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Japan's economy still has a
pulse
By Charles Olson
TOKYO
- Why isn't Japan broke? It has faced a litany of
disaster since 1989 when the stock market collapsed to
less than a quarter of its value today. The world's
second-biggest financial system has suffered through
four recessions, defying all attempts by a continuing
series of inept governments to restart the economy,
which is now in seemingly permanent deflation. Despite
disposing of more than 60 trillion yen (US$500 billion)
in dud loans, "Japan's banks now face a more severe
challenge than ever, given the decline in their
financial strength and earning power," according to the
Bank of Japan in a report last August.
"There is
a whole chunk of the population that is behaving like
people who know they are going to be fired but who have
to dress up and put on suits and come in each day," says
a researcher for a US think-tank.
But the bars
and restaurants in Tokyo's Roppongi nightclub district
continue to be packed. Tokyo remains for the most part a
tidy, prosperous-looking city. Japanese tourists bound
for overseas have increased in 26 of the past 39 months,
according to the Japan Tourism Marketing Co. Until
Asia's severe acute respiratory syndrome (SARS) scare,
they thronged Hong Kong's upscale shopping meccas,
snapping up Gucci and Louis Vuitton bargains at the
Peninsula Hotel and haunted the shops in Pacific Place.
Some 3.62 million Japanese visited the United States in
2002, which while down from the previous year is still a
significant number. Some 3.83 million Japanese have
already toured abroad so far in 2003, up 2.3 percent
over 2002, until fears of SARS drove their number down
sharply in April.
While the Nikkei index of 225
stocks hit a 21-year low on March 31 at the end of the
fiscal year, having fallen from 38,915.87 in 1989 to
below 8,000 today, profits are rebounding sharply
outside the financial sector. There is still no end in
sight to the problems of bank solvency, credit
availability and deflation, which are moving into their
second decade. And part of the recovery is due to a
weaker yen against the dollar, which may get reversed as
the US looks for ways to stimulate its own economy.
Nonetheless, auto companies are reporting record profit
levels and other exporters have benefited from what the
weak currency. Even the steel industry is looking
better, and some companies never went bad in the first
place. The size of Japan's economy keeps on providing
salaries even when the market and profits are sending
distress signals.
The disconnect between share
prices and corporate profits may largely be a result of
the strange mechanics of corporate participation in the
stock market, from intensive crossholding relationships
to a recent failed attempt to take over funds from the
public pension funds. A Nikkei survey of non-financial
companies at the end of the March fiscal year suggests a
V-shaped recovery. The surveyed 1,623 companies are
expected to post net profits of 6.22 trillion yen
(US$51.8 billion) for the year ending in March - after a
$1.7 billion net loss the previous year.
Much of
Japan isn't broke, and many of its companies never lost
money. Toyota continues to set record profits, while
Nissan has exceeded its targets for its turnaround. A
weaker yen, despite its recent rebound against the US
dollar, has helped the auto sector and boosted the
profits of the likes of Canon and Ricoh, two technology
stocks with strong-market positions in digital cameras
and office equipment. Demand from China and firmer
domestic prices also helped the steel industry as
production rose to 21-year highs, so that even this
classic heavy industry is showing the benefits of
restructuring.
It isn't just the exporters.
Sundries-maker Kao is expected to report record net
profit for the year as they have regularly done for more
than a decade, with a 15 percent return on equity and an
increased dividend. Even some companies such as KDDI,
with heavy exposure to the overbuilt international
telecoms market, is considering a dividend increase.
So why the gloom? Why does the stock market
continue to hit the lowest levels in two decades?
Not all stocks have been going down. The
small-stock sector of the Nikkei first section has been
rising steadily since the beginning of the year, while
the larger stock indexes have plunged. A lot of the
selling has been blamed on several trillion yen worth of
funds that are being returned to public pension funds.
Several years back, corporations thought they could
out-invest the public pension funds, so they took over
part of the public money. Investment results have been
painful for the past several years. However, because the
public funds had restrictions on how the funds were to
be returned, stock was being sold to raise cash for the
returns. Recent politicians' comments of easing
requirements may have helped push the index back up over
8,000.
Other selling probably has occurred as
companies reduce stock holdings to avoid exposure to
declining valuations of their stock holdings. Increased
demand for truth in reporting has resulted in larger
write-downs of stock holdings that have lost half their
value. The 1,623 companies in the above Nikkei survey
lost 12 percent of their expected net profits (a $7.2
billion loss) because of write-downs of stock assets
when the market hit its low on the last day of the
fiscal year.
Other items, such as liabilities
for pensions and reduction of deferred tax assets, have
eroded balance sheets, along with large restructuring
charges, pushing equity levels remarkably low for even
the once-powerful NEC and Fujitsu.
But with
operating rates in the manufacturing industry at 96
percent, Japan's businesses seem to be worth saving. It
is harder to say the same about the banks, which
squeaked through the fiscal year end with passable
capital adequacy ratios, mainly by selling more of their
own shares. This helped the politicians keep Prime
Minister Junichiro Koizumi's financial attack dog,
Economic and Fiscal Policy Minister Heizo Takenaka, from
nationalizing the banks, at least for the time being. So
maybe the center will hold long enough for the rest of
the economy to recover some vigor.
Another
overblown area of concern is the 2003 office building
"crisis" resulting from a glut of new office space
coming on to the market. While it may create some
suffering for existing building owners and sweat for
their creditors, bringing office space vacancies to 8.2
percent from near nothing in the bubble period is a
healthy sign for businesses who are benefiting from
lower rents. Land prices have been falling for 12 years
from strangulation levels, with the National Land Agency
announcing in March a 5.8 percent drop in residential
and an 8.0 percent drop in commercial land nationwide in
the last year. Market-clearing in property rents is
essential to these businesses as they seek to become
competitive.
Japan has serious problems with its
public debt, problems of funding pension plans, and
underemployment, but the large part of the population
not directly affected immediately are free to go on
spending, buying expensive brand items, traveling
overseas, and living life. Life is too short to stop
living because of pension uncertainties, especially for
those under 40.
Outsiders who are surprised at
the liveliness of Japanese shopping areas and
restaurants despite all the bad news forget just how
large the economy of Japan is, and how deep its economic
assets go. Housing stock, which continues to grow and
improve, is an example. Low interest rates and falling
land prices make homes more affordable, improving
disposable income. The family that bought during the
bubble may still be saddled with negative equity, but at
the margin, more housing in more convenient locations
continues to be built. And the economic benefit, felt by
the individual, doesn't necessarily show up in a growing
gross domestic product (GDP).
Of course, no area
points up the differences between the haves and the
have-nots in Japan as does housing. Years ago, Japan
prided itself as the most middle-class of all nations.
In response to questionnaires, 90 percent responded that
they were middle-class. That fiction, like many other in
Japan, is becoming harder to maintain. Nowhere is it
more striking than in the view from the $1,000-a-night
suites at the Hyatt Park Hotel in Shinjuku. Below,
stretching behind the Tokyo Metropolitan City
headquarters, is Shinjuku Central Park. From the 38th
floor, the park appears to be a lovely green patch
surrounded by tall buildings. But a walk in it brings
one face to face with the squatters who are adapting in
their own way to tougher times. For here is a new class
that can't quite be called homeless, because they return
every night to their shelters built of cardboard and
blue plastic. Some have been doing it for years. And
high above, at the New York Grill, office ladies who
have moderate salaries are enjoying the luxury of the
$50 luncheon buffet. Living in Japan accustoms one to
these contrasts.
Nowhere is Japan's love of
luxury, design and simple newness more clear than in the
newly opened Roppongi Hills. Visitors are flooding to
the 54-floor office tower and complex that seems to
stand alone, with companion buildings, above a lowrise
horizon. Every tasteful texture of stone, glass, wood,
stainless steel and water has been used to provide a
Disneyland of views and angles that contain yet another
maze of design shops and designer restaurants. And yet
the sheer enthusiasm of the place reflects the energy of
all the people who walk through it, ready to enjoy the
latest new space that says to them, enjoy it - you
deserve it.
Of course, the problem for the
owner, Mori Building, is filling the office space above
the shops. Rumors are that the real-estate group is
moving its own subsidiaries in to keep the lights on,
and that after September 11, 2001, major occupant
Goldman Sachs tried to get out of its commitment to move
in.
Where else is the evidence of Japan as a
basket case? Total unemployment has held steady at
around 5.4 percent for a year, not much worse than the
4.7 percent in 2000. Job offers to applicants sit at
around 0.60, not far off the historical average, while
overtime hours have been climbing and are 6 percent
above last year. Somebody is starting to work hard.
In addition to strong operating rates overall,
semiconductor production is up 25 percent from last
year's disastrous levels. And the manufacturing industry
is expected to increase capital spending slightly this
year, for the first time in several years.
So
where is the problem? It is a vicious circle of falling
asset prices, suffering banks and clueless politicians.
In Japan, many things have delayed the facing of the
music and extended the downside. Politicians are the
major authors of delaying tactics to resist drastic
solutions, preferring schemes to prop up prices or
limiting the amount of write-downs. A dozen years after
the bubble, proposals to use public money to support the
stock market are still being given coverage in the
press.
Of course, deflation and hyper-low
interest rates make it difficult for banks to turn
around their business, even if they receive their funds
for next to nothing. So they enter "new" areas, such as
trying to expand home loans to individuals or get into
the securities business. But every time they turn
around, falling asset prices have again threatened their
capital adequacy, and they either have to raise new
equity or call back loans from small and medium
business, threatening a credit crunch in that important
sector. Outstanding loans have been shrinking between 4
and 5 percent a year for the past three years, although
it is not clear how much of this is due to writeoffs of
bad loans, and how much is due to squeezing new ones.
And then there is the government, always close
to being a basket case. With falling tax revenues, bond
issuance is being pushed to record levels, pushing the
problems into the future. Hunger for investors has
reached such levels that unsuccessful attempts have even
been made to sell the government's 10-year bonds to
individuals.
A bold move to force
nationalization of the banks, which some foreign
investors thought could finally lead to a real V-shaped
recovery, was blocked by an army of politicians
mobilized by their friends in the banks, and the reform
government of Koizumi backed off. In a similar vein,
Koizumi has not made a lot of progress with other areas
of fiscal reform. The best that can be said of him is
that so far he has survived.
So where does Japan
go from here? Deflation can be strange. Is an average
dividend yield of 1.2 percent on the stock market
sufficient to draw investors who can get barely anything
on a bank account? It is twice the yield on the long
bond. And Japan moved faster than the US in cutting
taxation on dividends. If firmer earnings mean more
confidence that dividends won't be cut, maybe the market
could establish a floor before as investors look for
yield from stocks. A stock market that is no longer
falling would take pressure off corporate profits and
the banks' capital ratios. Then maybe the economy could
go back to normal for a while.
It is hard to
say, but Japan still has an economy large enough to bear
even further pain and still provide income to those who
are perfectly happy to spend it on a good meal or a
designer bag, or for that matter a lot of other goods
and services that can be purchased in this large
economy. Japan isn't dead yet.
Chuck
Olson has lived in Tokyo for 28 years. He is a
freelance equity research analyst and former Internet
chief financial officer, investment professional and
industrial consultant.
(Copyright 2003 Asia
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