Commentary: A Little Growth: Just What Japan Doesn't Need

By Brian Bremmer

In Tokyo, the scent of quick money is in the air again. The Nikkei is up 11% this year, more than any other major stock index. Corporate Japan forecasts a 51% jump in profits for the year ending next March. And on June 7, the government was expected to announce that the nation's economy blasted out of the recession in the first quarter and grew at a 7.7% annual clip.

Yes, Japan has freed itself from the grip of a nasty nine-month contraction. The dire predictions of a cascade of major bank failures didn't materialize. Exports to the U.S. and elsewhere in Asia have rebounded. Household spending increased in April for the first time in three months. In addition, Japan is benefiting from a big shift in capital flows away from the U.S. During a two-week period in mid-May, overseas investors steered $8 billion into the Tokyo Stock Exchange. "We are seeing a big bounce back," says Ian Burden, chief investment officer at Invesco Asset Management Ltd. He thinks the market could rise another 10% this year.

But is this the real deal, the start of a lasting economic recovery? Unfortunately, that's about as likely as Japan winning the World Cup. To begin with, Japan's unreliable economic statistics probably overstated first-quarter growth. Second, the drop in the dollar could deep-six the modest recovery that actually is happening. In any event, Japan's long-running bank mess will keep a lid on the economy until it finally gets resolved. That's why economists are betting that for the full year, Japan will be lucky to grow even 1%.

In fact, it's easy to argue that the Japanese are getting just what they don't need: enough growth to ease the pressure for reform but not enough for a solid recovery. So, investors jumping in are likely to be disappointed. For one thing, the earnings estimates look pretty suspect, says Goldman, Sachs & Co. economist Kathy Matsui. Japanese companies are notorious for overestimating expected profits. And about half the expected 51% jump in pretax profits is clustered in the electronics sector, so the earnings recovery won't be broad-based. Matsui also worries about a continued decline in the dollar, which could take the yen from 124 per dollar now to the 115 that is the breakeven point for most exporters. "This year's earnings recovery," she says, "is enormously dependent on export earnings." Small wonder that the Bank of Japan on May 31 spent about $10 billion to cool off the yen's recent surge, in one of the biggest currency interventions ever.

The central bank has also been printing money like crazy this year in an effort to end deflation and get people borrowing and spending again. Japan's monetary base is growing at a blistering 36% annualized rate, a pace not seen in almost 30 years. Usually, such money-supply jumps presage inflation and also a sharp upturn in economic growth. But in Japan deflation continues, as the very big and very ailing banks refuse to lend the money that's being pumped into the system. New loans dropped 5% in April from a year earlier. The banks are weighed down more than ever with bad debts, equaling almost 11% of their loan portfolios. Nikko Salomon Smith Barney economist Jeffrey Young says resolving the problem will "absorb many years of [bank] profits."

Meanwhile, the government is pointing to the budding recovery as proof that its policies are working. Most Japanese are not fooled. "The government is not dealing with the debt problem," says Hiromasa Yonekura, president of Sumitomo Chemical Co. "People are not satisfied." Yonekura advocates a quick bank cleanup and deep tax cuts. Sounds reasonable. What the Japanese will probably get, though, is a botched recovery and more pain down the road.

Bremner covers Japanese finance from Tokyo.

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