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Reality check in Japan

Ajay Jaiswal

THIS has been an eventful fortnight for Japan. The global financial markets have been keen to analyse and ascertain the political fallout of the national elections on the country's fiscal and monetary policies.

Japan has been following an expansive monetary policy for almost a decade now in the hope of propelling the economy on the path of growth. The ambition to see positive growth has led the Government to attach undue significance to certain GDP figures, whi ch in isolation do not change the scenario. This year, the economic agency admitted to not having included one sector in the fourth-quarter GDP numbers to achieve the overall target number.

The Bank of Japan has been showing angst at the continuation of the zero interest rate policy. It describes the policy as unrealistic and would like to move away from it as soon as possible. The statements from the Central Bank Governor in the last coupl e months reiterate a similar desire.

The LDP coalition won the general elections last fortnight but its numbers in the Diet has reduced. The seats won by the LDP and its power within the coalition has also reduced. In such a scenario, it would be even more difficult for the Prime Minister, Mr. Yoshiro Mori, to push through strong fiscal policies and reforms. The Prime Minister has managed to put Mr. Kiichi Miyazawa back as the Finance Minister but has experienced problems in distributing power among the smaller parties.

Expectations for the BoJ to move away from the zero interest rate policy at its July 17 meeting drove the market to buy yen against the dollar last week. The market struggled to push the USD/JPY below the 105.00 level. The Finance Minister, Mr. Miyazawa, made strong statements indicating that 105.00 was a pain threshold level and they would intervene if yen appreciated beyond this level.

The Tankan survey of July 4 assumed greater importance for its clues on business sentiment. The survey showed sentiment to be far better than the market expectations.

The market saw the dollar drop to 104.28 immediately after the Tankan survey results but the currency moved sharply back up above 105.50 in no time. There was talk of big US hedge funds, which bought in dollars below 105.00 levels. The dollar has since r allied close to 108.00 against yen. Why has the market turned around so quickly? The answer likes in economic realities.

The international rating agency Fitch IBCA announced the downgrade of domestic sovereign bond issuance rating of Japan from AAA to AA+. A similar downgrade from Moody's is expected to be announced sometime soon. The downgrade reflects the concerns on the huge Government domestic borrowing programme. Japan has the highest ratio of borrowing to the GDP amongst the industrialised nations.

The monthly corporate bankruptcy figures this year have been the highest in the last five years. Could there be a glimmer of hope in this _ that good money is no longer chasing bad and preventing badly run businesses to close down? These hopes were dashe d immediately after the elections. The Government announced a multi-billion dollar package for the departmental chain Sogo to save it from severe financial distress. It would not be easy for Japan to come out of the mess if reforms are not ushered in.

The recent failure of a Japanese life insurer and rumours of some more in distress do not bode well. The sagging equity market and low yields on sovereign bonds create a problem for investment managers of funds in Japan. The maturing postal deposits are creating surplus liquidity in the system, which is waiting to be invested. The currency risk perceptions have prevented these funds from moving overseas.

However, the fall in yen would reduce such risk and create opportunities for investment overseas at much higher yields. Conservative estimates of such investible surplus is around $57 billions. Hence, a falling yen could result in forcing further weaknes s.

The G-8 meeting in July would also give the US an opportunity to share its concerns on a positive interest rate in Japan for the economy.

Saudi Arabia caused volatility in the crude oil market this fortnight. A Saudi official had announced that it would unilaterally raise daily production by 0.5 million barrels per day to bring down prices. This would have been over and above the June 21 O PEC hike of 0.78 million bpd. Oil moved below the $30 a barrel mark briefly following the statement. Saudi Arabia later clarified that such a raise in production would not be a unilateral decision and would need the support of other OPEC members.

The inflationary risks from high oil prices would increase swiftly if OPEC does not move quickly. The impact of high prices on the world economy and crude demand would keep OPEC worried.

The land of the rising sun would need a strong dose of fiscal reform to pull itself out of the quagmire it is in. The wait for strong growth would be longer.

(The author is Senior Manager, Corporate Treasury Sales, Southern India, for HSBC. The views expressed here are his own and not necessarily those of his employer.)