Has Japan Turned the Corner?


By Brian Bremner It's one of the most perplexing market calls out there right now: Is the 36% rally in Japanese stocks since late April the real deal? Is the perpetually underperforming Japanese economy -- beset as it is by dud loans, excess capacity, and deflation -- finally moving into the sunny uplands of sustainable growth and prosperity?

I'm still not convinced. We've seen plenty of false-dawn market rallies in the Nikkei over the last 13 years. And when Japan strings together several quarters of decent growth, the change-resistant pols running the ruling Liberal Democratic Party have a habit of forgetting that meaningful economic reforms are needed to get the country out of its long run of stagnation.

Still, I'm willing to look at the case the optimists make. Many Japan watchers were surprised by the April-June quarterly results released in mid-August, which showed that the economy grew at an annualized 2.3% pace. That marked the sixth straight quarter of growth. In a still-iffy global economy, such news is especially welcome.

CASH CASCADE. Japan's unemployment rate still seems stuck in the 5% range, but the new-job placement figures suggest things are looking up in the labor market. The really good news, though, is that capital spending is finally showing signs of life. It has been improving on a quarter-to-quarter basis since last summer. This is another positive sign, as Japan will never enjoy sustained growth until companies start investing and expanding again.

Then there's the market rally itself. A lot of foreign mutual funds and pension funds are starting to get very enthusiastic about Japanese stocks. Some $30 billion-plus has flowed in since April, and $2.7 billion stormed in the second week of August alone, according to data provided by Barclay's Capital.

On top of that, a number of big private equity funds, such as Ripplewood, Lone Star, and Cerebus, have been trolling around for deals left and right. Ripplewood, which already owns a major bank called Shinsei, looks like the first winner: It agreed to buy Japan Telecom (JPNTY) from British mobile-phone giant Vodafone (VOD) for about $2.2 billion on Aug. 21.

INVESTORS' MESSAGE. A recent survey by the Nihon Keizai newspaper says corporate-turnaround companies have amassed about $8 billion in capital, either to buy shares of or take over other companies. True, Japan is still a laggard when it comes to being open to foreign direct investment. But there's no denying that attitudes have changed dramatically from a decade ago, when selling Japanese corporate assets to foreigners was thought to be pretty close to a treasonous act.

Here's another lapel-grabber: Japanese companies are starting to get deadly serious about shareholder value. Share buybacks in the 2002 fiscal year that ended in March hit a record $22 billion, and Goldman Sachs thinks such transactions will hit $25 billion in 2003. That's one reason why the average return on equity for nonfinancial Japanese companies is expected to shoot up to 7.6% in 2003 -- which would be the highest level since 1990.

Indeed, it's a very good thing when Japanese corporate chieftains start paying attention to their investors. Another good thing: Japan is proving to be a major beneficiary of China's mega-economic expansion. Two-way trade shot up 33.9%, to $60.4 billion during the first half of 2003 on a year-on-year basis. Japanese exports -- everything from electronic parts for PCs and mobile phones to industrial machinery and autos -- were up 49%, to $25.76 billion.

China's share of Japanese global exports is now about 15% and growing fast. Japan has always been very vulnerable to downturns in its biggest export market, the U.S. Having another major export destination in China will be a very good thing in the long run.

HARD WORK AHEAD. In summary: A number of positive trends are starting to come together in Japan. Economists think Japan's economy has a good shot at growing 1% this year and maybe 1.5% next year. True, those figures aren't stunning. But earlier this year, that kind of growth looked downright impossible. And if the U.S. recovery really gathers steam, yet another favorable wind will blow Japan's way.

The real issue will be what Prime Minister Junichiro Koizumi and his economic advisers do with the sudden burst of prosperity, or at least stability. They can't afford to ignore the still sizable bad-debt problems at Japanese banks and the vast overcapacity in so many industries that feeds into Japan's destructive deflation.

The changing sentiment among foreign investors from despair to guarded hope is a big reason behind the market rally. If they see the Japanese political establishment revert to usual form and kiss off economic reforms, investors will head for the exits. Believe me, they've done it before.

Japanese pols and corporate executives still have quite a bit of tough work ahead to make the economy more vibrant. Let's hope they make good use of this respite from economic pain. Bremner, Tokyo bureau chief for BusinessWeek, offers his views every week in Eye on Japan, only for BusinessWeek Online


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