This year would be different. That's what dispirited Japanese heard from Tokyo officialdom as they headed off to the hot springs and ski resorts for the extended New Year holidays. After eight years of stagnation, 1999 would be the turnaround year. The ruling Liberal Democratic Party was setting aside $700 billion to fix the crippled banking system, bring tax relief to companies and consumers, and kick the broader economy into higher gear with a massive public investment drive.
Yet as the Japanese drift back to their offices and factories after the break, troubling developments are already marring this boosterish outlook. The government's plans to raise $645 billion in bonds are driving bond prices steeply lower, forcing rates to double since last fall. That raises the specter of a debt-market crash that could batter consumers and banks alike. And in a paradoxical twist, the rising rates are attracting foreign bond investors looking for higher yields. That has touched off a 24% surge in the yen since August. The runup is scaring Japan's manufacturers, who dread what a strong currency will do to their exports, their only source of profits these days. Instead of being the start of a rebound, 1999 is already looking like a year of fresh disasters.
Jittery investors shaved more than 4% off the Nikkei during its first two trading sessions this year, until the government sparked a rally by signaling its intention of selling yen. But the overall outlook remains bearish. The basic fear is that Japan has stretched its public finances to the breaking point.
To pay for the $700 billion salvage effort, Prime Minister Keizo Obuchi plans to flood the market with bond offerings, some 25% more than last year--a move that will crowd out other borrowers. He has no choice, since the government badly needs the money. Japan's severe recession has clobbered tax revenues and resulted in a budget deficit projected at 10% of gross domestic product, among the highest in the developed world.
The new bond offerings are just the latest in a string of debt issues by the government to cover its mounting deficits. Until now, a ready market kept bond prices rising. Banks liked the safety of government paper. The Ministry of Finance, which had access to Japan's $2 trillion-plus postal-savings system, regularly picked up a big chunk of any government bond issue. The Bank of Japan was a big buyer, too.
But now the government's usual customers have other things to do with their money. Finance Minister Kiichi Miyazawa has petrified bond traders by announcing that the MOF is cutting its planned purchases of new government bonds in half. Instead, the ministry is buying corporate bonds to ease the credit crunch, and helping state-run groups like the Japan Development Bank as they bail out such cash-starved companies as Nissan Motor. And the Bank of Japan is not in the mood to buy more government bonds.
RISKY PAPER. Meanwhile, Japan's private banks, saddled with nearly $1 trillion in dud loans, don't have much ready cash left to spend on bonds. And of course, by flooding the market with new issues, the government creates a bond glut, raises its deficit, and hurts its own credit quality. Since government paper looks a lot riskier than last fall, yields have risen.
Rates of 2% or so wouldn't matter so much if the Japanese economy weren't in such a fragile state. Already, the spike in rates is trickling down into the real economy. Major consumer lenders such as Sanwa Bank Ltd. and Sakura Bank Ltd. have pushed up home mortgage rates nearly one percentage point, to around 4%--very high given the weakness in consumer spending. That's going to further crimp housing demand, just when ordinary Japanese are feeling the impact of lower bonuses and wages.
Corporate borrowing costs are also sure to rise at a time when cash flow and earnings are under pressure. A 100-basis-point rise in rates could lower corporate earnings by 11% this year, according to some estimates. "The rise in funding costs is really going to drive down business sentiment even further," figures Kazuko Mizuno, an economist with Warburg Dillon Read. A Bank of Japan survey shows confidence among executives is already at a four-year low.
Higher lending rates do produce higher profits for banks. But in Japan's dysfunctional economy, the banks have relied heavily on gains in their bond portfolios to prop up earnings. Morgan Stanley Dean Witter economist Robert A. Feldman fears the current drop in bond prices has probably wiped out the unrealized earnings of the banks' estimated $600 billion worth of bond holdings. If so, they will have to write off those losses.
Such write-offs will put even more pressure on banks' earnings, force them to call in even more loans, and so worsen the nation's credit crunch. Japan's new bank watchdog, the Financial Supervisory Agency, is already leaning on lenders to clear their loan books of questionable borrowers or face the fate of recently nationalized Nippon Credit Bank Ltd., which was slow to admit the extent of its nonperforming loans. That's why major construction companies such as JDC Corp., which recently filed for bankruptcy with $3.3 billion in liabilities, are failing left and right.
What an unhappy new year. And there's more. Perhaps the biggest hit from the interest-rate swing will be a sustained strengthening of the yen against the dollar, as adventurous foreign investors pick up higher-yielding Japanese bonds. Japanese paper looks more attractive now that central banks in Europe and the U.S. have cut their benchmark rates.
The result has been a boost in the yen to almost 110 to the dollar, its strongest level in 19 months. The stronger yen means more-expensive Japanese exports, from copiers to Lexus sedans. The stocks of big exporters such as Bridgestone, Honda Motor, and Canon have taken a drubbing from investors worried about overseas earnings. Tiremaker Bridgestone, for example, had assumed a rate of 129 yen to the dollar when it made its profit forecast for this year. If the yen stays at current levels, profits could be $144 million lower than forecast.
Small wonder that economists are slashing their forecasts for Japan. The betting is that the economy will contract 1.3% in 1999. Maybe all this government spending will eventually lift the economy. But as the new year starts, Japan's rescue plan is looking perilous indeed.