Japan's Recovery Looks Like The Real Thing

The country's recent economic performance resembles a full-blown rebound

At the bustling Tokyo railroad station, commuters no longer grimace in front of the neon stock ticker at the main Marunouchi entrance. There's no need: The Nikkei is up some 56% over the last year. Car buyers who in recent years favored mini subcompacts selling for under $10,000 are suddenly putting their money down for luxury sedans. And vacation bookings for the Golden Week celebrations that kick off Apr. 24 are up 3.3% in 2004 -- the first increase since 2000. Not only will more Japanese be soaking at local hot spring resorts this year but more will be sunning themselves on the beaches of Maui and Bali.

After years of fits and starts, it looks like a real recovery is under way in Japan. Of course, some grizzled Japan-watchers are skeptical. Everyone said Japan was on the mend back in 1996, when the economy clocked 2.5% real annual growth. But that upturn got crushed by the Asian financial crisis a year later. In 2000, a 1.1% rebound in gross domestic product quickly turned into a two-year deflationary slide, as Japan's tech sector crashed and U.S. demand evaporated.

But this time feels different. The U.S. recovery and hypergrowth in China have stoked Japanese exports for almost a year now. Stock buybacks, improved earnings, and steady restructuring among Japan's big listed companies have boosted average return on equity to 6% in 2003, from virtually zero in 2001. On Apr. 12, the government reported that Japan's current-account surplus for February had shot up 46%, year-on-year, to $20 billion, the eighth straight monthly advance. That followed an eye-popping 135% leap in January's trade surplus. Plus, signs of vigor in the local economy prompted the Bank of Japan on Apr. 9 to upgrade its outlook, noting that "improvements in business sentiment have been spreading across industries." Even Japan's long-depressed service sector is showing signs of life. Retail sales jumped 1.7% in February over the previous month, the highest growth rate since 1997.


So far, then, it looks like this recovery has legs. Coming off a 2.7% GDP expansion in real terms in 2003, most economists forecast 3% growth this year. Corporate sentiment as measured by the BOJ's most recent Tankan quarterly survey registered its most buoyant results since 1997. The poll tracks willingness to invest and hire among 10,000 companies. And the sharp rise in the price of commodities such as cement and steel due to demand from China is giving Japanese players pricing power. A Nihon Keizai Shimbun survey of 1,426 listed companies indicates that pretax profits in the fiscal year ended on Mar. 31 rose an average of 15.6%, the second year of robust gains.

Japanese consumers, who responded to a dismal decade by hunkering down, are beginning to snap out of it. Household spending jumped 5.2% in February over a year earlier, driven by rising pay, overtime, and bonuses. Innovative retailers such as Aeon Corp., which sources from China and offers discount pricing, are thriving. With $33.3 billion in annual sales, Aeon has just passed Ito-Yokado Co. as Japan's top retailer.

And if the recovery holds up, a lot of pent-up consumer demand could be unleashed. Two years ago, Akiko Kondo, 42, a housewife in suburban Tokyo, could barely make ends meet when her husband's summer bonus was slashed. Now, she is more upbeat. "I'd like to buy a DVD recorder, if we have a chance," she says. "That was unthinkable before."

What could send this Japan recovery into a tailspin? The main threat would be an economic train wreck in China, where an overheated economy is forcing Beijing to try to rein in lending and economic growth. If the Chinese economy pulls up sharply as a result, dial back forecasts for Japan -- since the mainland now accounts for some 30% of its economic output.

The other issue is the health of the financial system. The number of nonperforming loans continues to shrink -- down 10%, to $300 billion, for the half-year ended in September. That's an impressive improvement, though a rebounding stock market and stronger corporate earnings have helped. However, an Apr. 7 International Monetary Fund report points out that regional banks, which account for 44% of Japan's dud-loan figure, remain a big headache. The upshot: Financial regulators can hardly rest easy. Also, any uptick in interest rates would sting both highly leveraged companies and the government, which depends on ultracheap debt to fund services. Public debt now tops 144% of GDP.

Most important of all, Japan will continue to suffer from its own demographics. Japanese 65 and older already make up 18.5% of the population, a number that will rise to 30% by 2030. A graying population doesn't consume as much, or work as hard, as a younger, more dynamic nation. In short, Japan still has a difficult future. But this cycle is showing strength. The Japanese, at long last, can relax and enjoy Golden Week.

By Brian Bremner in Tokyo

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