With the economy in freefall, only brutal economic reforms can help the Land of the Rising Sun now
Since the Japanese equity market peaked 12 years ago, investors have been lured to more false dawns than they care to remember. Gripped by deflation, the economy seems unable to lift itself out of a debilitating malaise. Promises for reform and restructuring in both policy and corporate spheres have come and gone without much impact.
Now that fears of a global double dip recession are becoming more widespread, just how much longer can Japan leave its problems unattended and what is the rest of the world to do about it? The latest focus has been the country's $404bn budget and the widening deficit. Standing at 140% of gross domestic product, it is already the highest among developed nations.
Central to the deficit is Japan's social security bill, which soaks up over 22% of budget spend. High unemployment and increasing social problems are reducing insurance contributions. But the greatest challenge facing policymakers is the ageing population and the huge medical costs it generates. Public discussion has been all but impossible because it is considered poor form to show any disrespect to the elderly. But economically and culturally, Japan is starting to feel the weight of its demographic profile.
The government is well aware of the looming shortfalls. It has tried to trim spending with a 3% cut in its public works budget and another 2% from a discretionary budget, but these shavings will count for nothing as the cost of debt servicing climbs to more than 20% of the total budget. In the corporate sector wages and profitability are under pressure, which is undermining the future fiscal base. Tax revenues have been falling, while employment insurance premiums are going up.
With no result from monetary or fiscal stimulus, some experts are recommending selling national assets. Selling the family silver has worked for other nations, but dumping assets on a fragile stock market would just add to problems. Who would buy, and at what price? Foreign buyers, who have sustained the Japanese equity market through many of its recent crises, are now net sellers. To great government acclaim, the domestic corporate sector has just received a dollop of tax relief. However, few businesses are grateful for the gift because they believe the concessions will inevitably be clawed back or revoked.
Investors have stood by as the Nikkei 225 index hit fresh six month lows in August ahead of the end of the first half of the year at end September. The weakness in the stock market reflects closely the weakness of the banking sector, whose problems have been widely documented. A crisis has been imminent for some time, but the survival margin is now infinitesimal. Last year one calculation suggested that the Nikkei needed to remain above 11,000 to keep the banks out of trouble. It ended the year at 11,004 and is now regularly below 10,000.
In an attempt to shore up the stock market, the authorities are now putting further restrictions on short selling. There is not even consensus among policymakers that this is the correct course, and for good reason. The Finance Ministry knows that such intervention, like attempts to prop up currencies in the money markets, will eventually prompt a blizzard of selling.
Japan bulls have kept the faith as the market has slid through one support level after another. If it wasn't a sector story, it was small caps, or some other angle. Now, with nowhere left to hide, they offer the best reason yet for buying Japan: the worse the global economy gets, the faster brutal reform will arrive.
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