The Wrong Way To Prime Japan's Pump?

Don't go by the Nikkei. The stimulus plan may not work

It's a scene that has become all too familiar in Tokyo: prosecutors swooping down to make arrests and carry away boxes of papers in yet another financial industry scandal. But this time was different. The Jan. 26 raid came at the august Ministry of Finance, where two senior bureaucrats were arrested on charges of tipping big banks off to surprise inspections in exchange for $70,000 worth of lavish entertainment. The next day, Finance Minister Hiroshi Mitsuzuka said he would resign to take responsibility. Said the 70-year-old Mitsuzuka: "I deeply apologize for this disgrace."

You'd think such turmoil would throw the Japanese stock market into another tailspin. Instead, traders shrugged off the news. With the Nikkei stock average already back to around 17,000, up 15% from December's 2 1/2-year low (chart), investors are suddenly feeling their oats again. And why not? The resignation of Mitsuzuka, who was closely linked to Prime Minister Ryutaro Hashimoto's misguided program of fiscal austerity last year, immediately paved the way for Japan's lower house to pass a $15.8 billion tax cut. There is also talk of Hashimoto unveiling further tax breaks for corporations and ordinary Japanese, more public-works spending, and a $240 billion bailout plan for banks and depositors--all by Feb. 20.

But Japan has unveiled numerous unsuccessful economic stimulus plans in recent years, and many investors fear this one--and the rally it has produced--may also end in disappointment. The government's real motive may actually be to talk the Nikkei up to 18,000 by the end of the fiscal year on Mar. 31. Doing so would bolster beleaguered banks, boost consumer confidence, and assure Washington and Asian allies that Hashimoto isn't going to let Japan sink into depression. Indeed, Tokyo officialdom has a track record of manipulating the market with calculated news leaks, then failing to deliver.

GREAT TEMPTATION. The temptation for the ruling Liberal Democratic Party to jawbone the market higher has never been greater. If the Nikkei were to fall below 15,000 by the close of the fiscal year, ailing banks, already saddled with $600 billion in dud loans, would face more losses on their massive stock holdings. Citing asset quality problems, Standard & Poor's Corp. on Jan. 27 downgraded the credit rating of Dai-Ichi Kangyo Bank and Horuriku Bank. With the Nikkei at 15,000, some lenders, including Fuji Bank, Asahi Bank, and Chuo Trust & Banking, might even see their capital ratios fall below the internationally mandated level of 8% of assets. Even stronger players, such as Bank of Tokyo-Mitsubishi, are sweating. "We can make the 8% mark if the market is around 17,000," says a spokesman.

Japan is also under pressure from Washington to get serious about restarting its economy ahead of a Group of Eight meeting of finance ministers on Feb. 21 in Birmingham, England. With U.S. Treasury Secretary Robert E. Rubin expected to discuss measures to stabilize the currency meltdown and debt crisis in East Asia, the Japanese don't want to show up empty-handed.

If Hashimoto has his way, they won't. The government will make a $240 billion stability fund available to shore up the resources of Japan's Deposit Insurance Corp. That will help cover depositors of failed banks, buy preferred shares in weaker lenders, and make loans to banks in need of capital. A $15 billion income tax cut announced late last year for the tax season in March will probably be extended another year. Corporate tax rates have already been cut modestly, by $3 billion. Some $48 billion in accelerated public-works spending will be added to the mix.

The package could gain even more oomph if the Ministry of Finance were to allow companies more freedom to repurchase shares, as former Prime Minister Kiichi Miyazawa has proposed. Even under current restrictions that effectively force companies to finance repurchases out of retained earnings, completed and announced buybacks by Toyota Motor, Mitsubishi Chemical, Matsushita Electric Works, and other big corporations totaled $8 billion last year. UBS Securities Ltd. equity strategist Neil Rogers thinks that figure could double over the next year. If buyback restrictions were lifted, permitting them to be financed with debt, Rogers thinks the market could climb as high as 22,000 over the next year.

Still, Hashimoto's economic plans probably won't do much for consumer spending, which represents 60% of Japan's output. HSBC James Capel equity strategist Jason James thinks it would take a $40 billion annual tax cut frozen in place for two or three years to get consumers spending again. And building more fishing ports and bridges, though great for the LDP's pals in the construction industry, won't jump-start Japan. From 1992 to 1996, Japan spent nearly $525 billion on such projects with little effect on consumer spending.

The bank bailout also may disappoint if it ends up bolstering weaker players at the expense of stronger ones. Back in November, after the collapse of Yamaichi Securities, top officials of the MOF vowed that true basket cases would be permitted to fail. Now, not only is public money going to be used to prop up banks, but the LDP is weighing a plan to let them revalue land holdings at market rates instead of their acquisition costs. They would be allowed to take any paper profits tax-free and add the gains to their capital.

The LDP thinks this could boost bank lending by $250 billion, thus helping to ease the credit crunch. That possibility, coupled with the bailout, has moved bank shares sharply higher. But Merrill Lynch & Co. senior economist Michael Hartnett frets that if Hashimoto is merely putting off a much needed shakeout in Japan's overcrowded banking sector, lenders and the market could head south in a hurry once the relief effort runs out of steam.

East Asia's economic woes also continue to be a problem for the Japanese market. Exports have been the sole pillar of an economy where consumer spending has declined for the last nine months and business investment has been sluggish. But Japanese exports to Asia are already down 4% from the pervious year, and steeper declines may be in store. As a result, Salomon Smith Barney has halved its gross domestic product growth estimate to 0.6% for fiscal 1998, which ends in March, 1999.

There's no question that Japan has the kind of financial resources to get its economy back on track. Yet spending money to prop up the status quo in the troubled financial sector isn't going to cut it. Neither will modest tax reductions. Unless the government gets really serious about economic stimulus and reform, the Nikkei may again go into a deep freeze not long after Japan's cherry blossoms do their thing this spring.

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