Fund manager's comment/Simon Donne
After 10 years of economic and political floundering, it is tempting to believe Japan is finally approaching a make-or-break situation.
While the economy has fluctuated between recession and half-hearted attempts at self-sustained growth, Japan's structural problems have remained unsolved. Annual budget deficits throughout the 1990s have led to the gross public debt ballooning to 130% of GDP, banks' capital reserves have been eroded by bad debt write-offs, demographics have become less favourable and the Bank of Japan (BoJ) has already reduced interest rates to zero.
Although Japan being back in recession is not a new situation, the combination of a more serious global economic slowdown and an inability to rely on traditional fiscal support packages means doing nothing is no longer an option.
It is now impossible to discuss the outlook for the Japanese stock market without mentioning Prime Minister Koizumi. Even if many of the extensive reform proposals are neither new nor original to the ruling party, the public seems to have embraced the concept of change.
One by one, the necessary conditions for releasing Japan from its decade-long sclerosis could fall into place over the next few years. One of the more important developments would be forcing banks to dispose of existing non-performing loans and to reduce their equity exposure.
If Koizumi's measures are implemented, Japan's growth will be further weakened while painful adjustments are made. Japan has squandered a decade during which strong global growth could have helped offset this period of induced weakness. It now has to carry out these reforms against a global economic downturn. If the economy proves too weak to withstand extra pressure from structural reforms, the outlook for its economy and stock market could become extremely bleak.
The sense of urgency needs to be maintained and translated into speedy legislation and implementation. As economic growth remains under pressure, it will be important that the political determination behind the reforms, and the public support for them, remains firm.
Consumer and corporate sentiment should improve once confidence in Japan's longer-term growth outlook has been raised and lingering problems from the 1980s bubble removed.
The longer-term outlook for Japanese equities is a sharper risk/reward profile ' higher risk but potentially higher reward. Our shorter-term view is that the market will react more to global economic news and stocks will largely follow global sector news. Consensus earnings and economic growth forecasts are still too high but the market has already moved back towards its March low. Can Koizumi successfully navigate the three Rs ' recession, reform and recovery?
New PM Koizumi promising reform.
High public support for change.
Reforms could raise growth potential.
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