Clouds hang over Japan’s banking system

by Gumisai Mutume

Washington, 29 March 2001 (IPS) - Unless the Japanese government decisively handles its banking crisis, the world’s second largest economy could soon be embroiled in a financial disaster that could take down the world economy with it, a corporate think-tank here warns.

“The Japanese government has been gradually adopting partial banking reforms, but there is a general reluctance by politicians to bite the bullet,” says Adam Posen, senior fellow at the Washington-based Institute for International Economics (IIE). “It is a miracle that Japan managed to get this far without real problems, but the tide is turning and the threat is now very real.”

The IIE, a pro-globalization think-tank in Washington has just released its latest policy brief on Japan, titled ‘Decisive action or financial panic’, authored by Posen. The document warns of dire times ahead if the banking crisis haunting Japan is not urgently solved.

Over the last few years Japan’s woes have become all too familiar - an economy that has averaged one percent annual growth since 1992, instability in its stock markets, an overvalued currency that has made exports too expensive and a perennially troubled banking system.

Things came to a head this month as panic struck Japanese markets, pulling the stock market index down to a 16-year low. Finance Minister Kiichi Miyazawa did not help matters much when he announced that government finances were “very close to collapsing”.

At the heart of Japan’s economic woes are the country’s banks, which are yet to clear their balance sheets of bad loans derived from a financial crisis that struck a decade ago.

Posen says the panic on the markets was a signal that the partial banking sector reforms have brought the economy to a point of no return, requiring immediate write-offs on non-performing loans.

“If write-offs are not undertaken by the time Japanese banks reveal their mid-year financial results at the end of September under new accounting standards ... money will simply leave the Japanese financial system, if not Japan altogether,” says Posen.

Over the last few years, banks have been rolling over bad loans instead of writing them off and these loans now amount to at least 82 trillion yen - 16% of a year’s gross domestic product, according to the Bank of Japan. The amount even overshadows the total amount of capital held by the banking system, which is 60 trillion yen.

“On purely economic terms, the country’s Financial Services Agency should close or merge half the Banks in Japan,” notes the policy brief. “Though the political reality will prevent this, the FSA must make clear to the public that the Japanese banking sector must shrink.”

In an attempt to prop up consumer confidence and deal with the mounting problem of deflation, the Bank of Japan recently announced a zero percent interest rate policy. Deflation occurs when the value of goods and services falls.

Japan is the first industrialised country to have experienced real deflation since the 1930s.

Its economy has been hurt by deflation which causes people to defer spending, knowing that their money will be worth more in the future, resulting in slow spending. It also drags down the value of the economy as gross domestic product (GDP) in money terms also shrinks.

The last two years have seen the prices of goods and services fall by about one percent each year in Japan. The price of land fell by 5% last year, the 10th consecutive year that land prices have dropped.

Japan’s other pressing problems include a huge public debt. Government debt averaged 60% of gross domestic product a decade ago, according to the Organisation for Economic Co-operation and Development. It is now about 120% of GDP.

Government attitudes continue to be steeped in conservatism despite claims that it is pursuing reforms to enable greater foreign investments and deregulating industry in what has traditionally been a very closed economy, says Akio Mikuni, a Japan analyst.

For instance, Mikuni says, conservative politicians are pushing the Bank of Japan to print more money and pump it into circulation to create inflation as a pain-free alternative to cleaning out the debts of the banks.

With elections to choose a new prime minister coming soon, political expediency may over-ride economic considerations. While visiting Washington earlier this month, Japan’s Prime Minister Yoshiro Mori promised to clean up the banking system within six months. However, this was immediately contradicted by his chief cabinet secretary Yasou Fukuda, who said, Mori had meant that he would seek a plan to ease government debt rather than deal with the banks.

Such politicking, which is no stranger to the current economic malaise, has often been blamed for the erosion of confidence in the leadership’s ability to effectively deal with the country’s problems. Members of the Japanese parliament, the Diet, officials in the trade and economy ministries and other agencies have been known to reverse their stated positions many times.

IIE says that if there is a recession in Japan, it will harm growth prospects for its neighbours through diminished exports to Japan and less foreign direct investment from Tokyo. A declining yen could also put pressure on the currencies of emerging Asian markets, affecting their abilities to service their foreign debts.

A slowdown in Japan may also stall multilateral efforts at a new round for the World Trade Organisation, which is gaining momentum. Economic decline of the world’s second largest donor nation could also hinder progress in third world debt forgiveness and in the pace of reforms at the international financial institutions.

What is also worrying economic observers here is that bad news in Japan comes at a time when the US economy is in low gear and the combined effect of the slowdown in the two economies that account for some 46% of global GDP could be severe.

The United States and Japan take in 32% of Korea’s exports, 36% of Thailand’s, 38% of China’s and 43% of the Philippines.

The Asian Development Bank recently revised downwards, its forecast for growth this year in the region to 5%, lower than the 7% attained last year. There are fears that Asia may not attain even these revised figures in the event of recession in the world’s two biggest economies.

“The entire world will suffer from a slowdown in Japan and the US,” says economist Martin Mayer of the Brookings Institution. “While Europe is still growing, it does not take in a lot of world exports and it will not be able to act as an engine for global growth in the same way the US has done over the last 10 years.” .

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