Why Japan's Bureaucrats Won't Bail Out The Nikkei

Japanese Prime Minister Morihiro Hosokawa, decked out in a cashmere sweater and scarf, looked natty enough in Seattle as he joined President Bill Clinton and Asian heads of state for a weekend of conversation about economic cooperation. But Japanese investors didn't like what they saw. With Hosokawa making no firm promise to revive the ailing Japanese economy, the Nikkei stock average dived 3.1% when bourses opened on Monday.

Still, it wasn't just Hosokawa's waffling that sent the market into free-fall (chart). Although many investors hope the Finance Ministry will ride to their rescue once again, the powerful bureaucrats have steadfastly refused to block the Nikkei's dive as they did with their "price-keeping operation" last summer. Even though the Nikkei has dropped 13% since Oct. 26, Japan's economic regulators seem determined this time around not to let investors and corporations forget the frequently repeated message that the easy-money days of the 1980s are long past. So the regulators now seem prepared to sit tight, perhaps until the fiscal year ends next March, even if such inaction means putting the economy on its knees.

PROFIT SQUEEZE. That risk is large, and it is growing daily. On Nov. 22, the government disclosed that its index of leading economic indicators fell to 36.4 in September from 50 in August. Household spending for the month, meanwhile, was off 1.7% from a year ago, its fifth straight decline. And many think corporate profits will be down 10% or more by the end of the fiscal year.

The squeeze on profits could even prompt big corporations to start making genuine layoffs, marking the first big crack in their venerable lifetime-employment system. Some bureaucrats think the stock market's drop is just the shock Japan needs to bring serious cost cuts about. "The faster the drop, the better," says Ryozo Hayashi, director of the Ministry of International Trade & Industry's General Affairs Div., his hand swooping down as he traces a diving Nikkei.

Finance Ministry officials are taking a similar line. They argue that Japanese banks must move swiftly to clear their books of perhaps $400 billion in bad loans, even if that results in a seriously weakening stock market. In fact, sometime around August, the ministry quietly lifted its earlierunofficial "guidance" suggesting that bankers refrain from massive stock sales to cover losses incurred from write-offs and additions to bad-debtreserves.

The banks appear to have acted quickly on this policy shift: The respected daily Nihon Keizai Shimbun estimates that banks took some $5.6 billion in profits when the market was stronger a few weeks ago by selling stocks. Although the banks typically bought the shares back to retain long-term business ties, the profits they booked from the sales will help them maintain their dividends even as they take a $13 billion earnings hit in order to cover bad loans.

The ministry's policy shift was born of necessity. Alicia Ogawa, financial analyst at Salomon Brothers Asia Ltd., thinks that finance bureaucrats had wanted to keep banks more or less in line with each other, so that each would deal with about the same amount of bad debts each year. But then, she says, the bureaucrats started to realize that the true magnitude of the problem loans at some banks was much larger than they expected. Worried that the lending mess could tie up the banks--and lending--for years, the officials began telling the bankers, in effect, to do whatever it took to clear their books within two or three years. That apparently started the banks racing to sell their stocks.

A RESCUE? Despite the tougher new stance from MITI and Finance, the betting in Tokyo is that the bureaucrats are not totally out of the game. At its Nov. 22 close of 17,384, the Nikkei is still well above last August's low of 14,309. And in any case, it's the Nikkei's level next Mar. 30 that really matters. That's when banks have to revalue their stock-market portfolios as they close their books for the fiscal year.

If things are still looking gloomy by then, the Finance Ministry may yet change its tune and mount another rescue operation. But don't expect much action now. The keepers of Japanese economic policy are clearly more willing to let market forces inflict pain for the sake of encouraging long-term reforms. That approach might well mean that the country will emerge stronger in a year or two. But in the meantime, worried Japanese will be in for plenty more sleepless nights.