Japan begins forging a road map for recovery from its worst postwar disaster next month, a process that may determine whether it sheds the legacy of the 1980s bubble or has a third “lost decade” of stagnation and deflation.
Key to the result: whether the nation’s companies end an aversion to borrowing, taking on debt to propel domestic investment and wage gains, and whether policy makers embrace a stimulus financed by Bank of Japan money creation, analysts said.
Prime Minister Naoto Kan aims to compile in April the first of what he says may be multiple supplementary budgets. With lawmakers advocating a range of amounts and financing options, Morgan Stanley MUFG Securities Co. calculates that a “bold” plan would yield 2.7 percent annual growth for 2012 to 2015, and a “cautious” one means a 1.1 percent annual pace of contraction.
“The only time you can get things done is in moments of genuine crisis and catastrophes -- there’s a small opportunity to do an extraordinary amount,” Malcolm Gladwell, author of “The Tipping Point,” who writes for New Yorker magazine, said in an interview with Bloomberg Television. “Japan -- a country whose politics were in deadlock and sluggish for many, many years -- I hope they can seize this moment and accomplish a lot.”
Kan told lawmakers two days ago that a debate will be needed on all options to pay for rebuilding from the record 9.0-magnitude earthquake and tsunami that hit March 11. The initial spending package is likely to be around 3 trillion yen ($36 billion), about the same as after the 1995 Kobe quake, according to Takuji Aida, senior Japan economist at UBS AG in Tokyo.
The catastrophe struck an economy that suffered stagnation for much of the past two decades, with the benchmark Nikkei 225 Stock Average still lingering 73 percent below its December 1989 peak. Public debt was already twice the size of gross domestic product, a legacy of failed stimulus packages and limited revenue gains. The BOJ’s benchmark interest rate was near zero after policy makers cut it to help end deflation.
Some lawmakers from both the ruling Democratic Party of Japan and Liberal Democratic Party have called for a 20 trillion yen reconstruction package, financed by central bank purchases of government debt. Such a step is allowed if approved by the Diet in special circumstances.
By contrast, senior DPJ officials including the head of its fiscal committee and deputy chairman of its tax panel have recommended higher taxes to help pay for rebuilding. Cabinet members have also signaled they will dispense with a planned 5 percentage point cut to the corporate tax rate.
“The window is not likely to be open for more than a few months” to set a “bold” course of action that changes the economy’s direction, said Robert Feldman, head of Japan economic research at Morgan Stanley in Tokyo. Feldman’s bold scenario envisages 40 trillion yen of total new spending, with no tax increases and 50 percent financing by the BOJ.
BOJ Governor Masaaki Shirakawa has repeatedly opposed monetizing the debt. He said March 25 that abundant cash was already being made available to financial institutions, and that the bank was buying a “large amount” of bonds in the secondary market. Directly financing deficits “would lead to a limitless expansion of currency issuance, spur sharp inflation and yield a big blow to people’s lives,” he said March 22.
The central bank is considering offering temporary loans to banks to encourage lending to companies with cash-flow problems in the aftermath of the quake, according to three people familiar with the matter. The plan may be presented to the BOJ’s board as early as next month, the people said, speaking on condition of anonymity because the discussions weren’t public.
A group of DPJ lawmakers including Yoichi Kaneko submitted a proposal to Finance Minister Yoshihiko Noda on March 18 calling for BOJ financing for a 20 trillion yen package. LDP Diet member Kozo Yamamoto advocated a similar response.
Because Japan is already in deflation, the risk of monetizing the debt is low, according to some analysts. Consumer prices, excluding fresh food, haven’t sustained a 1 percent increase in sequential years since the early 1990s. BOJ board members identify stable prices as an inflation rate of around 1 percent.
Concerted BOJ quantitative easing now would help produce inflation, allowing nominal gross domestic product to climb, Prasenjit Basu, an economist at Daiwa Capital in Singapore, wrote in a report this month. Nominal GDP, which is unadjusted for price changes, shrank 7.1 percent to 479.2 trillion yen last year from its 1997 peak of 515.6 trillion yen.
‘Exacerbating’ Debt Problem
“Japan’s nominal GDP has either been stagnant or declined each year during its long period of deflation, exacerbating its debt-sustainability problems,” Basu wrote.
In Morgan Stanley’s “cautious” scenario, the BOJ avoids financing deficits, the government enacts a total of 10 trillion yen of spending and the sales tax is increased 2 percentage points, to 7 percent, to help pay for rebuilding. Real GDP, which is adjusted for prices, contracts 1.1 percent on average over the 2012 to 2015 period.
Cheap borrowing costs in recent years hadn’t helped Japan escape stagnation because companies weren’t willing to take on debt, after they struggled with the aftermath of the plunge in stock and land prices in the 1990s. Average bank loans outstanding only rose in four of the years since 1993.
Borrowing as a percentage of assets slid to an average of 43.7 percent last decade from 69 percent in the 1990s as companies de-leveraged. The figure stood at 42 percent at the end of March 2010, the most recent BOJ data available. Willingness to borrow again may help propel growth, said Richard Koo at the Nomura Research Institute Ltd. in Tokyo.
“There’s been a debt-rejection syndrome, and we needed a shock to get out of it -- this may actually do it,” said Koo, chief economist at the research arm of Japan’s biggest brokerage. “Companies will have to borrow money because they’ve got to get themselves back in production.”
Firms from Sony Corp. to Nikon Corp. suspended production in the wake of the temblor, which devastated Japan’s northeast and left more than 27,000 people dead or missing. Toyota Motor Corp. closed 18 facilities.
Reflecting the initial economic toll of the quake, data released today showed that Japan’s manufacturing deteriorated at the fastest pace in at least nine years in March.
The index of purchasing managers fell to 46.4 from 52.9, the Japan Materials Management Association and Markit Economics said in a joint release, the biggest drop since the survey began in October 2001. A number below 50 indicates a contraction.
Aida at UBS calculated that the more companies lower their savings, the faster GDP may climb. He estimated a zero percent corporate savings rate, along with a measure of optimism about fund-raising among smaller companies, would yield a 2.6 percentage point bump to economic expansion.
Kan, who took office in June, has yet to lay out how he plans to deploy the supplemental budget. The Cabinet Office last week estimated the damage caused by the disaster at 16 trillion to 25 trillion yen.
The temblor struck in the afternoon of a day when Kan’s political future was cast in doubt by revelation he had accepted a campaign donation from a non-Japanese citizen. The controversy has since disappeared, with Kan inviting Sadakazu Tanigaki, the head of the LDP, to join his cabinet and Tanigaki pledging to cooperate on the supplementary budget.
“The instincts of the DPJ are on the cautious side; however, the DPJ is also practical, and realizes that it must support the economy and economic revival,” said Feldman, who has analyzed Japan’s economy since the 1980s bubble years. “After an initial period of caution, I expect a swing toward the bold scenario.”