistics of Corporations by Industry, Quarterly had turned out to be lower than expected, and expressed concern that business fixed investment could be weakening.

Members agreed that the employment and income situation remained severe. However, a few members said that the deterioration could be expected to slow as corporate profits improved. A different member said that one reason why the positive effects of the improvement in corporate profits were not spreading to household income and private consumption was that the improvement in corporate profits was mainly due to the decline in the break-even point achieved through corporate restructuring.

Members agreed that private consumption continued to be weak. One member said that indicators of private consumption were currently showing somewhat greater volatility, and attention should therefore be paid to the effect on private consumption as households became increasingly aware of the rise in the burden of, for example, increased medical costs arising from the reform of the medical care insurance system.

Regarding price developments, a few members said that, although the decline in the consumer price index (CPI) slowed in April, this was due to temporary supply-side factors, and thus it was unlikely that the rate of decline in the CPI would diminish further, given factors such as the large output gap, the effect of the decline in wages on service prices, and the decline in commodity prices including that of crude oil.

With respect to the economic outlook, members concurred that the basic scenario--an increase in exports and production generating the momentum for a recovery based on a gradual recovery of overseas economies in the second half of 2003--remained valid. One member said that it was, however, likely that in the first half of fiscal 2003 the recent weakness in exports would cause the economy to deviate slightly below the path projected in the "Outlook and Risk Assessment of the Economy and Prices" released in April 2003.

One member said that, given that inventory and business fixed investment had already been constrained due to uncertainty about the economic outlook, it was unlikely that negative shocks would accelerate deterioration of the economy.

With regard to the outlook for overseas economies, many members pointed out as a positive factor for the U.S. economy the rise in stock prices there. These members said that this was mainly due to expectations that recent monetary and fiscal policy measures would be effective, and thus careful monitoring was required of whether economic indicators and firms' business performance actually improved in line with these expectations. One member said that it was becoming more likely that the economy would achieve a steady growth path of 3-4 percent in the second half of 2003, given the depreciation of the U.S. dollar by nearly 10 percent, the effects of tax cuts, and the decline in long-term interest rates.

Many members expressed the view that, although U.S. economic indicators had recovered to some extent, there was no evidence that the momentum for a further increase in production and income was growing. One member said that there were signs that the deterioration in some indicators related to production and employment was coming to a halt.

One member said that risks to the U.S. economy were shifting from exogenous factors, such as the situation in the Middle East and the possibility of terrorist attacks, to ones that were more linked to economic fundamentals, such as the sustainability of capital inflows to the United States and households' heavy debt burden.

With respect to Asian economies, many members agreed that, assuming that SARS was not spreading any further, it was unlikely to have long-term negative effects, but it was nevertheless inevitable that it would gradually have some negative effects for a time. One member said that, if the recovery of the U.S. economy became more certain as expected, this would have a positive effect on Asian economies.

Some members referred to European economies and said that stock prices were increasing reflecting the rise in U.S. stock prices and the interest rate cut by the ECB, but these economies, particularly the German economy, seemed to be showing stronger signs of slowdown due partly to the appreciation of the euro and the effects of various structural problems.

B. Financial Developments

Most members expressed the view that financial market stability had been secured, despite developments such as the problem of Resona Bank. One member said that the Bank's swift policy action not only prevented the money market from becoming unstable, but also gave market participants confidence that the Bank was paying due attention to the financial system. A different member described the current market situation as one in which market participants had an excessive sense of security as a result of the Bank's ample provision of liquidity and safety nets. This member expressed concern that, in this situation, market participants' sensitivity to risk was no longer sharp.

Some members said that due attention should continue to be paid to the risk of financial market instability stemming from the financial system problem.

A different member commented on the positive effects of the Bank's additional provision of liquidity that, together with the effect of foreign exchange intervention, it had been effective in securing the stability of the foreign exchange market, and also the monetary base had achieved a growth rate consistent with the desired nominal GDP growth of 3 percent.

Many members said that the rise in Japanese stock prices was mainly due to purchases by foreign investors against the background of the rise in U.S. and European stock prices. In addition, as factors contributing to the rise in Japanese stock prices, some members pointed out that business performance of firms, particularly exporting firms, was improving, there was an increased awareness of the strong competitiveness of Japanese blue-chip firms in the global market, and the appreciation of the yen was coming to a halt.

Some members commented on the recent global trend of a rise in stock prices and a decline in long-term interest rates occurring simultaneously. They said that this was mainly attributable to the fact that the FOMC issued a public release in May which expressed its concern about the disinflationary trend in the United States and which could be taken as a commitment in terms of policy duration. A few of these members said that in Japan, the portfolio rebalancing effects that were expected from quantitative easing measures might have finally started to materialize.

Many members explained the factors behind the further decline in long-term interest rates in Japan to a historical low and said that banks and institutional investors had been more actively purchasing JGBs and taking more duration risk in the face of limited investment opportunities. One member said that they had also been prompted by the decline in the volatility of interest rates to increase their purchases of JGBs for their risk management.

Some members pointed out that the decline in long-term interest rates was due to expectations regarding the persistence of deflation and the continuation of the Bank's monetary easing. One member said that, even though the Bank had not increased its outright purchases of JGBs, long-term interest rates had declined further because market participants were expecting, based on the Bank's decisive action to deal with the problem of Resona Bank, that the Bank would not allow prices of JGBs to fall sharply.

Many members agreed that close attention was required as to whether long-term interest rates would remain extremely low. One member said that the simultaneous rise in stock prices and decline in long-term interest rates in the United States would not be sustainable, and either stock prices or long-term interest rates would adjust when the direction of the economy, toward either inflation or deflation, became clear. This member added that Japanese banks and institutional investors should pay closer attention to the risk of possible adjustments in long-term interest rates in Japan including the effects of adjustments in long-term interest rates in the United States.

One member said that the further contraction of credit spreads, such as those on corporate bonds, indicated that the corporate financing environment was recovering to such an extent that the effects of monetary easing measures had even reached bonds with a BB rating.

V. Summary of Discussions on Monetary Policy for the Immediate Future

On the monetary policy stance for the immediate future, members agreed that it was appropriate to maintain the current target range of "around 27 to 30 trillion yen" for the outstanding balance of current accounts at the Bank, in view of the following factors. First, the present situation required no change in the Bank's assessment that economic activity remained virtually flat as a whole. Second, although exports were currently showing some weakness, this development had been anticipated at the previous meeting and the Bank had already responded to it preemptively. And third, the money market had been stable in the intermeeting period.

One member said that, as there was still no prospect of overcoming deflation, the Bank should make a credible public commitment in order to realize an increase in the money stock in the future and generate inflationary expectations. Therefore, the Bank should examine basic issues with regard to setting a numerical target for prices to maintain price stability. A different member said that, as the Bank was strongly committed to overcoming deflation, it should further discuss ways to improve the transparency of the conduct of monetary policy from the viewpoint of enhancing its accountability with respect to how it would deal with deflation.

Members next discussed the scheme for outright purchases of ABSs. They basically supported the outline proposed by the staff, and commented on the following points.

Regarding the significance and effects of outright purchases of ABSs by the Bank, members agreed that the emphasis in the scheme was on improving the infrastructure of the ABS market and nurturing it through purchases by the Bank, and the transmission mechanism of monetary easing could be strengthened as a result. One member summarized possible effects as follows. First, banks would be able to release capital that had been allocated to loans and make new loans. And second, a combination of various levels of risk and return would be available and this would encourage more investors to participate in the ABS market, and as a result, the cost of capital for firms would be reduced. A different member expressed the view that development of the ABS market would promote setting of lending rates in accordance with risks involved in loans, which was the most important issue with regard to financial intermediaries in Japan. Moreover, it would provide the prospect of an end to the excessive dependence on indirect financing.

One member said that if liquidation of receivables, which directly benefited small and medium-sized firms, took time to implement mainly due to institutional issues, positive effects of development of the ABS market might be limited for the time being to reducing banks' risk assets. Therefore, the Bank should continue to devise measures that would contribute more effectively to promoting smooth financing of small and medium-sized firms.

With regard to types of assets eligible to be purchased, members agreed that in order to make the proposed scheme effective, the Bank should purchase ABSs with a broad range of underlying assets that were deemed to contribute to smooth financing of small and medium-sized firms. One member expressed the view that the Bank should therefore include synthetic-type securities, whose market was expanding recently, as assets eligible for purchase.

Regarding the staff proposal that the Bank purchase only publicly-offered securities, one member considered this appropriate because the Bank could thus avoid distorting the market mechanism as it would be purchasing only market-priced securities.

As for purchases by the Bank of mezzanine tranches of ABSs, a few members said a scheme that would allow the Bank to purchase not only mezzanine but also senior tranches was desirable to avoid distorting pricing among tranches. In response to this, a few other members noted that, if the Bank included senior tranches in its purchasing, it should bear in mind that its purchases would reduce investment opportunities for investors in the private sector.

Regarding creditworthiness of ABSs, most members agreed that purchases by the Bank of mezzanine tranches of ABSs with a BB rating would be a considerable departure from the terms and conditions for assets eligible to be purchased by the Bank to date. However, in order to foster the development of the ABS market, members agreed that it was appropriate to approve such purchases as an exception on the following conditions: a ceiling should be set for the amount outstanding of purchases of ABSs; and appropriate risk management should be applied by the Bank. This was based on the members' view that, to enhance policy effects, purchases by the Bank of mezzanine tranches, for which there were very few private buyers, were necessary. One member, who was cautious about the Bank's purchases of mezzanine tranches of ABSs with a BB rating, however, agreed with the purchase only on the condition that the Bank reviewed, as deemed necessary, the eligibility for purchase of assets and the maximum amount of purchases taking into account the size of the market and the financial soundness of the Bank. This member expressed the view that the amount of mezzanine tranches purchased was unlikely to be substantial as long as the Bank maintained the purpose of the scheme--to improve the infrastructure of the ABS market and nurture it--and did not set prices higher than the market prices in order to pursue a larger amount outstanding of purchases.

Some members said that careful attention should be paid to how accurately credit ratings reflected risks, as they were the yardstick for judging creditworthiness.

Some other members noted that as the Bank would purchase assets with relatively high credit risk, it should thoroughly examine the accounting treatment of the purchased ABSs, for example, valuation methods and a possible requirement of loan-loss provisioning.

Regarding purchase prices, many members remarked that the proposal was appropriate from the perspective of avoiding distortion of the market mechanism, as it suggested that prices for ABSs and synthetic-type securities should be decided based on the public offering, and those for ABCP should be determined through competitive auctions. A few members, however, said it was important to ensure that prices were appropriately set at the public offering. One of these members said that, when purchasing the publicly-offered securities, the Bank should check whether the remaining securities issued were sold properly to investors.

As for the maximum amount of the purchases, some members said that, although it was difficult to provide a strict rationale for setting the maximum amount of purchases at 1 trillion yen, and the amount was determined based on the judgment that the Bank should set a sufficiently large amount outstanding for the purchases, it was important to set a ceiling for purchases before implementing the scheme in order to secure the financial soundness of the Bank. A different member expressed the view that the total amount outstanding of the purchases would be far below the ceiling level of 1 trillion yen if the Bank purchased only mezzanine tranches, and to enhance risk management the Bank should examine setting a ceiling not only for the total but also for the amount outstanding of mezzanine tranches.

A few members said the staff's proposal that a maximum amount of purchases per issue should be set was appropriate since the risk of distorting the pricing mechanism would be reduced.

Many members commented that the development of the ABS market should be led by the private sector and the Bank should support it when and if necessary. A few members said that to help nurture the market, the Bank should respond flexibly based on the development of the market and market participants' requests. One member commented that it was appropriate that in the staff proposal the ABS purchase scheme was regarded as part of the comprehensive framework to improve the infrastructure of the ABS market and nurture it. This member continued that the member welcomed the staff's plan to work on possible disclosure of data regarding ABSs purchased by the Bank, as this would contribute to the development of the market, and organize a forum where market participants would exchange views from various perspectives.

A few members said that if government financial institutions were to purchase ABSs, it would be necessary to examine the role of government financial institutions and the Bank. One member expressed the view that the Bank's role of taking credit risk in the ABS market should be reduced if government financial institutions entered it.

VI. Remarks by Government Representatives

The representative from the Ministry of Finance made the following remarks.

(1) The state of the Japanese economy remained severe, as seen in the continuing deflation. Concerns over disinflation and deflation were becoming widespread worldwide. In view of the situation, the government was promoting further deregulation and implementing the budget in a timely manner as measures to overcome deflation. In addition, the government was currently formulating the "Basic Policies for Economic and Fiscal Policy Management and Structural Reform 2003."

(2) The Bank would decide, at this meeting, the outline of the scheme for outright purchases of ABSs with underlying assets mainly related to small and medium-sized firms, taking account of comments received from market participants. The government would like the Bank to start purchasing ABSs as soon as possible after it had made the necessary practical arrangements, and hoped that this would help secure smooth corporate financing and stimulate the flow of funds in the economy. Since the new scheme was also aimed at contributing to the development of the market for liquidation of assets, the government would like to ask the Bank to deal with issues related to its development, by for example, reviewing the framework in line with future development of the market.

(3) The government would also like the Bank to devise measures for more effective liquidity provision, both in terms of quality and quantity, so that funds would flow smoothly into households and firms and throughout the economy, and also implement more effective monetary easing measures.

(4) The representative stated his personal view that private financial institutions were not sufficiently fulfilling the role of providing funds to small firms. The representative continued that he would like the Bank to contribute to encouraging them to delegate to their branch managers the authority to extend loans, and to promoting project finance.

The representative from the Cabinet Office made the following remarks.

(1) The second preliminary estimates of GDP for the January-March quarter of 2003 were released on June 11, 2003. Growth of real GDP was revised to an annualized rate of 0.6 percent from the previous quarter, and to 0.1 percent on a quarter-on-quarter basis. The decline in nominal GDP was revised to an annualized rate of 1.5 percent from the previous quarter, and to 0.4 percent on a quarter-on-quarter basis. The rate of the decline in the GDP deflator from the same period of the previous year was revised to 3.3 percent. This confirmed that in the Japanese economy deflation continued, a self-sustained recovery led by domestic demand had not yet started, and structural reform was still underway.

(2) It was necessary for the government and the Bank to work together to make the inflation rate positive as soon as possible. The government would accelerate structural reform in which an expansion of private demand and employment was prioritized, thereby realizing sustainable economic growth. To this end, the government was formulating the "Basic Policies for Economic and Fiscal Policy Management and Structural Reform 2003," which included policies for overcoming deflation and revitalizing the economy, at a meeting of the Council on Economic and Fiscal Policy and intended to release it by the end of June.

(3) The Bank had been examining the basic framework for the conduct of monetary policy since March 2003, and as part of the process, it discussed the outline of the scheme for outright purchases of ABSs earlier in the meeting. In order to overcome deflation in fiscal 2005, the government hoped that the Bank would engage in further deliberation on monetary policy measures, including reviewing the basic framework for the conduct of monetary policy, and implement ones that were effective in overcoming deflation.

VII. Votes

Based on the above discussions, members considered that it was appropriate to maintain the current guideline for money market operations.

With regard to outright purchases of ABSs, members agreed that the Bank should conduct such purchases based on the outline proposed by the staff.

To reflect this view, the chairman formulated the following two proposals and put them to the vote.

The Chairman's Policy Proposal on the Guideline for Market Operations:

The guideline for money market operations in the intermeeting period ahead will be as follows, and will be made public by the attached statement (see Attachment 1).

The Bank of Japan will conduct money market operations, aiming at the outstanding balance of current accounts held at the Bank at around 27 to 30 trillion yen.

Should there be a risk of financial market instability, such as a surge in liquidity demand, the Bank will provide more liquidity irrespective of the above target.

Votes for the proposal: Mr. T. Fukui, Mr. T. Muto, Mr. K. Iwata, Mr. K. Ueda, Mr. T. Taya, Ms. M. Suda, Mr. S. Nakahara, Mr. H. Haru, and Mr. T. Fukuma.

Votes against the proposal: None.

The Chairman's Policy Proposal on Outright Purchases of ABSs:

As a result of examination in line with "Examination of Possible Purchase of Asset-Backed Securities" (Policy Board Decision on April 8, 2003), the Bank has decided to purchase ABSs in accordance with the attached statement, "Outline of the Outright Purchase Scheme for Asset-Backed Securities," and will work on necessary arrangements so that the new scheme is put in place by the end of July 2003 (see attachments 2 and 3).
A public statement concerning the above proposal will be decided separately.
A summary of comments received from market participants and the Bank's response to them will be made public.
The Governor will decide on the content of the release prescribed in item 3 above.
Votes for the proposal: Mr. T. Fukui, Mr. T. Muto, Mr. K. Iwata, Mr. K. Ueda, Mr. T. Taya, Ms. M. Suda, Mr. S. Nakahara, Mr. H. Haru, and Mr. T. Fukuma.
Votes against the proposal: None.

VIII. Discussion on the Public Statement

Members discussed the draft of the public statement prepared by the staff regarding the decision of the Policy Board on outright purchases of ABSs, and put it to the vote. The Board approved "Purchases of Asset-Backed Securities" by unanimous vote and decided to release it immediately after the meeting (see attachments 2 and 3).

Votes for the proposal: Mr. T. Fukui, Mr. T. Muto, Mr. K. Iwata, Mr. K. Ueda, Mr. T. Taya, Ms. M. Suda, Mr. S. Nakahara, Mr. H. Haru, and Mr. T. Fukuma.
Votes against the proposal: None.

IX. Discussion on the Bank's View of Recent Economic and Financial Developments

Members discussed "The Bank's View" of recent economic and financial developments, and put it to the vote. By unanimous vote, the Policy Board decided to publish "The Bank's View" on June 12, 2003 in the Monthly Report of Recent Economic and Financial Developments (consisting of "The Bank's View" and "The Background").⁸

8The original full text, in Japanese, of the Monthly Report of Recent Economic and Financial Developments was published on June 12, 2003 together with the English version of "The Bank's View." The English version of "The Background" was published on June 13, 2003.

X. Approval of the Minutes of the Monetary Policy Meeting

The Policy Board approved unanimously the minutes of the Monetary Policy Meeting of April 30, 2003 for release on June 16, 2003.

Attachment 1

For immediate release

June 11, 2003
Bank of Japan

At the Monetary Policy Meeting held today, the Bank of Japan decided, by unanimous vote, to set the following guideline for money market operations for the intermeeting period:

The Bank of Japan will conduct money market operations, aiming at the outstanding balance of current accounts held at the Bank at around 27 to 30 trillion yen.

Should there be a risk of financial market instability, such as a surge in liquidity demand, the Bank will provide more liquidity irrespective of the above target.

Attachment 2

For immediate release

June 11, 2003
Bank of Japan

Purchases of Asset-Backed Securities

At the Monetary Policy Meeting (MPM) held today, the Bank of Japan decided the outline of the scheme for outright purchases of asset-backed securities (ABSs) as shown in Attachment 3. Based on the outline, the Bank will work on necessary arrangements so that the new scheme be put in place by end-July 2003. The Bank has reached today's decision after it continued to examine the possible purchases of ABSs since the MPM held on April 7-8, taking account of comments received from market participants.
ABSs are expected to contribute to promoting smooth corporate financing by reducing credit risks through their diversification as well as by reallocating credit risks to investors with various risk preferences. The Bank judged that it can play an important role in encouraging the development of the ABS market by directly taking credit risks through purchases of ABSs as a temporary measure. By encouraging the development of the ABS market through this unprecedented scheme for a central bank, the Bank could strengthen the transmission mechanism of monetary easing against the background of banks' weak financial intermediary function.
In designing the scheme, due attention was paid so that the Bank's purchase would contribute to sound development of the ABS market, without distorting market mechanism. In order to make this scheme most effective, the Bank purchases various types of ABSs as eligible assets, including those with relatively higher credit risk. The Bank purchases ABSs with a broad range of underlying assets, including loans and receivables, if they are deemed to contribute to smooth financing of small and medium-sized enterprises. The Bank sets the maximum amount outstanding of purchases at one trillion yen for the time being in order to give maximum support to the development of the ABS market while maintaining the financial soundness of the Bank.
The improvement of the market infrastructure is essential for further development of ABSs. The Bank will continue to make efforts in order to improve the infrastructure of the ABS market in cooperation with market participants, taking their comments into account. The Bank will work together with relevant authorities and government financial institutions for supporting the effort of market participants.

Attachment 3

Outline of the Outright Purchase Scheme for Asset-Backed Securities

1. Eligible assets to be purchased

(1) Types of eligible assets

Asset-backed securities (publicly-offered)
Synthetic-type securities (publicly-offered credit-link notes)
Asset-backed commercial paper (including dematerialized commercial paper)

(2) Eligibility criteria

[1] Characteristics of securities

Securities shall be denominated in Japanese yen.
Securities shall be issued in Japan.
Securities shall be governed by Japanese law.

[2] Underlying assets

Underlying assets^* shall be those deemed to contribute to smooth financing of small and medium-sized enterprises. The eligible assets shall not be limited to loans or receivables.
- In the case of synthetic-type securities, "underlying assets" mean pools of assets whose credit risk is transferred by financial transactions such as credit derivatives.
50 % or more of the value of underlying assets shall be composed of assets related to small and medium-sized enterprises (i.e. enterprises with capital of less than 1 billion yen).
When underlying assets are pools of bank loans, their borrowers shall be those classified as "normal" based on the FSA's examination manual through banks' self-assessment of loan portfolio.

[3] Creditworthiness

(a) Asset-backed securities and synthetic-type securities

Securities shall be rated BB or higher by all rating agencies (minimum of two ratings).
Original maturities shall be up to three years.
Proceeds raised through the issuance of synthetic-type securities shall be invested in pools of financial assets deemed appropriate by the Bank in terms of their marketability and creditworthiness (e.g. JGBs).

(b) Asset-backed commercial paper

Commercial paper shall be rated a-1 by at least two rating agencies.
Original maturities shall be up to one year.
Asset-backed commercial paper fully supported by the financial institutions that have current accounts with the Bank may also be eligible (as prescribed in the temporary rules for eligible collateral).

2. Purchasing procedures

(1) Asset-backed securities and synthetic-type securities

After an initial public offering is closed, the Bank will purchase the requested amount of the securities from the selected counterparties at their request. Purchase prices shall be decided based on those applied for the public offering.
Eligible counterparties shall be selected in advance from the financial institutions that have current accounts with the Bank's Head Office, mainly based on their creditworthiness.

(2) Asset-backed commercial paper

The Bank purchases eligible commercial paper through competitive auctions.
Eligible counterparties shall be selected in advance from those for the purchase operations of commercial paper with repurchase agreements.

3. Maximum amount of purchases

(1) Total amount outstanding

For the time being, the maximum amount outstanding of the Bank's purchases shall be 1 trillion yen.

(2) Limit per issue

For asset-backed securities and synthetic-type securities, the amount purchased by the Bank shall not exceed 50% of each tranche of an issue.

4. Others

This purchase scheme shall be valid until end-March 2006.
The outline mentioned above, including the range of asset-backed securities to be purchased, the purchasing procedures, and the maximum amount of purchases, shall be reviewed and changed, if necessary, depending on factors such as development of the asset-backed securities market as well as the financial soundness of the Bank.