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Get Four
|  | FEBRUARY 17, 2006
By Kenji Hall and Ian Rowley Japan's Rapid Growth SpurtThe country's gross domestic product is rising at a blistering pace. Could it outperform the U.S. this year?Check out Tokyo's bustling electronics shops for signs that Japan is definitely back. At Bic Camera's five-story complex in downtown Tokyo on a weekday afternoon, dozens of people were eye-balling giant flat-screen TVs. Though they sell for anywhere between $1,000 and $6,000, demand for the gadgets is white hot. "Big-screen TVs are popular because of the Olympic games in Italy and this year's World Cup soccer finals," says Yumi Kawahara, a spokeswoman for the electronics chain. Yet there is far more driving the economy than die-hard Japanese sports enthusiasts. On Feb. 17, the Japanese government revealed that gross domestic product expanded at a blistering 5.5% pace in the October-December quarter -- which blows away the 1.1% annualized growth the U.S. managed last quarter. "This is not a one-quarter wonder," says Jesper Koll, chief economist at Merrill Lynch in Tokyo. "Japan's GDP has risen more than 5% for three of the last four quarters." PASSING THE U.S.? The fourth-quarter GDP figures (which advanced 1.4% in price-adjusted terms compared to the previous quarter) got a boost from a variety of sectors. It's not just the fabled Japanese export machine that's doing all the work anymore. Private consumption, which accounts for more than half of the entire figure, grew 0.8 percent in the quarter, from the previous quarter. So robust is the rebound that some are predicting Japan will outperform the U.S. in 2006 for the first time since 1991. "We think the U.S. could expand by around 3% while Japan's economy could grow somewhere between 3.5% and 4%," says Macquarie Securities economist Richard Jerram. The growth spurt should signal to Japan's central bank that it's time to wean the economy from a policy of ultra-easy money. In fact, despite the feel-good vibes from the GDP data, the Nikkei 225 stock average actually tumbled 2.1% to 15,713 on Feb. 17. Investors fret that the Bank of Japan might feel compelled to shift away faster than expected from its five-year run of loose credit and near-zero interest rates. Higher interest rates over time might drain cash from Japanese stocks, which have delivered roughly 38% returns over the last year. NEW MARKET, NEW MEASURES. Since 2001, the Bank of Japan has flooded the interbank money market with cash, a policy prescription known as quantitative easing. It chose the drastic measure when a 0% target for short-term interest rates, set in 1999, failed to solve the country's economic woes. That was fine when the economy was struggling through recession, its banking system groaned under massive bad debts, and consumer price declines on everything from stocks to celery were undermining corporate earnings. But with consumer prices rising in November and December, and the economy now in high-speed mode, Bank of Japan Gov. Toshihiko Fukui needs to make a critical policy call (see BW, 10/10/05, "Still Curing Yesterday's Disease"). Most economists expect Fukui to shift course and start draining some liquidity from the now-healthy banking system when a key BOJ outlook report on inflation and growth is released on April 28. Even so, it could be another six to eight months before the bank even lifts its target for short-term rates from near zero. TIMING IS KEY. So far, Fukui has delicately sidestepped questions about when he will change the bank's five-year-old policy. He faces maximum political heat. Prime Minister Junichiro Koizumi's top economic advisers are leaning on the bank to stay the course. It loves the cheap government debt it can raise given Japan's monster central government debt levels. Finance Minister Sadakazu Tanigaki has warned that "mild deflation" persists and that it's too soon to lift rates. Others have even threatened to strip the central bank of the policy-making independence it gained just seven years ago. The BOJ's timing will be crucial. If it acts too soon, the bank could send long-term interest rates skyward. That is bad for Japanese bonds, and could snuff out early signs of a property rebound and kill off the stock rally. Wait too long, however, and investors might be tempted to go on an asset-buying binge, bringing froth to stock and land prices. It could mean the difference between a steadily expanding economy -- and one that's growing too quickly to be sustainable. Even now, Japanese stocks seem pricey. Though the Nikkei has slipped 6% in the past two weeks, it touched a five-year high of 16,710.55 as recently as Feb. 2. Merrill Lynch estimates that stock price-earnings ratios are around 21 based on forecasted 2006 earnings, vs. 17 for S&P 500 stock index shares. Land and rental prices are recovering as well. And in hotspots like Tokyo's Marunouchi business district, rents for office space are up 15% to 20% compared to a year ago, and vacancies are less than 1%, says Toshio Nagashima, executive vice-president at Mitsubishi Estate, which owns 30 office buildings in the area. MIRACLE GROW. Of course, there's still plenty of reason to cheer. Exports rose 3.1% last quarter, partly thanks to Japan's globally dominant auto industry. Though carmakers continue to shift production overseas to avoid losses from unexpected currency swings, they remain huge exporters. In 2005, exports of cars and parts surged 7% to $116.4 billion, compared with 2004. Japan's No. 1 auto maker Toyota (TM ) may be adding to its capacity all over the world, but it will still export 2.1 million vehicles for the fiscal year ending March, 2006 -- a rise of 7.5% from the previous year. Businesses are also investing in new equipment and factories. Sharp (SHCAY ), for instance, said on Jan. 13 it set aside $3.5 billion this year for plants that produce glass panels for its flat-screen TVs. Its $1.3 billion plant in Kameyama, Japan, is set to open in October. If the expansion remains intact come October, Japan will have set a new record for its post-World War II era -- outdoing even its miraculous growth run of the 1960s. Stay tuned. This recovery is definitely for real.  With Hiroko Tashiro in Tokyo Hall and Rowley are correspondents in BusinessWeek's Tokyo bureau Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. 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