Will Japan Trick or Treat? by Korman Tam
In what is likely to be a crucial week for the yen, traders will pay close attention to both the government's anti-deflation package and the Bank of Japan's monetary policy meeting, both of which take place in the latter part of the week. The yen strengthened last week following delays in government proposals, as markets interpreted the move as succumbing to the opposition and potentially watering down the reforms that were deemed too harsh. Nonetheless, some argue that yen sentiment remains biased towards further weakness since the implementation of reforms will trigger a string of bankruptcies, drive up unemployment and exacerbate Japan's current deflationary pressures. Meanwhile, toning down reform pledges only indicates that the economy will continue to deteriorate, thus, weakening the yen.
Prime Minister Junichiro Koizumi's ruling party, the LDP, secured a majority of the seven seats up for grabs in the by-elections held over the weekend. The LDP now controls 277 seats in the 480-seat lower house and 137 in the 247-seat upper chamber. Some feel that the success of the elections may give Koizumi additional leverage in supporting Financial Services Agency and Economics Minister Heizo Takenaka's banking reform proposals.
Nonetheless, the old-guard in the LDP have been particularly vocal against Takenaka's 'hard-landing' approach and have made it clear they see more harm than good coming from his aggressive stance on banking reform. Recall last week that Takenaka's special task force was strong-armed into postponing the release of its interim report on the disposal of bad-loans after being blasted by both old guard LDP lawmakers and bankers denying the severity of the state of Japan's financial system. Interestingly, the leading bankers have also begun mulling over a potential lawsuit against the government to quell Takenaka's plans. Moreover, key LDP lawmakers on a Sunday talk show again criticized the financial czar. The ruling party leaders said that tackling deflation should take precedence over the cleanup of the banking sector. Hideyuki Aizawa, head of an LDP panel in charge of discussing anti- deflation policies, lashed out at Takenaka's proposals, saying their implementation would send banks' capital adequacy ratios to around 4%, well below the 8% required by the Bank of International Settlements.
Despite the old guard's heavy resistance to reform, PM Koizumi sounded surprisingly optimistic last week's APEC meeting, stating that he expected the ruling coalition to back a tougher stance on banks' bad loans. He also reiterated he would take steps to clean up the banking system along the lines of Takenaka's proposals and added that the government would take measures to help the economy and financial system weather the storm. It now remains to be seen if Takenaka would be able to stand his ground against the old guard in the ruling LDP and follow through with his 'hard-landing' approach, or whether his aggressive reform pledges will be watered down to accommodate his critics.
The Bank of Japan has made it clear it supports Takenaka's plans and will only consider additional easing measures once the government's economic and reform packages are unveiled. The central bank's options include inflation targeting, which BoJ Governor Masaru Hayami opposes, an increase in the current account target from its present level of 10-15 trillion yen, or an increase in the outright purchases of Japanese government bonds. (JGBs). Yet, it is unlikely the BoJ will announce any further monetary easing this week, prior to the release of the government's economic package.
Markets have been trying to distinguish the level of coordination between the government and the BoJ, with lingering concerns over whether both can be flexible enough to accommodate the other. Perhaps instead of easing at this meeting, the central bank will develop means to collaborate with the government in order to cushion the impact from a hard-landing approach. In doing so, not only does the central bank alleviate some resistance from influential LDP members, but would also help to ensure the cleanup of its banking sector. This week will shed much light on the direction of the Japanese economy and whether it is a nation capable of reform. |
