No. 8 — February 26, 1999


Feature Article



A February visit to Tokyo that included interviews with government officials, discussions with Japanese and American businesspeople, conversations with financial leaders and factory tours — along with a good deal of walking and observing — produced a collection of impressions about the state of Japan's economy that gave substance to perceptions formed from the vantage point of Washington, D.C. Although all indicators suggest continuing weakness in the real economy, the cleanup of the banking industry's overwhelming bad-loan problems appears to be proceeding in a methodical fashion. At the same time, Big Bang financial reforms have forced companies to pay much closer attention to profitability and the return on capital — a focus that, in turn, has driven corporate restructuring. Deregulation also has provided profitable opportunities for foreign financial services providers. Their expanding market presence has reinforced incentives to restructure.

However, many observers — both in the government and outside it — feel that because of its negative short-term implications for employment, further deregulation is not appropriate now. The prevailing attitude is that crisis management first must deal with the financial sector's troubles and with fiscal stimulus. Then, in a year or so, when the real economy is expected to be healthier, an invigorated drive for more deregulation can be launched.

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Weekly Review


Japan's rapidly growing public-sector debt continues to complicate the economic management tasks of the Ministry of Finance and the Bank of Japan as well as the work of bond traders worldwide. Both interest rates and the yen's exchange rate, which tends to reflect interest rate trends, have been unusually volatile since late 1998. These new realities are the product of a series of MOF maneuvers over the past three months, the most recent of which resulted in the yen again weakening in mid-February. The Japanese currency closed February 19 in New York at ¥121.05=$1.00, a 10.2 percent depreciation from its January 11 value of ¥108.72=$1.00.



The April 11 Tokyo gubernatorial election is beginning to resemble a horse race of largely independent candidates, none of whom seems to be able to hold the inside track. The decision of so many people to run without the explicit backing of a political party seems to be aimed at attracting the support of the huge bloc of unaffiliated voters that propelled outgoing Governor Yukio Aoshima to an upset victory in April 1995. In reality, though, experts say that parties' de facto endorsement of certain contenders may create even more confusion in the minds of nonaligned Tokyoites, causing unforeseen — and perhaps unwanted — developments in both local and national politics.



The Philippine government signed two loan agreements with the Export-Import Bank of Japan February 17 totaling $600 million. Half of this amount will go toward banking industry reforms and will be matched by the World Bank. The other $300 million, which will be doubled by the Asian Development Bank, will finance changes in the country's electric power industry. According to Philippine Finance Secretary Edgardo Espiritu, the bank reform program has twin thrusts: to strengthen regulatory functions and to promote transparency. The electric utility project is aimed at expanding private-sector participation in this business. An initial $200 million tranche of Ex-Im Bank money is scheduled to be released in late March. Philippine President Joseph Estrada and members of the Legislative-Executive Development Advisory Council pledged February 17 to give priority to the enactment of four economic reform measures tied to the release of the $600 million in Ex-Im Bank financing.



The lower house of the Diet approved February 19 the ¥81.9 trillion ($682.5 billion at ¥120=$1.00) general account budget for the coming fiscal year in the fastest time ever, ensuring that it will go into effect April 1. The Liberal Democratic Party-Liberal Party alliance shepherded the spending bill to a final lower house vote after just 19 days of deliberation, deflecting all attempts by opposition parties to tack on amendments. The record-setting initial budget features a 10.5 percent hike in public works outlays and a 5.3 percent increase in total discretionary spending, both paid for by an all-time-high ¥31.1 trillion ($259.2 billion) in new deficit-financing and construction bond issues (see JEI Report No. 1B, January 9, 1999). With the LDP, the Liberal Party and the New Komeito supporting the budget authorization, observers expect it to sail through the upper house as well. In any event, the legislation is considered passed 30 days after approval by the House of Representatives.

While the nonperforming loans held by banks currently are the focus of government and public attention, the process of cleaning up a precursory debacle continues. In 1995 and 1996, the failure of seven jusen (housing loan companies) shook Japan's financial system, even though the amounts involved — ¥6.4 trillion ($53.3 billion at ¥120=$1.00) of ¥13 trillion ($108.3 billion) in jusen loans were considered unrecoverable — were modest in comparison with the volume of bad loans currently burdening banks. Tokyo's plan to liquidate the failed mortgage lenders broke new and controversial ground by using ¥685 billion ($5.7 billion) in public funds (see JEI Report No. 24, June 28, 1996). That operation became the template for the current framework for handling unviable banks, which is backed by ¥35 trillion ($291.7 billion) in taxpayer funds, including ¥17 trillion ($141.7 billion) to pay off depositors at failed banks.

Tokyo has won a test of will involving the seven direct descendants of the Japanese National Railways over its plan to dispose of JNR's remaining debts. Last October, the Diet approved a formula for paying off the ¥27.8 trillion ($231.7 billion at ¥120=$1.00) legacy over the next 60 years (see JEI Report No. 40B, October 23, 1998). Although the government will be responsible for most of the debt, the plan called on the seven railroad operating firms to shoulder ¥180 billion ($1.5 billion) of the burden. The seven firms, three of which have sold some shares to the public, protested hotly, arguing that they already had paid their fair share. They took on ¥14.5 trillion ($120.8 billion) of JNR's debts when they were created in 1987 and contributed another ¥170 billion ($1.4 billion) in 1997 to a pension plan for JNR workers when it became clear that the plan was underfunded.

Liberalization of financial markets on a global scale will take a step forward March 1 when, on schedule, 52 nations implement an accord negotiated in 1997 under the auspices of the World Trade Organization (see JEI Report No. 47B, December 19, 1997). The WTO financial services agreement will open banking, securities and insurance businesses in many signatory countries to new competition. In the insurance field, one U.S. industry group calculates that the WTO pact will affect 95 percent to 97 percent of the policies written in the 52 countries, which themselves account for about 90 percent of global financial services.

With Tokyo pumping trillions of extra yen into public works projects in an attempt to get the economy moving, the Clinton administration continues to press for greater access to this windfall on behalf of foreign engineering, construction and architectural services firms. In its mid-1998 annual review of the bilateral construction market pact, Department of Commerce officials expressed dismay that outside firms had won only about $50 million in Japanese contracts in FY 1997. This was less than half the value of the previous year's total and well below the $300 million high-water mark set in FY 1995. Despite the meager results, Washington declined to put the construction issue on the front burner.

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