Japan must move quickly to stop the bleeding
By Brian Milner -
Friday, February 1, 2002
Larry Speidell spends a good deal of his working time trying to persuade U.S. institutions to embrace
more foreign equities. He sees opportunities lurking everywhere -- even in benighted Russia -- for
those willing to look beyond their own backyard and do some serious homework.
But ask Mr. Speidell about investing in Japan and dark clouds cross his normally sunny countenance.
"I don't have a lot that's good to say about Japan," says the director of global research with
Nicholas-Applegate Capital Management in San Diego.
In fact, he adds, it's a play for "the pure contrarian" -- the sort who likes putting money in situations
that are so awful they just don't seem capable of getting any worse.
Yet, in Japan's case, that's exactly what could happen, as a gloomy review issued yesterday by
Standard & Poor's and dour assessments made by economists attending the World Economic Forum
in New York make clear.
Just over a decade after Japan's bubble economy burst like a cheap balloon, years of stagnation have
been replaced by "a worrisome deflationary recession, with no signs of an upturn for the foreseeable
future," the S&P report says.
Even worse, from an investor's point of view, is the agency's assessment of credit quality, which it
expects to continue deteriorating "throughout essentially all sectors of the economy."
Meanwhile, in New York, Morgan Stanley's chief economist, Stephen Roach, told the WEF gathering
that "Japan is at its moment of truth" in dealing with its worsening crisis. It has no choice but to
reform its financial sector.
"The danger is that Japan is in a state of receding permanently as an economic power," warned Gail
Fosler, chief economist with the U.S. Conference Board.
It's easy to see what's behind the latest pessimism. Prime Minister Junichiro Koizumi came to power
riding a wave of popular support for his pledge to clean up the political system and to enact the tough
reforms needed to fix the financial system and the economy. That was nine months ago, and the
world is still waiting.
In the meantime, corporate failures are on the rise; the insurance industry is a mess; and the banks are
looking more feeble than ever. That, S&P says, makes government intervention seem inevitable, at
least to shore up the bigger banks. But smaller institutions may be cut adrift, and their depositors and
lenders will be forced to share at least part of the pain.
Seven out of 10 Japanese companies lost money last year, including some of the biggest tech and
telecom stars.
Yesterday, electronics powerhouse NEC joined the likes of Toshiba and Fujitsu in the red-ink brigade.
NEC posted a whopping ¥155-billion ($1.83-billion) loss in its most recent quarter, as sales plunged
nearly 10 per cent. A year earlier, the company had a profit in the quarter of ¥8.3-billion.
"At this stage there is little ground to hope for a bottoming out of credit quality in Japan's corporate
and banking sectors in the next two years," S&P says.
The agency cut Japan's credit rating twice last year -- removing the coveted triple-A ranking it held for
more than 20 years -- as economic prospects dimmed, government failed to implement badly needed
financial reforms and public sector debt continued to soar. Now, S&P warns of another possible
downgrade if there are "further delays in either structural reform or economic recovery."
Moody's, the other major New York rating agency, is likely to prove just as pessimistic in its next
report, and this could spell big trouble for the already reeling financial system.
Analysts warn that if the banks are slashed again, they will face serious problems in their international
dealings with other financial institutions. Because of their massive problem loans, weak earnings and
increasingly limited financial flexibility, most are already saddled with triple-B-level ratings, putting
them at the edge of investment grade.
"The event most likely to trigger a catastrophic failure in Japan's financial system will be a downgrade
of banks' credit ratings to levels that will choke off their credit relationships," says Carl Weinberg,
chief economist with High Frequency Economics and a long-time Japan watcher.
Long-promised and desperately needed structural reforms could provide the antidote to all this gloom,
as S&P and other Japan watchers note.
Already, as S&P says, the growing number of business collapses in recent years, including several
major financial institutions, has made investors more conscious of credit risk. This has led, in turn, to
improved risk management practices.
These, combined with capital markets reforms during the past three years, "should eventually result in
a more efficient allocation of capital and help with the painful, but inevitable, process of restructuring
Japan's economic base."
If the government does finally deliver on its promises, the battered economy could recover quite
rapidly. And even before that, long-depressed stocks could surge.
With the right reforms, "the Japanese stock market could show a dramatic revival," Mr. Speidell says.
But without them, the whole place could go bust.
bmilner@globeandmail.ca
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