Koizumi's Rx: Get Used to the Pain

The Japanese Prime Minister's reforms are badly needed medicine for an ailing economy. Just don't expect a quick cure, or an easy one

By Brian Bremner

So whatever happened to the Koizumi rally? In May, when Japan's mop-topped reformer, Junichiro Koizumi, emerged as the country's new Prime Minister, some analysts and market pundits predicted a euphoric rally for the Nikkei.

After all, Koizumi vowed to come forward with a serious restructuring platform to pull the economy out of its protracted stagnation. Japan would finally get serious about fixing its debt-besotted banking system and clearing out the excess capacity and labor permeating the economy -- or so the theory went. A Nikkei rally would get underway, pricing in a Japan recovery in late 2002 or 2003.

Well, dream on. On July 9, the Nikkei dropped 211.44 points to 12,094.64. Should it fall another 300 points or so, it will set a record 16-year low.


  Truth is, investors should continue to steer clear of the Nikkei even though Koizumi is on the right track. Right now, the markets are more focused on the upfront pain that Koizumi's policies of fiscal austerity and creative destruction will bring than the prospect of the economy returning to the sunny uplands of prosperity. And with good reason: The world's second-biggest economy is approaching an ugly hard landing.

Koizumi's economic policy team has been telling the markets that its overall plan needn't be a catastrophe. Finance Minister Masajuro Shiokawa and Koizumi's top economic adviser, Heizo Takenaka, vow to keep the economy growing, albeit all of 1%. Also, they figure that job losses resulting from banks pulling the plug on deadbeat corporate borrowers will involve maybe 200,000 souls in the workforce.

Yet, given how multifaceted Japan's economic woes truly are, few observers think the country will get off that easy. Most private economists think that the job losses will involve 1 million workers, pushing up Japan's jobless rate from 4.9% to 7% or so. A new report by HSBC Securities, entitled "Buy the dream, sell the reality," paints a truly gloomy picture over the next two years.

Japan's economic output will fall on a quarter-to-quarter basis throughout 2001 and will scarcely do better in 2002. Industrial production, which drives corporate earnings and hence share prices, will collapse 6.5% in 2001 and won't recover until the end of 2002. The HSBC report is also forecasting for Corporate Japan profit declines of a whopping 17% in 2001 and about half that much for 2002.


  And once the cathartic shakeout in the corporate sector gets underway, Japanese banks will face fresh troubles. More bankruptcies will mean more bad loans that will have to be written off against earnings. Merrill Lynch credit analyst Koyo Ozeki thinks that the bad-loan problem is roughly $400 billion.

Given that Japanese banks' current capital base is only $322 billion, that probably means another infusion of public money to bail out the worst-hit banks, similar to the dose in 1998, when two major financial institutions collapsed and the entire banking system seemed in grim shape.

Then, there's the unraveling of Japan's networks of cross-holdings between Tokyo money-center banks and corporate Japan. It amounts to about 33% of total tradable shares, and both sides want to dump stocks to put precious capital to more productive use. That's ultimately a worthwhile thing to do, but in the short term, it will continue to put selling pressure on the Nikkei.


  The good news -- yes, there is good news -- is that Japan is finally starting to address problems that have bedeviled the economy for more than a decade. But this is no ordinary midcourse correction. It's more like shock therapy, and it will take a long while before global investors know where the bottom truly lies.

Someday, should Japan pull out of its 12-year bear market, some very smart money will make a killing by timing the economic recovery just right. But for right now, and probably for the rest of 2001, I wouldn't touch Japanese stocks with a barge pole.

Bremner, Tokyo bureau chief for BusinessWeek, offers his views every week in Eye on Japan, only for BW Online

Edited by Beth Belton

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