Japan's Economy: Today and Tomorrow
Akinari Horii
It is always a pleasure to come back to Philadelphia, for this is the city that let me have all the good memories between 1979 and 1981 when I studied business and finance at Wharton School. It is, however, not necessarily pleasant to talk about Japan's economy these days. Before I begin my remarks, therefore, allow me to remind you of the usual disclaimer for a central bank official's speech, i.e., the views expressed here are my own and do not necessarily represent those of the Bank of Japan. This is a kind of magic spell that makes me feel less constraint, and therefore less uneasy, about my presentation.
Now let me begin by examining recent economic developments in Japan. Economic growth performance in Japan has been disappointing during most of the past eight years. During the recent twelve months, it has become worse than a disappointment. Japan's economy is facing a threat of deflation for the first time since the 1930s in the United States, Japan, and other industrial countries. Outputs have been declining for four consecutive quarters at an annual rate of 3 percent. Not only has the unemployment rate been renewing the record high, but also employment has been decreasing. On top of that, both prices and wages are declining. These are indeed worrisome.
Against this background, the Japanese government has prepared an emergency economic package amounting to over 20 trillion or $200 billion. I expect this package to create a substantial amount of demand for goods and services in the economy and therefore hold the declining GDP in check.
However, a few caveats should be in place against optimism about Japan's economic outlook. First of all, Japan's GDP has declined by three percent during the past four quarters. Therefore, I am not sure if these fiscal stimuli would prove to be sufficient to turn the current trend in the economy upwards. Secondly, because of the prolonged recession as well as repetitive fiscal expenditures during the past eight years, the budgets of both the central and local governments are deep in deficit, which makes any fiscal stimulus less and less feasible in the future. Thirdly, this emergency package of November 1998 is in fact the eighth fiscal package during the past six years. The first one was the package of August 1992 amounting to 11 trillion, followed by seven fiscal policy packages. Practically on every occasion when the fiscal stimuli were given to the economy, they had some positive influences on economic growth. After their direct impetus phased away, however, Japan's economy came into recession again. The fact that repetitive fiscal stimuli failed to sustain economic growth demonstrates that Japan's economic problem is more structural than cyclical.
Thus far, monetary policy has also failed to achieve a strong economic recovery in Japan. On July 1st, 1991, the Bank of Japan cut the discount rate, beginning its easy monetary policy only a few months after the peak of the earlier economic boom. After a series of interest rate reductions, the Bank of Japan cut the discount rate again in September 1995 to a half percent, making this the lowest discount rate in the history of central banking in the world. Even during the times of the Great Depression in the United States, the discount rate stood at one percent with the exception of extraordinary lending for war chest. Since September 1998, the Bank of Japan had been aiming money market rates at a quarter of one percent, until two weeks ago, when the Bank decided to aim money market rates as low as possible, or as close to zero. Interest rates are not standing in Japan but lying on a rock bottom. The Bank of Japan has also been conducting aggressive open-market operations, which are reflected in a massive growth in its balance sheet. The monetary aggregates have, however, been increasing by a modest rate of four to five percent per annum. Obviously, the money multiplier fails to function properly. In addition, the nominal GDP has been showing negative growth for four quarters in a row. In other words, the velocity of money has been falling dramatically.
As such, repetitive fiscal stimuli as well as unprecedented monetary ease have failed to bring with them sustained economic growth. In my opinion, it is because at the core of the weak growth performance lies the malfunctioning of financial intermediation. The Japanese banking system has been left with a huge volume of non-performing assets after the speculative bubbles burst in the early 1990s. As a result, a large number of banks have seen their equity deteriorate, and therefore became less able to take risks in lending and other businesses. The upshot was that financial intermediation in the entire economy clogged. It remains so today, eight years after the bubble burst.
With respect to the banking problem of non-performing assets, the right set of policy is clear enough in view of similar episodes that occurred in history. For example, a success story of the United States in the 1990s as well as its failure story in the 1930s give us a lot of lessons with respect to the right policy set. Both successes and failures in Sweden and Finland in the 1990s also offer us policy guidance. In a nutshell, these episodes tell us the following. Have banks identify the magnitude of non-performing assets by realistic accounting standards; get rid of the non-performing assets from banks' balance sheets; create a market for distressed loans and/or collateralized real estate; restore capital, the scope of which depends upon banks' decisiveness with respect to restructuring; and engineer orderly exit of unsound banks whose restructuring is not promising. It is extremely important to do all this quickly, and during the period of implementation, confidence in the stability of the financial system must be preserved by all means.
Now let me be more specific about what has been done and what remains to be done in Japan. During the past twelve months, there have been a few remarkable developments in legislation as well as banking fields. The law has been legislated to make it possible to nationalize, or establish bridge banks for, failing banks. Public funds as much as 60 trillion, or twelve percent of GDP, are pledged by the government to maintain the stability of the financial system. On the banking side, a huge amount of provisioning has been made against bad assets. Banks have begun some restructuring like scaling down overseas operations, cutting remuneration for its executives and employees. Quite a few banks are seeking alliance with partners not only in Japan but also in other countries. There are examples of banking consolidation as well. By strong suggestion of Bank of Japan Governor Hayami, nearly all money center banks in Japan apply for capital injection by the government. In my opinion, all of these are right steps toward redressing the banking problem in Japan.
Of course, no one should be complacent, for there remain a number of steps yet to be taken. Firstly, a bulk of non-performing assets remains on the balance sheets of banks. Therefore, not only banks' cashflow remains weak, but there also remains a significant degree of uncertainty about banks' future losses, should such non-performing assets grow worse further and asset prices decline. This uncertainty of future profits accounts for, in part, the Japan premium in international financial markets. In order to regain certainty and improve cashflow, banks must sell off non-performing assets. Secondly, in order to facilitate such charge offs, markets for distressed loans and collateralized real estate must be jump-started. In my opinion, the two nationalized banks -- LTCB and NCB -- as well as newly created RCC (Resolution and Collection Corporation) could contribute to this by beginning aggressive sales of their distressed loans. Thirdly, banks must restructure their business from a standpoint of strategic efficiency. Without a decisive restructuring plan, no new capital would be made from the market. Finally, those banks whose balance sheets have been so damaged that any restructuring might seem infeasible must either be closed or merged into another bank.
All this must be done fairly soon. For one thing, Japan's economic growth performance is likely to stop worsening soon owing to massive fiscal and monetary policy stimuli, but if and when all the stimuli phase away, it may resume its downward trend. In other words, if banks miss this window of opportunities, they will be forced to wait until the next time, if ever, to come. Let me remind you of another deadline for financial reform, i.e., end-March 2001, when all the temporary safety nets will be gone, and so will be capital injection because the law is written that way.
I have already spent lengthy time discussing Japan's economy and finance. At the risk of exhausting your patience, allow me to speak quickly about Japan's financial "Big Bang." In Japan, the deregulation program termed Big Bang is in place, which covers a wide range of financial services. I know there is much skepticism in this country toward Japan's financial Big Bang, but as far as this is concerned, I am rather optimistic. First of all, legislation effecting Japan's Big Bang has already been made. In other words, Big Bang is a fait accompli de jure. In fact, American and European financial services companies have already begun to take full advantage of this Big Bang by offering a variety of products for Japanese investors. Some of these firms have acquired Japanese financial service firms, and others set up joint ventures with Japanese firms. At the same time, Japanese non-financial businesses are also active in seeking a wider avenue of funding as well as investment. As Big Bang brings with it material effects on the avenues for private-sector borrowing and investment, that will help restore functioning of the financial intermediation.
The Big Bang also has a significant implication for the global market, particularly speaking for Asian financial markets. In theory, Japan's Big Bang will offer global borrowers and investors a wider use of the yen and/or an active intermediation in the Tokyo market. For a wider use of a currency by non-resident, a safe and efficient payment system is essential, and the banking system plays a pivotal role in it. I know no currency whose main payment function is borne outside the banking system. The dollar, the euro and the yen are no exception. Therefore, in my opinion, without a strong banking system, a wide international use of the yen might prove to be a pipe dream.
On the other hand, financial intermediation for foreign borrowers and investors in Tokyo could in theory be achieved without a strong commercial banking industry. As is often pointed out, there is a huge pool of savings in the Japanese private sector, which is a great attraction to international borrowers. Investment banks and other securities companies could promote intermediation of these financial resources for non-resident borrowers. One of the most important features of Japan's Big Bang is, in fact, the massive deregulation of securities licensing and pricing, and therefore Big Bang may indeed prove to be successful in expanding intermediation in the Tokyo market.
In this regard, too, I consider the use of the yen to be essential. Otherwise, why would borrowers in other countries be attracted to the Tokyo market, when they can opt for New York, London or Zurich? The rich pool of savings can flow out of Japan easily for investment in New York, London and other financial centers, where active intermediation of financial resources of the world takes place.
In sum, without a strong and active banking sector, Big Bang might end up being nothing but a parochial development. Conversely, if Big Bang succeed in bringing with it the attractive yen supported by efficient and sound banking system, it will facilitate efficient intermediation not just in Japan but in the rest of the world at large.
Eight years have passed since speculative bubbles burst in Japan, and we still see its adjustment incomplete. It is indeed frustrating to face this fact. But it is perhaps fair to say that in recent months, the financial-systems policy in Japan is geared in the right direction, and in the banking sector, there are some encouraging developments. Some of you may be tempted to underscore only "in recent months," but being late is better than never.
During the past four months, I have come to Philadelphia three times to speak about Japan. My first occasion was October 1998, shortly after the ruling party and the opposition agreed on the safety net legislation. My second visit was December 1998, after the government prepared a large fiscal policy package and nationalized two large banks. And this time, after aggressive monetary ease. Every time I've come to this great city, I become less pessimistic about Japan's economy. I hope next time Philadelphia invites me, I will be more optimistic.
Thank you.
This page last updated 3/12/99 jdb
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