Even before the terrorist assault on the US, the Japanese economy was heading rapidly towards its fo...
Even before the terrorist assault on the US, the Japanese economy was heading rapidly towards its fourth recession in 10 years. Exports had collapsed on the back of the global economic slowdown, and this in turn had depressed private sector capital expenditure and consumer confidence. To exacerbate matters further, the new reformist government under Koizumi had decided to cap public spending in an effort to rein in the rapid growth of national debt. Following the terrorist attacks however, economists have had to trim 0.3% to 0.4% off Japan's growth figures for this fiscal year as the US economy is likely to fall into a recession, depressing Japan's exports further.
In response to the possibility of a deepening recession, the Bank of Japan has taken a more proactive stance in supporting the economy. This involved pumping more money into the system and cutting the discount rate from 0.25% to 0.15% in a concerted effort with other G7 central banks to boost liquidity and global economic growth. The Bank of Japan has also been active in the currency market, intervening to buy US dollars in an effort to prevent the yen rising above the ¥115 level against the dollar.
However, perhaps a more serious long-term setback caused by the US tragedy has been the delay in the progress of Koizumi's reform programmes. In the wake of the terrorist attacks, Koizumi's government has been preoccupied in deciding an appropriate response to terrorism and in particular, whether the nation's Self Defence Force is constitutionally able to play an active role in supporting America's military plans.
Prior to these events, Koizumi had published an outline of his reform plans, which included a promise to speed up bad loan write-offs by strengthening the operation of the state-run Resolution and Collection Corporation (RCC). Koizumi recently set a clear target for banks' bad loan reduction for the first time by saying he aims to bring down the ratio of bad loans to outstanding loans to between 3% and 4% by March 2005 through intensive purchases of bad debt by the RCC. This news boosted bank stocks, raising investors' hopes that bad debt reduction will accelerate, and with current equity valuations at historically low levels, any further positive announcements from the government are likely to boost the equity market.
At the corporate level, restructuring and M&A (mergers and acquisitions) activity is becoming more common in Japan. This trend is expected to accelerate further as the economy plunges deeper into a recession. Corporate bankruptcies are also likely to increase, weeding out weaker companies with high levels of debt amassed during the economic bubble of the late 80s. Survivors of the structural changes taking place in this difficult time should reap the benefit as they should become fitter, and with fewer competitors.
As a result, in our portfolios we are focusing on companies that are building a stronger corporate structure through restructuring and M&A activity and are likely to emerge as the ultimate winners in each industry.
Koizumi's reform plans should boost equities.
Equity valuations at a historically low level.
More restructuring and industry consolidation.
Recession to deepen as economy weakens.
Economic reforms may be delayed further.
Difficult to predict the outcome of US actions.
Nick Reid is a senior investment manager at Gartmore
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