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Japan's Cities Are Sinking In Debt

International Business: JAPAN


The country's next big financial mess is here

Among the world's great metropolises, no city seems better managed or more prosperous than Tokyo. The smoothly running subway, the immaculate parks, the unobtrusive police booths at every major corner, the absence of dangerous slums, the well-maintained schools--it all gives the impression of a carefully planned, well-tended place, a marvel of urban engineering. Western visitors are always hard-pressed to find evidence of Japan's crisis when they roam the Tokyo streets, taking in the sights of the Ginza or sipping latte from one of Starbucks' newest outlets.

Yet looks can be deceiving. In the past few days, Tokyo city officials have come clean on their own version of the Asian crisis--a gargantuan budget emergency that could cost billions to fix. And Tokyo isn't the only Japanese city in need of some major financial renewal. In fact, the news coming out of Japan's prefectural and municipal offices is fiscally terrifying. Briefly put, the local Japanese governments are broke, or very nearly so. They are going through a financial collapse that poses another major challenge besides the banking crisis (table). And if the central planners in Tokyo think that Japan's city halls can finance new public works to revive the economy, they may be in a for a very nasty surprise."HIGHLY DANGEROUS." To get a sense of what's going on, it's important to realize the role that the prefectures and city governments of Japan have played in building public works, keeping construction companies prosperous, and generating jobs. For decades, the Ministry of Finance has shuffled off much of Japan's deficits onto the local governments. The Diet would order up some public works, and the central government would foot the bill for many of them. But the governments of Tokyo, Kyoto, Osaka, Nagasaki, and other localities would also issue bonds in their own name to pay for many of the new fishing ports, harbors, and other projects of questionable value.

It was a clever way to keep a lot of the spending off the books of the central government. Says Tokyo University government-finance specialist Naohiko Jinno: "It's somewhat like the way big Japanese companies use their subsidiaries to keep their own finances in shape." Since 1992, the government has budgeted $300 billion for public works. Local governments were told to come up with 28% of that amount.

The freewheeling spending benefited lots of politically connected companies and gave many mayors big budgets to play with. But now local officials are in a panic because the overspending has brought them to the brink: The governments of Tokyo, Osaka, and Kanagawa, the prefecture for Yokohama, have edged close to insolvency and may have to fall under central government supervision to sort out their debt mess. It's as if New York, Chicago, and Los Angeles all reported acute fiscal crises at the same time. "We are moving into a highly dangerous, critical condition," concedes Tsutomu Ushioda, a budget official with the Tokyo metropolitan government.

Not only are these cities taking huge hits from sliding corporate and personal tax revenues but they are still being strong-armed by the central government to assume more debt to help bankroll a $124 billion public-works package announced last April. Yet few regional governments now have the stomach to borrow more. Already, Japan's local government debt is roughly 2% of gross domestic product, well over twice the level for regional governments in other industrialized nations. Debt at five of the most leveraged prefectures comes to $90 billion. Some of the figures make Japan's cities look like wobbly emerging-market states. In 1996, Kanagawa ran a budget deficit equal to nearly 24% of its annual expenditures. Nagasaki, Hyogo, Akita, and Kochi are in similar straits.

Moreover, many of these cities are now waging a quiet revolt against the central government. Recent legislation has given the localities a little more autonomy from Tokyo, and they are using that wiggle room to delay the projects they have been forced to budget for. While public-construction starts sponsored by the central government are holding steady, those launched by local governments have dropped 20% this year from 1997. As a result, Finance Minister Kiichi Miyazawa's pledge that Japan would spend its way out of recession may not prove true at all. That's especially troublesome since the big Oct. 7 rally in the Nikkei was based partly on hopes of a huge spurt in public-works spending. "There's considerable doubt that this one remaining source of demand in the economy will have anything more than a modest impact," figures analyst Ron Bevacqua of Merrill Lynch & Co.

Truth to tell, the government should not be recycling Japan's vast savings pool into public concert halls, resort spas, and generous social services. For one thing, it does a lousy job of allocating the money. In the Tokyo area, some $30 billion has been dispensed to build such projects as a lavish metropolitan headquarters and two international exhibition centers that were unneeded, notes Yasunobu Watanabe, a Tokyo prefectural assemblyman and member of the Japan Communist Party. "They should have reviewed, frozen, or canceled these projects," says Watanabe.LARGEST SPREAD. The spending spree has left Tokyo prefecture with $2.2 billion in debt-service costs this year. Those obligations will rise to $3.7 billion in 1999, and the government will be hard-pressed to cover them. In a sign that investors are getting edgy about all the local debt in Japan, the spread between 10-year municipal bonds and similar central government bonds has widened to 50 basis points--the largest gap ever seen, according to the Japan Local Bond Assn.

Now the cities have to raise money with new levies. The Osaka government may hike the entrance fee for public high school students tenfold to cover a steep drop in tax revenues. In Tokyo, politicians are thinking about scrapping the "silver pass," or free ticket on many types of public transportation. Little by little, ordinary Japanese are going to have to shoulder more of the costs of social services until governments can lower their debt levels to sustainable levels.

As the recession deepens, it may even be necessary to bail out Japan's cities. But that presents a conundrum: If the central government needs to spend billions saving the banking system, how is it going to come up with extra sums to save Tokyo, Kanagawa, and the other metropolitan areas?

Also, if the cities call a halt to their public works, then Japan's construction companies--already well in arrears on loan payments to the banks--could get into deeper trouble. And that, of course, would cause more woe for the banks. A separate issue: As banks start calling in loans of all kinds to shore up their capital bases, local companies will be starved for credit and be forced to shutter plants and lay off workers. That pain will reach the prefectures in the form of even lower tax revenues. Slowly but surely, the crisis is making its presence felt in every city, town, and hamlet.By Brian Bremner and Miki Tanikawa in TokyoReturn to top

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