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INTERNATIONAL ECONOMY: Limiting the damage as Japan's bubble bursts: GLOBAL REACH: In the last of his series on Japan, John Thornhill looks at how the rest of the world is reacting to the state of its finances
Financial Times; Mar 22, 2002
By JOHN THORNHILL
The past decade has seen Japan experience an economic miracle of an invisible and largely unacknowledged kind: it has avoided a 1930s-style depression.
The bursting of Japan's "bubble" economy at the beginning of the 1990s caused a massive contraction of asset prices and an 84 per cent slump in property values - shredding the balance sheets of the country's companies and banks, whose main form of collateral was real estate.
"It is truly amazing that we have not seen a great depression in this country yet," says Richard Koo, chief economist at Nomura. "The amount of money lost is Y1,400,000bn (Dollars 10,800bn, Pounds 7,600bn, Euros 12,300bn), three years of gross domestic product, and we are still talking about zero per cent growth."
The chief reason for Japan's economic resilience has been the government's determination to sustain demand through huge public spending programmes. Since 1992, successive governments have pumped more than Y130,000bn into the economy through no fewer than 10 fiscal stimulus packages.
Yet a decade on, the Japanese government is itself questioning how long it can continue to carry the financial burden without a pick-up in private sector demand. Government debt has soared to 140 per cent of GDP and - on current trends - will rise to more than 200 per cent by 2008.
But financial institutions, which remain burdened by bad debts estimated by Goldman Sachs to be up to Y237,000bn, are still struggling in the face of a contracting economy and rampant deflation.
Foreign investors, bankers and credit rating agencies also doubt the sustainability of Japan's financial system and are beginning to limit their exposure to the world's second biggest economy.
Foreign investors own an estimated 4.8 per cent of the Y380,000bn Japanese government bond (JGB) market and held about 17 per cent of the Y359,000bn equity market at the end of 2000.
Already, large foreign banks, such as Citibank and JP Morgan Chase, are reviewing and reducing their "relatedness risks" to Japan. Some Korean banks are also considering whether to cut credit lines.
Moody's, the international credit rating agency, has signalled it might downgrade Japan's sovereign rating by two notches to a2. If it does, that could force some foreign institutional investors to dump their JGB holdings.
David Riley, managing director of the Fitch credit rating agency, says: "When you get into the single A category then you start to drop out of the ranks of the major industrialised countries and begin to look more like a highly rated emerging market.
"Investors are concerned about counter-party risks with Japanese banks. But that is not true in terms of the Japanese government itself. The Japanese government is certainly a long way away from being in an insolvent position and can still tap into a vast pool of domestic savings, but the debt cannot go on rising indefinitely."
However, other outside observers are less sanguine.
John Makin, an economist at the American Enterprise Institute in Washington, predicts that Japan's financial strains could soon turn critical, perhaps as early as this year. He argues that the government is only able to tap into this pool of domestic savings because deflation increases the real returns on nominally low-yielding JGBs and cash.
"But the problem is that deflation further erodes the balance sheets of already insolvent institutions. The government is unable to sustain these institutions because there are limits to what they can borrow," he says. "If the government is active in reflating the economy then the bond market will collapse."
Japanese officials call such gloomy predictions alarmist. The surprising strength of the US economy is sucking in Japanese exports, made more competitive by the relative weakness of the yen. Japan's stock market has surged since February.
The government is also promising to deliver a comprehensive plan to deal with banks' problem loans and take more effective steps to combat deflation.
"We are not yet in the stage of recovery, but decline is going to stop," said Heizo Takenaka, economy minister, in an interview with the FT this week.
In a recent research report, Goldman Sachs put at 50 per cent Japan's chances of muddling through for a few more years. But it also attached an equal 25 per cent probability to a strong recovery in Japan and a "deflationary tailspin" scenario.
Whatever the outcome in the world's biggest creditor nation, which holds Dollars 1,300bn in net external assets, the fallout will have a truly global impact. www.ft.com/japaneconomy
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