In the yearend column, I had commented on the contrast between the US and European equity markets on the one hand, and Tokyo's on the other: the former at/near all time highs and the latter at its 1996 low. The new year has not brought any cheers to Tokyo; if anything the Nikkei index has fallen even more. In the first full week of the new year (January 6 -10) alone the index fell 11 per cent to around 17,300, but has recovered a little last week to around 18,300 Friday morning. And, few are predicting a quick turnaround in sentiment or prices. Since its peak of around 39,000 at the end of 1989 the index is now down by about 53 per cent. To be sure, it is still about 25 per cent above the low of the '90s (14,500 in July '95).
While the trough of mid-1995 was understandable "" the yen had reached absurd levels of less than JPY 80 per dollar in April 95, making much of Japanese industry uncompetitive "" the reasons for the recent slump go deeper. While the exchange rate is much more reasonable now (JPY 116.7 per dollar last Friday morning), economic prospects for fiscal 1997-98 (April-March) are not too rosy. After four successive years of huge fiscal stimuli to prime up the economy, government debt has reached almost 90 per cent of GDP. The budget for the coming fiscal year is much tighter and envisages sharp increases in direct and indirect taxes. Personal income tax and social security contributions are to go up and so will the value added tax. This is likely to curb further the already weak domestic demand. And, even talk of export-led growth is anathema "" nobody wants the renewal of trade friction with the United States which took the exchange rate to egregious levels less than two years back. Contrary to expectations, the
current account surplus dropped 15 per cent in November to $5.72 bn (trade surplus $7.4 bn). The weak domestic demand is likely to put pressure on corporate profitability, which is one important factor underlying the bear market. Corporate profits which grew 17 per cent in 1995-96 are projected to increase less than half in the current fiscal year and even less in the next. And, the authorities have few weapons left in their armoury to spur the economy. Four years of fiscal stimuli have had only limited impact and monetary policy can hardly be loosened further with short term interest rates at 0.5 per cent.
No wonder they are trying something else "" deregulation in major sectors of the economy like financial services and insurance, telecommunications, airline services, distribution and retail trade. The need for a major overhaul of the economic model which Japan worked so successfully for fifty years was acknowledged recently by the minister of trade and industry when he said, it is clear that the current Japanese system...has reached its limit. The heavyhanded regulation and protection of domestic services in particular, have led to a situation where US costs are much lower than Japan's for many sectors: construction (73 per cent of Japan's), transport (20 per cent), electricity (30 per cent) and so on. Indeed, the only service cost which is cheaper in Japan is interest rates.So, while the model created world beating industries in sectors like automobiles and electronics, the domestic consumer has been ill-served by costly services and inefficient distribution. One wonders whether keeping domestic goods and
services costly and unaffordable was a deliberate ploy to increase savings.
The thorough deregulation to which the Japanese government is committed has also had an adverse, if selective, impact on equity prices. Shares in industries like telecom, financial services and insurance have fallen even more sharply than the index as deregulation and greater competition is expected to affect their margins in the short run. Meanwhile, even in the current slump, the market has marked up the share prices of Japan's world competitive companies like Toyota, Honda, Canon and Sony. It is the businesses dependent primarily on domestic markets that have suffered: in this respect at least the Japanese investor is showing greater rationality than markets are wont to display.
The share market slump has the banking industry worried. Japanese banks hold large equity investments and a part of the unrealised capital gains are included in tier 2 capital for capital adequacy purposes. For the industry as a whole, such unrealised gains amounted to $135 bn in the September '96 half-yearly balance sheets. The figure is estimated to have halved by now. In fact, by one estimate, 6 of the 20 major Japanese banks will have less than 8 per cent (of risk weighted assets) by way of capital, should the index fall below 18,000. Four more will join the ranks if the index falls to 17,000, and an additional three at 15,000. And, problems with capital adequacy would mean higher cost of borrowing. The prospects of the Japan premium resurfacing in the international financial market (see World Money 13.11.95), must surely be worrying the Japanese bank managements.
The other impact of the bear market is going to be on capital flows. Foreign investors, who have been net buyers of Japanese equities for the last two years, have been hit twice "" by falling equity prices and the depreciating yen. They have become net sellers. Domestic investors, mainly the big insurance companies, have also become major exporters of capital "" the yield difference between Japanese and US bonds is too attractive. Such flight of capital can only put further pressure on the yen "" another worry for the Japanese authorities?
