J@pan Inc Magazine Presents:
M O N E Y W A T C H
Weekly Financial Commentary from Tokyo
Issue No. 1
Thursday, October 16, 2002
Welcome to the premiere issue of Moneywatch, the newest member of our
growing family of free email newsletters. Each week, we'll bring you
insightful commentary on Japan's financial markets. Moneywatch will
be posted on the J@pan Inc Web site and soon you'll be able to have it
delivered directly to your inbox. We welcome your feedback.
-- The editors
Viewpoint: Root for the Winners, not the Losers
The Bottom Line
o Since 1990, when Japan's financial bubble market burst, Japan
has been suffering a "disease" of social and political denial
in the face of serious structural problems that, while
threatening in the long run, have not yet destroyed its basic
prosperity. The Bank of Japan's surprising action and signs
that the government is finally ready to take the bull by the
horns have been a rude wake-up call. That is, it is directly
challenging the myth that Japan can somehow muddle through all
of this without serious pain. The collapse of this myth is why
the stock market has reacted so negatively.
o Cleaning up the banking sector is no guarantee of a happy
ending for Japan's economy. A gloomier assessment is that the
Japanese disease goes deeper than bad loans. The
current theory is that eliminating the bad loans and the dead
wood behind them would make the remaining firms more
profitable. The surviving companies would increase
investment and employment, while banks would be able to
finance expansion with creditworthy borrowers, thus improving
o In reality, there is no need to stop at the banks. The Koizumi
administration needs to formulate policies that basically
represent a 180 degree turn from previous policies, i.e., to
help Japan's most competitive companies maintain their global
competitiveness, rather than nursing the losers that are
currently sucking the life out of Japan's economy.
Government Behind the Market Eight Ball
Since the Japanese stock market peaked in December 1989, Japan has
been suffering a "disease" of social and political paralysis in the
face of accumulating economic problems that, though threatening in the
long run, haven't yet destroyed the country's outward prosperity.
Fearful of change, the Japanese have pretended that these problems
would solve themselves and go away. Last week, the Nikkei 225 index
slid to a new low 8,197, the lowest it's been since March 1983, the
year when Japan's previous bubble of excess capital values was
generally believed to have begun. Net selling by foreign investors --
who, because domestic institutions have been on the sidelines or
forced sellers, have been accounting for an increasing amount of
trading value -- reached a record 1.213 trillion yen last month -- and
that was before Japan's stock market was spooked by the appointment of
bank reform hawk Heizo Takenaka as financial services minister.
The sharp slide in stock prices last week had the government in
near-crisis mode, as with each new post-bubble low came cries of "do
something" within the LDP and among business leaders. No one is
feeling the market heat more than Heizo Takenaka, whose "tough love"
comments and hardliner adviser appointments ostensibly set off the
latest wave of selling.
Basically, the market is discounting a scenario whereby the banks
really push to clean up their loan books and cut loose their dud
borrowers. In the process, the government will likely have to shut
down a bunch of bad banks and re-capitalize the ones that survive.
According to Teikoku Data Bank, there are about 200,000 financially
strapped companies with a total of 135 trillion yen in bad loans in
Japan. The bulk of these could fail in the next two years, pushing up
total bankruptcies to five times the current failure rate.
Undoubtedly, this will significantly exacerbate already virulent
deflation. Some economists claim that if Japan pushes to clean up the
banking sector, it will need 30 trillion yen to offset the
deflationary pressure on the economy.
Heizo Takenaka's Detractors
As the pressure increased for the Koizumi administration to produce
more tangible results from its so-called reform agenda, Hakuo
Yanagisawa of the Financial Services Agency became the scapegoat for
the reformist hawks. After the latest Cabinet reshuffle, Yanagisawa
was out, and the hawks, led by Takenaka, were apparently given the
ball to run with. However, while the ink on the economic and finance
minister's new name card is barely dry, he is already running into a
lot of flack from within the Liberal Democratic Party, the Bank of
Japan, the Ministry of Finance and even PM Koizumi himself. Koizumi
had counted on the surprise announcement of Takenaka as finance
minister to lend credibility to his administration's claims that it is
serious about cleaning up the banking mess. He was right about that.
But as soon as Takenaka began speaking about his plans to clean up the
banking sector, the stock market began to sell off.
The three "pillars" of the Takenaka philosophy are: more stringent
loan book audits; capital infusions for banks that require it; and
strengthened banking governance. The ostensible plan was to offset the
damage of accelerated bad loan liquidations with tax cuts and a
At a meeting of the Council on Economic and Fiscal Policy last week,
Takenaka tried to get an agreement to expand the planned tax cuts in
exchange for dropping the corporate tax cut proposal. As he sees it,
focused tax breaks in areas like property and housing are effective
countermeasures. As usual, however, the resistance to tax breaks
inside the Ministry of Finance runs deep. Not only could new tax break
measures be delayed, there is no agreement on the specifics of such a
plan. In other words, specific tax breaks may well not be included in
the much-awaited "integrated package" of anti-deflationary measures.
The Bank of Japan also rebuffed Takenaka when he met with BOJ governor
Masaru Hayami and asked him to seriously study inflation targeting.
Moreover, Koizumi himself ruled out making a proposal to the Diet for
a supplementary budget for the time being. Instead, he suggested that
a supplementary budget would be presented in January, after watching
what happens in December.
In other words, there are a lot of people in the BOJ, the MOF and the
LDP who would like to see Takenaka fail. The government set Oct. 17 as
a deadline to nail down its strategy to cushion the anticipated impact
of its full-scale assault on banks' bad loans, but Takenaka is already
indicating this may be delayed. These countermeasures will ostensibly
center on financial system reform but also include measures for tax
breaks and job-creation.
The not-so-hidden agenda of the "go-slow" proponents in the government
and the LDP is indirect capital infusion for the banks, i.e., having a
supercharged Resolution and Collection Corp. purchase the bad credits.
Moreover, without effective deflationary countermeasures, the pressure
would then shift to a more watered-down bad debt cleanup, which is
what Takenaka's detractors had been pushing for all along. In other
words, Takenaka is fast becoming the scapegoat for the "go slow"
proponents. Last week, Mitsui Horiuchi, LDP General Council chairman,
lambasted Takenaka for essentially presenting "coffee shop
intellectual" remedies, in his suggestion to the press that large
companies would also be subject to bankruptcies given accelerated
disposals of bad loans. Indeed, many of the old guard LDP view
Takenaka as an upstart with no real experience in dealing with real
world political policy.
No group is banging the drum of gloom and doom more than the financial
institutions themselves. The financial institutions' mindset is that
to change is to effectively commit suicide, as it will require that
they admit their loan classifications have been inadequate and thus
their capital is inadequate. The debt forgiveness that has been
popular heretofore actually permits the banks to boost their balance
sheets. Under government regulations, a bank must place in reserve
some portion of its bad loans: the worse the risk of default, the
greater the portion. Given that the reserves are logged as expenses on
a bank's balance sheet, the classifications used can shape whether the
bank winds up looking like a profit-maker or a loser.
If the government fingers them for capital infusion, they fear their
borrowers as well as their depositors will go somewhere else.
Ironically, their biggest borrowers cannot go anywhere else, because
they are zombie companies that could not survive without the largesse
of a major bank. Their depositors, however, can and will go somewhere
else, and this is why one of the first policies to go as discussions
of a major bank cleanup operation got underway was the cap on deposit
guarantees that was slated to come into effect next April.
Bank of Japan Plays Its Own Game
For its part, the Bank of Japan thought that it had thrown the Koizumi
administration a screwball with its surprise decision to buy stocks
directly from the banks. But the Koizumi administration's quick
reaction has apparently put the BOJ back on the defensive, as they
will now be under increasing pressure to ease monetary policy further.
At their latest policy meeting last week, the BOJ board decided to
leave monetary policy unchanged. The apparent reasoning was that,
given the fact that the introduction of across-the-board caps on
deposit insurance that was due to be implemented next April has been
delayed, there is no immediate threat to fund liquidity at the banks,
while both long-term and short-term rates remain stable.
However, provided the Koizumi administration can put together an
anti-deflation package this week, the ball will be back in the BOJ's
court -- this time with the Koizumi administration, the LDP and most
likely the financial markets demanding more aggressive monetary easing
to accommodate the anti-deflation package. Finance minister Shiokawa
stated the obvious when he observed to the Japanese press that the BOJ
"would probably be forced to ease monetary policy within the end of
The Bank of Japan also announced its "Basic Policy Regarding the NPL
Problem" at the end of last week. In it the bank demand that bank
adopt a new discounted cash flow methodology for determining future
nonperforming loan, or NPL, losses, as is already used by banks in
other countries. If discounted cash flow (instead of determining
projected loss ratios from historical loss ratios) is adopted, this
would require the banks to increase their loan-loss reserves on NPLs
from a current 20 percent for those loans requiring "careful control"
to at least 30 percent. Based on the banks' own assessment (scouts
honor), they have 46 trillion yen of loans requiring "close
supervision," of which 11 trillion yen requires "careful control."
The BOJ readily recognizes the possibility that some banks would run
out of capital if they were required to make increased loan-loss
provisions using the new methodology and that they would require
infusions of public money. While not included in the report, there
were calculations within the BOJ that the banks would have to provide
tens of trillions of yen in additional funds. The BOJ believes that
the banks need to completely remove the NPLs from their books, not
just make more loan-loss provisions, and it believes a souped-up RCC
could be instrumental in accomplishing this. However, the central bank
backed away from the issue of management responsibility in the report,
saying it was not able to comment on this issue now.
At the same time, the BOJ has announced the specific steps it will
take to purchase stocks from the banks. By the end of September 2003,
it plans to purchase 2 trillion yen in stocks from the banks and hold
them for five years. For individual stocks, the bank will limit its
holdings to less than 5 percent and of course will not disclose which
stocks it will be buying. In addition, it will not invest more than
500 billion yen in shares of any single bank.
Wanted: A 180-Degree Shift in Industrial Policy
The BOJ's surprising action and signs that the government is finally
ready to take the bull by the horns have been a rude wake-up call. It
directly challenges the myth that Japan can somehow muddle through all
of this without serious pain. The collapse of this myth is why the
stock market has reacted so negatively.
However, cleaning up the banking sector is no guarantee of a happy
ending for Japan's economy. A gloomier assessment is that the Japanese
disease goes deeper than bad loans. The current theory is that
eliminating the bad loans and the dead wood behind them would make the
remaining firms more profitable. The surviving companies would
increase investment and employment, while banks would be able to
finance expansion with creditworthy borrowers, thus improving their
But would cleaning up the banking sector make Toshiba or NEC more
competitive in global markets? Would it ensure that the bulk of those
companies listed on the Tokyo stock market that currently trade under
book value recover? In reality, there is no need to stop at the banks.
The Koizumi administration needs to formulate policies that basically
represent a 180 degree turn from previous policies -- i.e., to help
Japan's most competitive companies maintain their global
competitiveness, rather than nursing the losers that are currently
sucking the life out of Japan's economy. With true global competition
for capital, the market would take care of the dead wood.
-- Darrel Whitten
THE ABW MARKET LETTER
"What You Should Read After Irrational Exuberance"
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