Thawing the economy

26 January 1998 00:00  [Source: ACN]

The Japanese government plans to whip the country's ailing economy back into shape with a series of economic measures which include a relief fund and cuts in income and corporate taxes. Will this drive away the cloud hanging over the country's economy? Andrew Mollet finds out

The Japanese government has promised that a number of measures to stimulate the economy will be passed by the next session of the Diet. These include cuts in income- and corporate-tax rates and the establishment of a Yen30 000bn (US$228bn) fund to help resolve the country's chronic bad-debt problem. Preparations are also being made for government-affiliated financial institutions to lend a total of Yen25 000bn to firms which have difficulty obtaining operating funds from commercial banks. It is hoped that these measures will be sufficient to thaw the country's frozen economy, and therefore the economies in Asia. The US attributes a large part of the economic turmoil in Asia to international lack of trust in Japan's economy, and calls for Tokyo to take concerted measures to launch a domestic-demand-driven recovery. But given Japan's own poor state of financial health, there is little more it can afford to do. Asia's economic turmoil is causing Japanese manufacturing companies to overhaul their strategies in a region they long assumed would never regress, a survey by The Nikkei Weekly showed. Nearly half of the companies responding to the survey reported that their operations in other Asian countries were affected by a fall in local demand due to the turmoil. To make up for this, the manufacturers are exporting a larger portion of their local production to markets outside the region. Many firms said this strategy was successful because products made in countries whose currencies have plummeted are more cost-competitive abroad. In the long term, many Japanese companies plan to speed up steps towards making their operations in other Asian countries focus more on domestic sales. Success would reduce the risks of having to pay more for importing components and materials if the local currency weakens further, and from losing export sales if the currency strengthens. A modest 13% of the respondents reported that they have reduced or suspended production at Southeast Asian plants. However, Mitsuhiro Maeda, senior research fellow at Ministry of International Trade and Industry (Miti) Institute of Research, points out that much will depend on how long it takes for the region to recover from the current crisis.

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'If the recovery comes fairly shortly, the big devaluations in the local currencies, coupled with the return in demand for chemical and chemical-dependent products will provide Japanese chemical producers with a good opportunity to invest cheaply in production facilities,' Maeda says. 'However, if the recovery takes a long time - and, at the moment, the signs for a quick recovery are not good - then Japanese manufacturers might have to give up on the idea of using Southeast Asia as a production platform.' Chemical companies have generally been less hard-hit than some other companies, given the relatively low level of chemical exports to the region, he adds.

However, all is not rosy. Not only have exports to the region slowed, but many chemical companies which have set up production bases in Southeast Asia are facing significant foreign-exchange losses, since their investments were made in US dollars. 'Because the operations were designed to meet local demand, the slowdown in those economies has a severe effect on their profitability,' points out one senior Mitsui Chemicals source. 'We are seriously worried about the political instability in Indonesia. The volatile political situation not only exacerbates the economic problems, but it also threatens our investments in the country.'Trading companies are having an equally hard time. A Nissho Iwai source says that chemical exports to the region have more or less totally dried up. 'We are now virtually only supplying the US, European and Chinese markets, as is everybody else. This means a big drop in prices,' he says.

The few enquiries which the company receives from the region are all with very long payment terms, he adds. 'Banks don't recognise letters of credit any more, and insist on cash up front. The only ones who can afford this are the South Korean trading houses, and even they are becoming hesitant to let go of what little funds they have left,' he says.

Some trading companies, however, appear relatively more sanguine about the crisis. Mitsui & Co, for example, says its exports of polymers to the region have been little affected by the economic slowdown 'since our customers tend to either purchase higher- quality polymers or be re-exporters who are less affected by local demand patterns'.

'What has changed are price trends, which continue to head downwards. We are hoping that annual shutdowns by Japanese chemical producers in March will help stabilise prices,' a company source says.

But in spite of this, Mitsui & Co says that, along with most other companies, it is having to adopt stricter credit terms on its customers. However, it adds that the real problem lies not so much with the customers as with the banks.

'This is especially true of Indonesia and Thailand, where we have been forced to shift to safer financial institutions which are still willing to recognise letters of credit,' the source says. 'Where such shifts can't be made, we insist that our customers use confirmed letters of credit. If they are unable to, we will be forced to withdraw our dealings with them. The risks are too great at the moment.'Both Mitsui & Co and Nissho Iwai believe that the problems facing the region will 'last years'. Mitsui & Co adds that the region will continue to grow and, as a result, the company will not reverse its strategy of concentrating its efforts on Southeast Asia.

Nissho Iwai admits its Asian strategy is in tatters. 'The crisis has affected not only chemical exports, but chemical projects as well. All these have now been put on hold or scrapped altogether, as our local partners don't have the funding. It will be at least 2-3 years before any of these projects become a reality,' it says. Chemical manufacturers, however, are hoping that the worst of the crisis will blow over within the year. 'If not, we could be in serious trouble,' says one industry source. He adds that the future strategies of companies with regard to the region will be largely dependent on the state of the region's currencies: 'If local currencies remain weak, the yen will strengthen relative to them. This will hamper exports but make direct investment cheaper. However, the current crisis has made management far more prudent about investing in production facilities in the region.'The biggest problem facing Japanese chemical producers is South Korea. As Maeda points out: 'Japanese companies are very dependent on chemical exports to South Korea, and the crisis there already has a severe impact on them. This is true not only of exports directly to Korean chemical producers, but also of exports to Korean commodities and machinery manufacturers.'Another chemical industry source echoes Maeda's concerns: 'We have noted a big drop in demand from Korean producers, and it will get worse. The problem is that although the producers are able to export at very low prices given the collapse of the won, the amount of raw materials they can purchase is limited. As a result, their operating ratios are falling fast.''The big problem with South Korea is that there is far more than just a temporary slump in consumer demand. The difficulties its industry faces are deep-rooted structural ones that will take a long time to heal,' points out Maeda.

'But the severe financial problems facing the Korean chemical industry mean that they are not in a particularly good position to take advantage of the weak won to capture market share from Japanese producers in export markets such as the US.'Japan's Economic Planning Agency (EPA) has admitted that previous claims of a self-sustaining economic recovery proved inaccurate and is now openly expressing concern about the cloud hanging over the country's financial system. Uncertainties prompted by the failures of Hokkaido Takushoku Bank, Yamaichi Securities and other financial institutions are casting a dark shadow over nonfinancial sectors as well, the latest EPA report says. Regarding the relationship between bad loans and bank lending practices, the agency points out that since 1994, growth in lending has slowed at banks with extensive nonperforming loans. This increasing reluctance to lend on the part of banks with worsening balance sheets is hampering even healthy corporate operations, EPA suggests. According to the Ministry of Finance, Japan's banks hold about Yen76 000bn in problem loans.

Indeed, the International Monetary Fund recently lowered its 1998 economic growth forecast for Japan by 1.0 percentage point to 1.1%, in view of the series of failures of financial institutions and sluggish consumer demand. The revised projection attributed Japan's economic deceleration to the April consumption-tax hike which slowed consumer spending and capital investment, as well as to the government's weak fiscal policies. Japan's economic growth projection for 1997 was also reduced by 0.1 percentage point to 1.0%. At a recent press conference, top executives of Japan's four major business organisations called for further income-tax cuts and other tax incentives to stimulate domestic demand. 'The government's year-end economic stimulus proposals should be implemented immediately,' says Shoichiro Toyoda, chairman of the Japan Federation of Economic Organisations (Keidanren). Although the government has already decided on a temporary cut of income taxes to the tune of Yen2000bn for fiscal 1997, To-yoda urges extension of the reductions. 'Decreasing the future tax burden will change the way people use money,' he says.

The executives offer mixed views on economic conditions for 1998. Toyoda is optimistic, saying: 'The economy will gain in the second half providing deregulation is carried out without delay.'Jiro Ushio, chairman of the Japan Association of Corporate Executives (Keizai Doyukai), takes a grimmer view. 'If [the government] fails to implement a fundamental rehabilitation plan, the economy will not revive,' Ushio says.

Kosaku Inaba, head of the Japan Chamber of Commerce and Industry (Nissho), foresees negative economic growth for the year as a whole. Industry is also beginning to show concerns about the strength of the dollar. 'The yen's weakness against the dollar shows that Japan's economy is now viewed as unhealthy,' Toyoda says. 'The downturns of the foreign exchange and the stock market reflect deep-rooted distrust of Japan's financial system,' adds Jiro Nemoto, chairman of the Japan Federation of Employers' Associations (Nikkeiren).

Miti's Maeda adds that it is essential that efforts are made to stimulate investor confidence in the Japanese stock market. 'The recent sharp falls in chemical companies' stock values could have a disastrous effect if these low values persist. I doubt it will cause companies to actually go bankrupt, but it will certainly create difficulties in terms of securing future loans,' Maeda says.

A Smaller Business Finance Corp study recently revealed that one in five small companies fear difficulty in borrowing from financial institutions. The 19.5% figure is the highest since the 20.5% of January 1993, and suggests banks have sharply curbed lending. 'The rot runs all the way up from the consumer, through the retailer to the small-scale manufacturer and eventually on to the big industrial players,' the report says. In short, nobody is exempted from this crisis, and while the big players might have the financial clout to weather the storm, this survey shows that minnows are finding it increasingly difficult to survive without those vital bank loans - and, indeed, that many will not survive.

'In past crises, the smaller players were kept afloat with bank loans, so that they could be instantly ready to swing back into action once consumer confidence had been restored,' points out one analyst. 'This time, it will be different. The overall economic recovery will be slower, since many of the intermediate players will no longer exist, and will therefore have to be replaced.'

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Although all agree that something needs to be done, they also recognise that the government's hands are tied. While further cuts in income taxes and corporate taxes from 49.5% to 47% would be desirable, the poor state of the government's own finances largely precludes this. As one Ministry of Finance official puts it: 'We would love to cut income- and corporate- tax rates further, but we just can't afford it.'Many analysts point out that the government is failing to address the root causes of the problems facing the Japanese industry. 'What is needed is a severe bout of deregulation that will free up Japanese companies and allow them to restructure, and thus become much more competitive,' one analyst says. 'Moreover, this will become increasingly important as other economies in the region - particularly South Korea - speed up their own deregulatory programmes. 'If the Japanese are not careful, they will find themselves paying a heavy price for their procrastination.'





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