Investors can't ignore the world's second biggest market but persevering is proving painful
Over the past few months, Japan's Prime Minister Junichiro Koizumi has begun to sound like a host on one of those endurance games shows that for sheer horror outstrip all other clips featured on Tarrant on TV. 'Expect pain,' he tells his miserably abject but transfixed audiences. 'We need pain to make us better, to help us thrive.'
Perhaps happily for the targets, the threats or promises of the discomfort to accompany structural reform have so far largely failed to materialise. But the mere spectre of a strong whiphand has had a remarkably unifying effect on voters, who have rallied behind the charismatic Koizumi in the last few months.
On Sunday, the nation goes to the polls to signal just how much pain it is ready to take. Koizumi's Liberal Democratic Party needs to win over half of the 121 seats in the upper house of the Japanese parliament to retain its majority and receive any sort of mandate for change. The election is important in that it has been held out as the key turning point for investor sentiment. It is likely that the LDP will achieve the minimum target. But Koizumi must then get measures such as cuts in public spending past the significant faction inside his own party that has a very low pain threshold. He will have a relatively short honeymoon period with the voters and his internal opposition, in which to act.
For foreign investors, there are pockets of value and opportunities in Japan, but they are difficult to find. The stock market is at a 16-year low, the currency is suffering against both the dollar and the euro, and credibility is approaching an all-time low. Even resilient Japan bulls, and experts who have successively navigated its markets, can only offer qualified optimism about the post-poll scenario.
Some argue that it doesn't matter what the outcome is ' Japan has run out of domestic monetary policy options and must wait for falling US interest rates and an upturn in the global economic cycle to lift its markets once more.
The Japanese cabinet has approved plans to cap spending and create a government-backed fund to shore up the ailing banking sector. But the level of public debt (at 130% of GDP it is the highest ever among developed countries) means large-scale spending is out of the question. Sectors reliant on government spending are already feeling the effect of cutbacks.
Japanese investors have more or less learned to live on the knife-edge. But foreign players are still shocked by each new piece of bad news. A report from Goldman Sachs last week challenged the extent of bad debts carried by local banks, and the basis on which the loans are calculated.
This is not a small difference of opinion. Goldman, which has directed some fairly impressive academic firepower at the issue, suggests bad bank loans could amount to nearly half the country's gross domestic product.
The Financial Services Agency, the main regulator, insists they total just 3% of GDP. If the data is rejected or has to be substantially revised, it must throw the reliability of other key economic indicators into question.
To say the report worried the markets is an understatement. Everyone is already worried. What is really unsettling is that there appears to be less and less anyone can do about Japan. It is the world's second largest market, and even the biggest investors can't get a grip on it. They can't abandon it altogether, and it is painful to remain exposed.
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