Enron Global Markets Competitive Analysis
JAPAN UPDATE: 9/25/01

Risks Increase for Longer, Deeper Deflationary Recession If Current Policy Mix Muddle Remains, NPLs Unresolved


SUMMARY:

Deflationary Recession: Japan, apart from the raft of new and compounded difficulties consequent of September 11, was already facing a very difficult end of fiscal half-year and confirmation of another recession
After September 11: The impact of the shock to the world system over the past two weeks has reinforced - from outside - the structural challenges facing the domestic system
Yen Strength Despite Intervention: Recent efforts to stem rise of Yen, enlarge supplementary budget, reinforce the continuing reactive basis of policy-making in Japan, leadership challenges
Koizumi Still Enjoying Support, Keeping LDP Afloat: Cabinet's approval rating is 79%, with the LDP's approval at a 9-year high of 51%
Signs of Life: Bankruptcies down and retail sales component rises; as in the US, consumer behavior will drive outcomes
Surrounding Asia: Weakens further on concerns about risk aversion relative to emerging markets and depressed export outlook
Collateral Effects: US weakness reinforces trend toward coincident global recession
NPL Update: Still Vague: Koizumi finally releases basis for expanded RCC role in settling NPLs


REPORT:

Global Context
Japan's greatest challenge is coming from the coincidence of recession, deflation, high government debt stock, and, for the first time, sustained erosion of export surpluses and flight of manufacturing outside of Japan for export to Japan.  Part of the latest reductions in the world growth outlook and the related decline in world equities are due to the September 11 tragedy and its many human and economic consequences. This portion of the equity market losses will be hard to recover. Another part of the post-tragedy decline is a delayed reaction to the global deflation and recession which were deepening prior to September 11. (Economic data since September 11 provided firm evidence of sharply weakening economies in the U.S. and Europe.  Equities would probably have declined even without the tragedy.) This part of the recent equity loss argues for policy changes to stop the global slowdown.  The challenge, as described in previous reports, comes from differing priorities and magnitudes of responses across major economies to a global cycle downturn.  

Koizumi v. MoF
The Japanese government reportedly signaled some flexibility in its fiscal stance:  Koizumi said he may have to take a "flexible approach" to the Y30 trillion cap on new JGB issuance; but Shiokawa said the government's plan to keep new JGB issuance below Y30 trillion was unchanged.  The government is considering issuing up to Y5 trillion 10-year or shorter maturity "Koizumi bonds", funded by the sale of national assets as well as funds arising from administrative reforms (not included in the Y30 trillion cap).

BoJ
The central bank has shown no inclination to use monetary policy stimulus to stop the recession. Instead, it continues to pursue fiscal stimulus and structural reforms, policy steps are seen by several sources as actually deepening the recession. Though nominal interest rates are at zero, real interest rates are very high. The central bank provides Y6 trillion in excess liquidity to the commercial banking sector, but the funds are very short term and have not penetrated into the economy.

NPLs
Event: Koizumi administration officials released the program for expanding the Resolution Credit Corp's role in settling the NPL problem.  Because of still unsettled battles between FSA leader Yanagisawa and other Koizumi advisors, the details of this plan were still left vague.  Yanagisawa is involved in a two-front war, pinned between officials on one side who want to bankrupt the 20-30 top debtor companies immediately, and BOJ officials on the other side, who want to fund the RCC much more aggressively through buying specially issued RCC bonds to let the institution expand its purchases of bad debt.

Result: What has been decided is to have the RCC dramatically change the price at which they will purchase assets from banks and to expand its ability to make losses when it sells those assets. This is an "in principle" decision and the fights rage on about exactly what this new freedom should mean. Yanagisawa hopes to combine more activity on this front with his main idea of re-examining 'need-attention' loans (with help from market signals like the price of company stock, etc. detailed in our previous reports). Yanagisawa would create a new class for these loans and then require banks to raise the reserves they hold against these loans. 

Strategy: Using the RCC is seen as an alternative to direct capital injection.  As one senior advisor put it, "It's not just that Yanagisawa wants to avoid capital injection because he'd be blamed for the failure of his first injection. It's because capital injection (into "healthy" banks) doesn't work. We can't really force them to change management and to improve performance. There's a sense at FSA and the government generally that bankers are lousy and they'll never improve. Banks....are very unpopular. Providing capital to RCC is less obviously a direct help to the banks. That explains some of the interest on the part of politicians." And it explains why this will be part of the eventual solution.

BOJ's Interest: BoJ is interested in funding this RCC because it allows them to be part of the solution without adopting inflation targets or directly purchasing JGBs. Assuming the RCC will be financed through issue of government-guaranteed bonds, the BOJ would be happy to buy them as long as they were guaranteed (but not issued by) the Japanese government. BoJ does not want to directly underwrite bonds issued by RCC because that would be against the law (conveniently) and RCC would have a low rating. It's also true that BOJ likes the RCC idea better than going through the process of tighter assessment, bankruptcies, and capital injection, because it cleans up the banks' books in one swoop.

FSA's Concern: FSA official's comment: "There is a real problem in everybody pretending that the problem will be solved by taking all the bad loans to RCC. No matter how much money it gets, the RCC simply doesn't have the capacity to help reconstruct companies. Maybe it can farm out this work to those who do. But the most likely outcome is that it will just give up and resell everything at market price. This would mean that a lot of companies, including those which may be saved, will go bankrupt. There are social and economic consequences - it will be very deflationary. The banks will be a lot better off but industry will be in a bad way. That's why we have to take some more time and figure out how much of this can be done through the RCC and how much through better reserving for special attention NPLs." 

Koizumi Advisor's Assessment: One of Koizumi's advisors, looking over the state of play and admitting all of the hesitation that FSA officials feel, says, "There is no doubt that we still have lots of stuff to be worked out. But as I see it, we now have vague outlines of NPL disposal. In addition, the FSA now admits that it has to get tighter: i.e., it has to get to the 'need attention' loans and look at them more carefully, reclassify the bad parts of need attention loans, and those additional downgraded loans will have to be disposed of in the 2-3 year framework. In other words, the Y13 trillion total will go up significantly. We will give banks a break through the use of something significantly above market price in selling NPLs to RCC. But the most fundamental thing still to be understood is that the RCC will have to acquire reconstruction skills or buy them if the companies sold to RCC are to have a fair chance of recovery."