When Mr Abe took over as the Prime Minister of Japan, he had to contend with North Korean missiles. Now, he has to contend with Japanese machinery orders?an indication of industrial production. Orders dropped 7.4% year-on-year in September, though the consensus forecast called for a rise of 1.8%. Putting on a brave face, Mr Toshihiko Fukui, the governor of the Bank of Japan (BoJ), had said he expected interest rates to rise ?soon.? The short-rate in Japan stands at a paltry 0.25%. Interest rate futures show that the market expects this rate to be around 0.75% by end-2007. That reflects expectations of modest growth and a very slow exit out of deflation in Japan. Mr Fukui obviously does not concur with the market?s assessment. He is concerned about the risks of keeping rates too low rather than the risk of raising them too prematurely. Is he right?
The question is whether the BoJ is about to repeat its policy errors of the past. The Lex column of The Financial Times last Thursday expressed scepticism on the Japanese recovery story, and for good reason. Mr Takenaka, the former financial services minister has questioned the actions of the BoJ in mopping up money supply and liquidity too quickly from the economy. He blames that action for the economic slowdown.
Our belief in the Japanese economic recovery this time is based on the following: (a) It is driven by the private sector; (b) It is coming on the back of a genuine cleanup in the banking sector; (c) It is based on a classical recovery pattern seen in the US in the ?90s with investment spending and corporate profits recovery; and (d) it is based on a firming of land and property prices.
Yet, recent data has created a noise of slowdown so loud it is hard to ignore. Bank lending growth has slowed for the second month in a row. The Economy Watchers? Survey indicates a softening of the optimism on current conditions. The chart shows that the level of optimism has crested twice at 55 and has been unable to break above that level. It is just above break even now. The October survey is not available yet in English and the details would be as important, if not more, as the headline index reading.
The well intentioned but potentially dangerous move to cap interest rates charged by consumer finance companies may dry up credit for households. |
The diffusion index of confidence among small businesses has also stalled around the 50-level for nearly three years. In the monthly Tankan surveys, one sees signs of distress among small businesses in terms of their outlook for output prices, for profits and for credit conditions. The well-intentioned, but potentially dangerous, move to cap the interest rates charged by consumer finance companies might dry up credit for households at a time when wages are not rising. Many consumer finance companies had to increase provisions for losses, given the interest rate cap.
The Liberal Democratic Party wishes to bring down the maximum interest rates that consumer finance companies could charge over a period of three years, whereas the opposition Democratic Party wants it to be enforced immediately. It strikes one as a populist move but not necessarily a beneficial one for Japanese households, ultimately. Therefore, despite the compelling secular case to be optimistic about Japan, evidence to the contrary has been slowly accumulating. It might well be a seasonal dip to be followed by a revival. As the Americans are fond of saying, it might well be ?a pause that refreshes.?
However, there?s concern, and developments will be closely watched in the next week or so, to determine if the optimism about Japanese equities is justified in the light of growing evidence of economic stagnation. Perhaps Japan needs fresh and bold thinking to reinvigorate a rapidly ageing society. As argued before, there is a lot more in store for it than a few decimal points of economic growth.
As investment advisors, we are not in love with a stock or currency or country. We look for returns and when the balance of assessment leads us to the conclusion that the risk of losses dominates the potential for gains, we have to reduce or eliminate our exposure. We are on such a watch for Japan.
?The writer is head of research, Asia Pacific and Middle East, Bank of Julius Baer, Singapore. These are his personal views Email id: jeevatma@gmail.com
