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Japan's promise - and
problems
By John Berthelsen
There is very little but euphoria today over the
performance of Japan's benchmark Nikkei index of 225
stocks, which rocketed upward by 45 percent over the
past four months, making it one of the world's
best-performing equity markets. That the market has
fallen back over the past week on yen fears hardly
tempers the excitement.
There is added euphoria
over the re-election last week of Liberal Democratic
Party president and Prime Minister Junichiro Koizumi
with 61 percent of the vote in his party. Now, according
to a wide variety of commentators, Koizumi will be able
to take the action that has eluded him for the past
three years in restarting Japan's economy. Already, he
has replaced the finance minister with a strong ally and
placed other allies in strategic ministries.
But
the fact is that Japan's financial system is a chamber
of horrors and its long-term fiscal outlook, though
growing slightly better, is staggeringly bad and appears
to be based in large part on exports to recovering
Western markets. If the US were to stumble, Japan faces
yet another setback, Koizumi or no. There is plenty that
can go wrong before Japan regains its turbo economy.
The Japanese themselves seem to know this and
appear to have been staying out of their own market,
while foreign institutional ownership of Japanese stocks
is skyrocketing. Fujio Mitarai, president and chief
executive of Canon, the office-equipment maker, was
quoted last week as saying that, although the market is
largely driven by foreign investors, this is creating
the psychological boost essential to the recovery. The
gaijin think they have found a gold mine.
This is not the first time that equity markets
have come unhooked from reality; witness the recent US
experience from 1995-2000, when the Dow Jones Industrial
Average roughly quadrupled in value. Nor will it be the
last, and it is a continuing lesson that markets have
little to do with present real economic performance as
they look forward to future possibilities. They run on
sentiment and fear, Adam Smith to the contrary, and they
inevitably overshoot. But in the meantime, lots of
people make lots of money on the greater-fool theory,
which holds that you can always find a sucker to sell to
in order to get out in time.
Although the market
has been reacting to reports that Japan had been growing
faster than the United States for the first time since
1991, newly revised second-quarter gross domestic
product (GDP) figures indicate that real growth was
almost certainly much lower than the annualized 3.9
percent announced early this month, and actually was
probably somewhere in the neighborhood of 2 percent. The
Bank of Japan (BOJ) said on Tuesday that a record 51
percent of households have taken money from savings so
far this year, and that 22 percent of Japanese -
traditionally the world's most thrifty savers - have no
savings at all.
That shows that Japan's
sustained recovery may not be as fast as some
skyrocketing stocks indicate, after the equity markets
had been at dismal levels for more than a decade. The
GDP deflator has been negative since 1995 and, as a
result, the economy is smaller today than it was in
1997.
"The capital position and profitability of
the banks and life insurers are weak, and non-performing
loans, while declining, remain high," the International
Monetary Fund (IMF) said in a wide-ranging report issued
this month. "In addition, the financial institutions are
exposed to significant market and credit risks. As a
result, financial sector weakness has held back
prospects for a sustained [economic] recovery."
While Japan's financial system is fragile and a
systemic crisis now seems unlikely, the report
continues, "expeditious and forceful action is required
to avoid further deterioration". And, while Koizumi has
started his new tenure with dramatic action, it remains
to be seen whether he can sustain it in the face of
widespread opposition on the part not only of the
dinosaurs in his Liberal Democratic Party but of lots of
other vested interests in Japanese society. Other than
having extraordinarily unconventional hair for a
Japanese politician, his previous reform policies have
largely been abandoned either voluntarily or in the face
of concerted opposition within his own party.
Will the market continue to soar in the face of
this bleak assessment? If Asia's equity analysts have
anything to say about it, it probably will. The equities
strategists and economists covering Japan sharply
increased the consensus forecast after second-half GDP
statistics were released. The TOPIX index promptly hit
three-year highs before profit-taking set in,
nonetheless still managing to record a very healthy 2.7
percent gain over the week.
"Given the consensus
view, there is more scope for expectations about Japan
to be exceeded than is left for the US or Europe," said
a recent report by CLSA in Hong Kong.
JP Morgan
Fleming Asset Management agrees. A July research note
pointed out: "We continue to believe that there will be
further upgrades to profit forecasts in September and
October, as previous forecasts were quite conservative,
while recent economic data [have] shown signs of a
further acceleration in industrial activity. News flow
remains supportive and new ideas keep appearing, but the
strength of the yen may be a short-term risk."
However, for instance, the market was brought up
short this week by the currency markets, which
increasingly believe that the BOJ, which so far this
year is believed to have spent at least US$75 billion on
US treasuries to intervene to stem the yen's rise
against the dollar, may slack off buying, at least
temporarily. The dollar immediately dived to a
two-and-a-half-year low against the Japanese currency,
trading as low as 110.5 yen briefly.
There is a
growing danger that if the BOJ doesn't act before
September 30, the fiscal half-year point next week,
currency traders could go after the yen in a big way,
forcing the Bank of Japan to intervene decisively. For
instance, HSBC believes that the rising domestic economy
and firm asset prices will preclude yen intervention.
HSBC's year-end target for the yen is 107 to the US
dollar.
It is questionable how far the yen might
rise before it begins to threaten the fragile export-led
recovery. With short-dollar, long-yen positions growing,
according to the Financial Times, there is the
possibility of a massive wave of BOJ-sponsored yen
selling to catch the market off guard and force the
dollar sharply higher.
While the Japanese
authorities have taken important regulatory and legal
steps to strengthen the financial sector, and banks have
attempted to improve their capital adequacy, raise
provisioning and accelerate the disposal of
non-performing loans (NPLs), "it has become clear that
financial institutions have not been able to solve the
problems on their own", the IMF says, noting:
The banking system's capital cushion has been run
down to minimal levels, and most new capital has been in
the form of interest-bearing paper that is not the basis
for stronger balance sheets.
Life-insurance companies are under considerable
stress as a result of the declines in investment income
and stock prices, which have weakened their capital
base.
The corporate sector is highly leveraged and
deflation has increased the real burden of debt.
On a macroeconomic basis, land values remain weak,
reflecting the sluggish economy and overhang in the
real-estate market. Despite the broad run-up over the
last seven months, the Nikkei index of 225 stocks is
hovering near 11,000, hardly more than a third of the
38,000-plus where it closed in 1989.
Although Japanese banks have disposed of more than
90 trillion yen worth of non-performing loans amounting
to 16 percent of GDP since 1992, official NPLs still
account for more than 8 percent of outstanding loans as
new problem loans continue to emerge.
Return on assets (ROA) on an operating-income basis
in the corporate sector has remained flat since 1993. To
compare this with other Group of Seven countries, ROA in
Japan is about half to a quarter that of Canada, the
United Kingdom and the United States.
In another
IMF report issued this month on selected issues facing
the health and vulnerability of the Japanese economy
overall beyond the financial sector, a team of five
economists wrote that "we find that weak companies
account for a significant portion of total debt and
continue to make losses".
In 2002, despite
record negative real interest rates, companies with
non-performing debt accounted for 16 percent of Japan's
total debt, while those with losing money on operations
accounted for 10 percent of total debt. A quarter of
those weak companies had reported negative operating
profit for two years or more. While debt-to-equity
ratios in the corporate sector have fallen from a peak
of 287 percent in 1975 to 155 percent in 2002, debt
leverage is still breathtaking. That 155 percent
compares with an average of 80 percent in Germany, 70
percent in the US, and 45 percent in the UK.
The
fund managers are investing in individual companies, for
which they have research reports of fast growth
prospects, but the overall scenario is thus hardly
encouraging for the time being. The financial sector is
still weak, land prices have not recovered much and
several companies are still in need of restructuring to
make themselves profitable.
As Jamie Miyazaki
wrote for Asia Times Online on September 23 (Barbarians at the gate, vultures
overhead), the Industrial Revitalization Corp of
Japan (IRCJ), established in May as a kind of answer to
the Resolution Trust Co that cleaned up the debris of
the United States' savings-and-loan scandal, so far
looks ineffective.
The announcement this month
of the first batch of firms that the IRJC intends to
help restructure may indicate a new willingness by Japan
to tackle failing firms, or it may not. Its initial five
candidates for cleanup and their relatively small size,
with the exception of Mitsui Mining, may signal that the
IRCJ will function as a hospital for zombie companies
instead of a graveyard. No firms from Japan's TMT
manufacturing sector, which probably stand the best
long-term chance of revitalization, appear on the IRCJ's
initial candidate list.
There have been some
tough decisions made, particularly in allowing Resona
Bank, Japan's fifth-largest, in effect to go to the wall
in April, resulting in its de facto nationalization. The
markets seem to believe that this kind of reform will
continue, that privatization will pick up speed and that
business deregulation will move forward as well.
But it would be wise to remember just how far
Japan has to travel through some considerable thickets
before it gets where it has to go. Annualized 2 percent
GDP growth, in a fragile economy whose population is
aging inexorably with little chance of immigration to
revitalize it, does not translate into sustained 45
percent annual performance for the markets.
(Copyright 2003 Asia Times Online Co, Ltd. All
rights reserved. Please contact content@atimes.com for
information on our sales and syndication policies.)
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