By Anthony Rowley
Japan’s economy is increasingly seen as a safe haven in the global financial storm
Over the past year, Japan has seen political upheaval on a scale almost unparalleled in post-war history. Yet despite revolving-door changes in government – and even though the economy is teetering on the brink of recession – the country is nevertheless viewed as being a safe haven in the global financial storm, leading analysts maintain.
This paradox is explained by the fact that, whatever else happens in Japan in the short to medium term, the yen is almost guaranteed to rise further from the 22-year low that it touched (in trade weighted terms) a few months ago, and the flight of domestic capital from Japanese stocks and other markets that has continued for a decade or more appears likely to be reversed in coming months.
“Japan’s economy can be seen as a safe haven, as it is not particularly exposed to the fallout from the US sub-prime problems,” says Richard Jerram, chief economist at Macquarie Securities in Tokyo. “Because Japan has not received the benefits of financial innovation, it will not suffer significant losses from excessive risk-taking, nor economic damage from reduced risk tolerance. If you don’t go to the party, you cannot suffer the hangover.”
William Thomson, chairman of Private Capital Ltd in Hong Kong is equally upbeat: “Japan’s economic dependence on the US market is still large but has been reduced as its trade and investment with the rest of the world, especially developing Asia, has grown.”
After Koizumi
But while Jerram and others enthuse over investment prospects in Japan, the underlying situation appears problematic. The era of economic and political reform that characterized the reign of former prime minister Junichiro Koizumi ended in September 2006, when the maverick but popular politician bowed out after six years in office. Political turmoil set in thereafter, and economic reform began to flag.
Koizumi’s successor, the suave but politically untested Shinzo Abe, chose to pursue a different agenda, focusing on reform of Japan’s post-war pacifist constitutions, the need for Japan to raise its profile in international affairs and to revise the nation’s education system so as to emphasize patriotism and other traditional values. Abe’s declared aim was to create a “beautiful Japan”, although he was never able to explain the concept clearly.
Meanwhile, a backlash set in among many in Japan against some of the Koizumi reforms. The former prime minister’s Thatcherite views on the need for privatizing Japan’s myriad public enterprises (the giant postal savings and insurance system in particular) and for promoting individual enterprise above collective interests went out of fashion. Disparities in income between people and regions of Japan began to rise – along with popular discontent.
Abe appeared happy to soft-pedal the Koizumi reforms and might have made political capital out of this, had he not made a series of policy errors from early in his term. He under-reacted to a massive controversy in which the Japanese government admitted to having mislaid millions of national pension records, and his cabinet was plagued by a series of money politics scandals that resulted in multiple resignations of cabinet ministers and even the suicide of one. He lasted slightly less than a year in office. The LDP then closed ranks and chose as party president and prime minister 71-year-old Yasuo Fukuda, a conservative politician, who nevertheless has the reputation of being less of a hawk than Abe on constitutional reform and other issues that do not play well with the Japanese public. When Fukuda took over in September, many analysts predicted that he would serve only as a caretaker prime minister.
Weak links
Amidst all this political turbulence, some of the pillars of the Japanese economy have been swaying too. There are four of these: personal consumption, net exports, private capital spending and public spending. The biggest is personal consumption, which accounts for some 55% of Japan’s GDP and which has never been really strong, even through Japan’s long economic recovery over the past five to six years.
Lately, consumption has been looking sickly, largely because Japanese companies have used their earnings during the period of economic recovery to boost investment and dividend payouts (in line with the philosophies ushered in during the Koizumi era) rather than to raise wages. Unemployment has not begun moving above the multi-year low of 3.6%, which it reached at the height of Japan’s recovery too.
Private capital investment has also begun to flag, while public spending has been on a downward trend for several years, as Japanese governments have striven to rein in a total public debt that exceeds 150% of GDP. Three of Japan’s economic engines are therefore sputtering, and whether the fourth – exports – can continue to fire strongly depends very much on how far the US economy (and thus China’s too) are impacted by current global turbulence.
GDP growth was negative in the second quarter of 2007 by 0.5%, and if third-quarter growth also proves to be negative, Japan will be in technical recession. Few economists expect this to happen, but the consensus is for economic growth for 2007 to reach 2% at best with the prospect of further slowdown next year. Stepped-up wage growth or renewed public spending could accelerate growth, they say, but with huge debt and an ageing population to cope with, the government is in no mood to boost spending.
The investor’s view
To investors, the picture looks brighter, however. “Japan may well be the only equity market in the world that has already discounted the coming global economic slowdown,” says Jesper Koll, president and CEO of Tantallon Research, Japan. “Corporate Japan remains a top global competitor, with record high investment in R&D, unsurpassed technological leadership and the undisputed leader in global patent holdings. What more does one need to get excited about the long-term prospects for a country?”
Mark Cutis, chief investment officer at Shinsei Bank in Tokyo, is another bull of Japan. “Japanese equities are neglected and unloved,” he says. “Japan has probably been the worst performing equity market in the world for two years in a row. However, on a valuation basis, Japan remains extremely attractive, and the yen is seriously undervalued. Retail and institutional investors in Japan are seriously underweight in their market, and you could have a buying frenzy when the locals decide to return,” he adds.