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Paper presented at the 2001 G8 Pre-Summit Academic Symposium, "Assembling a New International Financial Architecture: The Deeper Challenges Summit" 17 July, 2001, LUISS University, Rome, Italy
I know my time is short. Therefore, let me concentrate on two sub-topics. The first is my observation on the nature of our new Prime Minister Jun'ichiro Koizumi's reform initiative and its implication for the economy. The second is a kind of following-up of what I told tow years ago in Bonn in this conference, that is, the Japanese response to the Asian financial crisis.
However, I am afraid that these two topics are still too broad and I may sound too sweeping or simplistic in my description from time to time. Be as it may, I hope I will have some opportunity to make further elaboration in the discussion time.
To begin with, I have to say that the Japanese economy still remains the most fragile among the three major economic regions of the world. And it casts a dark overshadow on the rest of the region. June is the month in which the mid-year revisions of economic forecasts come out from most of Japanese financial institutions. Their pictures are not particularly bright. The average growth projection for FY 2001 and 2002 are 0.1% and 0.8% respectively.
The progressive loss of momentum in the recovery during the last several months is almost exclusively caused by sharp drops of IT related exports and investment, which is in turn brought about by the economic slowdown in the US. Unfortunately, the Japanese economic outlook is still critically hinged upon the US economic performance in the months ahead. It probably suggests that, in case dollar falls, it would do so more against Euro than against Yen.
However, we have not yet witnessed a recognizable contraction in consumption, which appears just flat. Pessimists regard this as a lack of strength. Optimists think that it is holding up rather well. Either way, the current stagnation is not resulting from any traceable macro economic management failure.
Policy makers came to be grabbed by a notion that the traditional means of economic stimulation may have been exhausted. In substance, BOJ returned to a zero interest policy, but without any visible result. While inflationary targeting is discussed, disinflation continues in face of a gush of cheap imports from China. It became increasingly apparent that public works projects involve much of waste of money and are failing to induce private investment.
Against this background, PM Koizumi changed a focus of economic policy almost entirely from short-term management to structural reform and appears selling long-term optimism successfully to the nation. This is illustrated vividly by his unbelievably high approval rate of more than 80%, while his predecessor suffered from a meager 8%. PM Koizumi is now anticipated to win the ongoing Upper House election so as to hold on power.
In my judgement, his reform initiative is essentially a public sector reform. A key idea is to make it lean and efficient to maximize the private sector dynamism as a means to resurrect the economy. It is not limited to fiscal spending cuts and bold reallocation of budgets. He emphasizes overhauling of Fiscal Investment & Loan Program and sweeping privatization of public and quasi- public institutions that operate under the Program. He has long been known to be an advocate of privatization of Postal Saving Institute, which solicits savings from public at large and fund the Program.
I believe that this privatization is a critical ingredient of his initiative, which seems to enjoy a widespread endorsement of economists in Japan, including myself. In other words, deregulation efforts of the past have always been compromised to let public enterprises preserve their predominant turf. As a result, it is fair to claim that an incessant expansion of public enterprises has reached to the extent to which it is choking off the entrepreneurship of private businesses. Economists agree that PM has put forth a right structural policy, for the first time in many years.
However, the story can't end here. His another pressing task is to fix NPL at the banks. He is not eloquent yet on this front. Some critics, domestic and abroad alike, complain that he talks a lot but the action plan is absent and the market anxiety persists. I am not denying this criticism entirely but let me say that it tends to be somewhat misplaced.
If you assume that NPL makes banks fail to finance good business projects, it is basically wrong. Money is abundant. Remember Japan is still the largest capital exporter. Money is chasing borrowers with good prospect, but can't find many. I have been made to believe that the nation has to wait for deregulation and privatization to expand business frontiers for private businesses. It is especially relevant to the efforts to capitalize upon the opportunities, which IT and the new economy provide us with. In other words, it would be critical how to deal with NTT, a public monopoly of telecommunication.
The real problem as I see it is that the write-off of NPL at the banks is bound to force a painful restructuring of borrowers. It is not confined to some big businesses in construction, real estate and retail industries but also involves quite a number of the nation's small businesses. Many of them will have to retire eventually so that unemployment could rise significantly. A deflationary impact of this can be unbearable for the economy.
True, one can argue that corporate restructuring is inevitable and already overdue. Let me remind you, though, that it is legitimate for any government to try to engineer a soft landing in the process. It is reported that Financial Service Agency Minister and Commerce Minister are busy in working out the action plan and will announce the details in early August.
Accordingly, the economic prospect of the nation depend upon the two things: firstly, how PM will manage the process of this restructuring balance sheets of banks as well as problem companies so as to minimize its disruption for the rest of the economy, and secondly, how PM will proceed with his public sector reform successfully against resistance and encourage optimism of businesses and consumers. We have to wait until the time when PM reveals his action plans sometime before this autumn after the Upper House election.
Let me now turn to the second topic: namely, an update of the Japanese response to the Asian financial crisis. To begin with, I still have to say that the region can't expect much of the Japanese economy to provide the rest of the region's exports with an effective replacement of their markets as the US appetite for their products diminishes.
It appears that an unexpectedly swift recovery of 1999 and 2000 is now being replaced by some slowdown in the region's economies. Indeed, their embracing of a new economy turned out to work against them for this year. IT products are in serious oversupply verywhere. In consequence, the fact has been exposed somewhat cruelly that the restructuring of their old economy is still a long way to go.
I am not suggesting that the economic slowdown will inevitably lead to another round of crisis in the region, but it seems to me that the structural reform remains its most prerequisite policy task. IT boom of the last couple of years has been fueled by liquidity provided by foreign banks and investors. When that boom cools down, the domestic financial sector is unable to fund an indigenous growth.
A couple of footnotes here. First, the seriousness of the problems varies from one nation to another. The problem is more serious when recapitalization of banks' equity bases was insufficient, as seen in the case of Thailand. Moreover, given that the health of banking sector is restored, the problem of the economy does not go away when institutional constraint prevents wholesale corporate restructuring from going through, as seen in the case of Korea. After all, political stability and resolution is not yet perfect, as recently witnessed by the case of Philippine. Altogether, Indonesia still appears the most vulnerable in the region.
Second. The structural reform seems to face a further challenge of adjustment to the rise of China. China as a hero of structural reform has not disarmed my remaining caution as a researcher. However, I fully admit that multinationals, including Japanese ones, are keener than ever to extend its source of production network into China, which clearly capitalizes the best on the emergence of global market place that the new economy generates. Unmistakably, China's WTO accession will impose a fierce competitive pressure upon neighboring economies.
All this seems to suggest that the Japan's role in the region's effort to achieve economic stability does not wane. Some economists in Japan indicate in private that a unilateral intervention in currency market could weaken Japanese Yen and help the nation's exporters. However, be assured that this option will stay disregarded by the Japanese government who is also aware of its adversary implication for the rest of the region.
You might remember that the Japan did and said several things when the financial crisis hit the region. Japan offered a large amount of liquidity to the troubled nations, under the umbrella of a series of Miyazawa initiative. Japan also proposed Asian Monetary Fund, although it was quickly withdrawn in face of the US opposition. The Japanese government did a decisive role to keep Japanese lenders in line to hastily assemble lock-in agreement as to their credit facilities to Thailand and Korean borrowers. This is one form of what we now call private sector involvement.
Where does Japan stand now? It appears a bit difficult to represent the Japanese view accurately, because the discussions are made only among a small group of stakeholders; particularly sections in charge at the government and banks. Indeed, the subject of restructuring Japan herself overwhelmed any other policy subject, particularly at the highest level.
I hope it would not be a gross mistake to summarize the Japanese view in the following way. First, Japan is more or less pleased with multinational efforts since Cologne summit and establishment of Manila Framework to date to restructure international financial architecture. On the outset of the crisis, Japan told IMF many things.
For instance, Asian crisis was a capital account crisis and the conditionality suited for current account crisis is awfully inappropriate. On this account, monitoring capabilities of gearing activities at both borrowers and lenders should be strengthened and the emergency credit facilities available from IFI's should be enhanced. Moreover, conditionality should be tailored toward specific crisis situation as one differs from another in nature and complexity. In addition, contagion has to be stopped in its early stage.
To put it differently, Japan regards the recent development as a proper absorption of the Asian lessons, even though some of the radical proposals remain unanswered at IMF and others. Nonetheless, reactions of IMF to Argentine and Turkey cases seem to reflect its learning, even if not completely successfully.
Some progresses to intensify monitoring of highly leveraged institutions are encouraging. Redistribution of roles for various IFIs in the time of crisis seems to be going roughly toward the right direction. Creation and implementation of standards and best practices in the financial service sector is beyond any reservation, although Japan stresses the right sequence of steps. In addition, it is appropriate that some form of capital control, particularly as to short term ones, can be employed effectively to preempt a crisis and has to be regarded as a proper excise of prudential regulations.
At the same time, the memory is lingering on that the appropriate assistance has not come from outside the region automatically or swiftly enough. Consensus seems to be emerging in the region that some collective mechanism to supplement the global architecture would be highly desirable, if it does not revive an idea of AMF literally.
It is interesting to note that China altered its posture to become supportive. Japan acknowledges that she is bound to play a vital role to make any regional mechanism work. I am of the opinion that such regional mechanism does make a sense that crisis contagion illustrated their common stake eloquently in terms of investors' confidence.
However, the development in this direction seems does not seem to create a new institution in the near future. Instead, a series of agreements and forums are evolving. One such example is a Chiang Mai initiative, in which Japan is entering with other Asian countries into currency swap borrowing arrangement in case of a future crisis. Moreover, BOJ and MOF are making considerable progress on building up forums as a monitoring and coordinating platform as to macro economic management and financial market supervision.
However, I have to say that development of the regional external bond markets is rather a long-term excise. Replacement of hot money by long bond financing is clearly desirable, but it is not likely to grow fast for the time being that the Japanese institutional investors are not attracted to Asian bonds easily.. Incidentally, Japanese banks with enormous domestic problems are somewhat diminished in their role in the rest of the region. They seem to concentrate on serving Japanese multinationals.
This constraint on the Japanese banks has kept the important issue of private sector involvement in case of crisis from being fully discussed in Tokyo. Some claim that Collective Action Close erodes the very essence of readily marketable bonds, while others argue that prolonged and disorderly disruption in debt service payment is worse than orderly compromise. In any event, bond is not a predominant instrument for Asian borrowers.
If there is any consensus at this point in time, Japanese lenders do not seem to ready to accept detailed universal rules as well as an unconditional delegation of stewardship to allow IMF, say, to declare standstill. The Asian experience reminds Japanese lenders of a danger of an excessively straight jacket recipe for crisis management. They appreciate the excise to identifying such fair rules as accommodative to all the potential creditors. However, they do not see it necessary to make haste because the excise itself is an excellent preparation for a future crisis.
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