All Eyes on Japan's Teetering Economy

A diving Nikkei, shrinking GDP--how bad can things get?

It seems as if the financial meltdown that has afflicted Japan for a decade will never end. The newest signs of crisis include a free-falling Nikkei stock index, a rash of losses in the country's vital electronics sector, and fresh worries about Japan's debt-drunk banking system. Most embarrassingly, the International Monetary Fund has shifted its focus off the developing world and cast a gimlet eye on Japan: The fund is pushing to send in a SWAT team of examiners to pore over the books of Japan's banks. Meanwhile, Hakuo Yanagisawa, Japan's Minister for Financial Services and the point man in the bank workout, has been offering a more optimistic view of Japan's crisis. How bad could things get? Here's a primer:

Is the situation so dire that Japan needs an IMF inspection?

The Washington-based fund recently issued a critical report on Japan's banking system that cast doubt on official bad-debt figures. Financial Services Minister Yanagisawa insists that 15 major banks can afford to write off $145 billion in nonperforming loans in three years without any injection of public funds. The IMF is worried that Tokyo is downplaying a potential crisis involving not only acknowledged bad loans but also an additional $700 billion in debt whose repayment is in question. Meanwhile, private firms, including Goldman, Sachs & Co., have estimated that Japan's level of nonperforming loans is four or five times higher than Tokyo is admitting.

Will there be big bank collapses?

That's unlikely in the near term. A $50 billion capital injection in 1999 shored up the capital-adequacy ratios of the biggest banks. Smaller lenders and regional banks could go down, but the government is offering 100% blanket protection of bank deposits. An added issue is the practice Japanese banks have of including their stock portfolios in their capital base. Even though the collapsing Nikkei is hitting these portfolios, stock market declines probably won't sink the banking sector. Major banks have capital-adequacy ratios of around 10%--above the 8% they need.

So why is the IMF so concerned?

If Japan's banks don't clean up their loan books once and for all, they won't be doing much lending, and Japan won't have growth for years to come. That hurts Asian trading partners such as South Korea, Singapore, and others that trade heavily with Japan. Japan's $4.2 trillion economy is burdened with huge excess capacity and debt. Only a cathartic and painful shakeout will fix it.

How many jobs are at risk?

Plenty. Japan's jobless rate is already at a postwar high of 5%. Goldman Sachs analyst David M. Atkinson thinks net unemployment will eventually hit 2.1 million. Atkinson's numbers mean a jobless rate of about 8.5%--horrendous by historical standards.

What's behind the collapse of the Nikkei index to a 17-year low?

Foreign investors are heading for the exits as the Japanese economy decelerates. Just about every major indicator, from industrial production to consumer spending, is flat or heading south. Figures scheduled to be released on Sept. 7 for the April-to-June quarter are likely to show that the economy contracted at an annualized rate of 4% or more. The U.S. tech bust and soft global demand for chips and all manner of info-tech gear is creating huge losses for blue-chip companies such as Hitachi, Toshiba, and Fujitsu. Japanese bank and tech stocks account for about 35% of the market capitalization on the Tokyo Stock Exchange.

So is Prime Minister Junichiro Koizumi likely to back off from his plan for tough reforms?

Well, he is certainly in a jam. The economy has nosedived since he took power in April, though he has hardly begun the dolorous restructuring he promised. If Koizumi does a U-turn, abandons fiscal austerity, and resorts, like his predecessors, to big spending packages and new borrowing, investors could exit Japanese bonds en masse, which would send prices plunging and further aggravate the economic downturn. Koizumi is scheduled to release a detailed blueprint of his plans by mid-September.

Sounds grim. Can we expect a sustained recovery in Japan anytime soon?

Koizumi has argued that it will take three years of tough economic times to fix the banks, put deadbeat corporate borrowers out of business, and set the stage for a new period of growth. To get there, he'll need help. Japan's chief export market, the U.S., will have to begin to recover by 2002. And to further boost export growth, the yen will need to weaken dramatically, from 118 to the dollar to maybe 130--a level Japanese officials suggest they'd be comfortable with. Banks, meanwhile, must get ruthless with troubled borrowers. All of this is extremely tough to do politically. And remember, this is Japan, where things move slowly. So the rest of the world is going to have to cope with a very weak Japanese economy for years to come.

By Brian Bremner in Tokyo

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