Articles

Japanese Economic Recovery & Future Prospects

October 23, 2006

Speaker

Hiroshi Watanabe, Vice-Minister of Finance for International Affairs of Japan

Presider
Wilbur L. Ross, Chairman & CEO, WL Ross & Co. LLC; Director, Japan Society

Vice-Minister of Finance for International Affairs Hiroshi Watanabe shared his perspectives on the Japanese economy's health and the challenges ahead for the world economy. Presider Wilbur Ross highlighted Mr. Watanabe's "tremendous embedded knowledge and insight" gained through more than 30 years of service at the Ministry of Finance.

Over the last 12 or 15 years, Japan has experienced a kind of sunset and then a sunrise, Mr. Watanabe began. GDP growth during the past five or six consecutive quarters "has been very good," ranging from 5.6 percent to 1.9 percent on an annualized basis, and "my sense is that the annual potential growth rate in Japan is a little bit above the 2 percent annualized rate," he said. "This is one of the reasons we are so confident this kind of recovery can be sustained in the coming several quarters--I can say maybe eight quarters, that means two years, we have no fear of another dipping again in the Japanese economy."

For this last year and a half, GDP growth has been led by private consumption and private nonresidential investment, the vice-minister observed. In the recession period, in contrast, the occasional quarter or two of positive growth was made possible only through government spending and exports.

Businesses are replacing outmoded plant and equipment, and there's much more in the way of new investment, with big manufacturers now joined by smaller firms and by other sectors, including retail, construction and even financial companies, Mr. Watanabe said.

Nonperforming loans, which were 8.4 percent of total loans in early 2002, are down to 1.8 percent as of March 2006, on a par with the levels at U.S. and European banks, he noted. Of Japan's megabanks, one has now repaid all its government debt and all three will have done so within the next year or two; thus "the financial sector, especially the banking sector, is going to be more active in the coming days."

On the household side, Japan's unemployment rate has declined steadily, and at 4.1 percent as of July 2006 the rate is much lower than in other countries--though still well above Japan's historical average, which is only 1.5 percent over the last four decades, Mr. Watanabe pointed out. Part-time job numbers are down and full-time employment has begun to rise, as has the ratio of job openings to applicants. This gives households more confidence that they can maintain a good flow of income in future.

Private consumption gains are steady, albeit not dramatic, and are now starting to come from wage increases, as opposed to households dipping into their savings; in Mr. Watanabe's view this is another reason to believe that consumption growth will be sustained.

However, "we have still one concern," in that Japan's consumer price index "still remains very weak," the vice-minister continued.

The CPI rose only 0.5 percent for several months earlier this year, and as revised in August to make 2005 rather than 2000 the base year, it is now rising at only 0.2 to 0.3 percent, he noted. Meanwhile, the GDP deflator, measuring price changes overall rather than on a fixed basket of goods and services, is up this year but still in negative territory, at -0.8 percent. If the CPI becomes negative or the GDP deflator remains so, there will be renewed fear of deflation, Mr. Watanabe commented. However, he added, he expects slow growth in both measures in 2007 and does not believe that deflation will recur.

"In November, we are going to reach 57 months of consecutive growth in the economy. This is quite ironic," in that it is the longest consecutive growth period since World War II, he remarked. The longest prior period lasted 56 months, during the late 1970s and '80s, although growth rates then were much higher, peaking at an average of 10 percent, whereas average growth in this current period has been only 1.7 percent.

To assist the efforts of the private sector, the Japanese government is committed to achieving both fiscal consolidation and structural reform, Mr. Watanabe said. The privatization of Japan Post is perhaps the most significant structural reform in symbolic terms, in his view. Two of the privatized post office units, the insurance company and the mail and parcel delivery company, will be on a fully level playing field with their competitors, both domestic and foreign, and the postal savings bank--a bank in name only, since it does not make loans to corporations--will pay the same taxes as other banks.

Mr. Watanabe emphasized that the world economy has huge risks and uncertainties, one being oil prices: at $55 a barrel, Dubai is now at its lowest this year, but these levels are still very high compared with $18 or $15 in 2001.

Subsidies and price ceilings in emerging nations have delayed the impact of energy price increases on the real economy of these countries, he stated; heavy taxes on petroleum-related commodities in Japan and Europe have cushioned the impact there.

However, if oil prices remain high, the trade surpluses that almost every Asian country enjoyed in the early 2000s will disappear; the vice-minister said that "only Japan, China and hopefully Korea" will be able to maintain trade surpluses in 2006, and Korea will have some difficulty doing so in 2007 unless oil costs go down again.

Despite these risks to the economic health of its trading partners, Japan itself has considerable resilience in respect of oil price levels, he continued. Japan has reduced its dependence on oil, which now accounts for less than half of primary energy consumption and only 16 percent of power generation. Ironically, the yen's appreciation has cut the impact of price increases for oil products denominated in dollars. Moreover, Japan's energy efficiency as measured by oil consumption per unit of GDP is very good: "If we have the standard as the U.S.--I hope the U.S. cannot be the standard," he said with gentle mischief, "but anyway--if the U.S. is 100, Japan is only 42, and recently it is going down to 35." On this scale, India is close to the U.S., Europe and Southeast Asia are in between Japan and the U.S., and China is the worst, he added.

Despite continued activity by the European Central Bank, "I think at this moment we don't have any negative impact from interest rates" on international capital flows and the access of emerging nations to funding, Mr. Watanabe said. "The Western Hemisphere and even African countries have obtained positive growth, so I think this year and also at least the first half of next year will be one of the best economic seasons for the last three decades" and Japan will use this time to change itself and to adapt to new economic conditions.
 
To address the rise of protectionist sentiments and the persistence of trade imbalances on a global level, he urged that WTO negotiations be restarted, with a focus on opening up emerging-nation demand for manufactured goods, agricultural products, IT services, finance, medical care and education. Finally, Mr. Watanabe underscored Prime Minister Abe's commitment to improving Japan's relations with neighboring countries, including Korea and China as well as the ASEAN countries.

How do you see Japan's demographics affecting its economic recovery in the medium term, and will immigration play a big role?

Japan will maintain its labor supply for at least a decade by deferring baby-boomer retirements and encouraging women to participate more in the labor market, Mr. Watanabe answered. If the birth rate doesn't start to rise thereafter, then Japan will need to think about immigration policy, and in fact Japan has concluded economic partnership agreements with the Philippines and Thailand and hopes to expand these arrangements to bring in more new workers.

Can you comment on personal savings and spending rates as compared with the 1980s?

Even during the bubble the savings rate was high, and slowdowns during the last five years may be due to demographics, responded the vice-minister. "We're very much optimistic," he said, and he told the story of two 99-year-old ladies, twins, who earned money for making a TV commercial and were asked by a reporter what they wanted to spend the money on. Their answer: "We are going to save for our old age!"

Is there some adjustment fatigue going on, and will Japan continue to remake itself now that the pressure is off?

People feel that we are running a marathon, but we have another seven kilometers to go, so we're in the final stages, Mr. Watanabe replied.

There are geopolitical concerns on North Korea, and also on Iran, where Japan's petroleum dependence ratio is still running about 14 percent. China's economic adjustments, including the prospect of some irrational spending in connection with the 2008 Olympics, and some domestic political uncertainty, will bear heavily on the economies of Korea, Taiwan, Thailand and other ASEAN neighbors, whose growth has been fueled by exports to China. This means that the Japan-China dialogue that's already started, the sharing of experiences and views, is important, he added.

How concerned are you about foreign exchange and weakness in the yen?

Responding to this as a general question, "I don't think the current situation is weak," he said.

He noted a market perception--"definitely people believe--I don't say it, but people believe, in the market"--that Europe will raise interest rates; and if that happens it will give the euro something of an advantage in terms of rate of return.

However, he indicated, the concept of a real effective rate can be misleading unless it's considered in context with other factors, such as inflation versus deflation and trade surplus versus trade deficit. In any event, the real effective rate is only one determinant of what happens in the foreign exchange markets.

Is there speculation pushing the yen down?

"People have somewhat over-exaggerated the size of the carry trade and also its impact on the foreign exchange market," the vice-minister answered. It is several trillion yen, not several trillion dollars. With a somewhat stable and less volatile foreign exchange market, it's very natural for people to take advantage of low-interest-rate currencies to invest in high-interest-rate currencies, he added.

This year we've seen a number of enforcement actions that have led to equity market volatilities. With postal privatization, and baby boomers retiring in large numbers, will there be more securities market reforms to make equity investments less risky for retirees?

Privatization will have little impact on the equity markets, and mutual funds and various types of discount bonds will absorb the baby-boomer investment demand, Mr. Watanabe indicated. Also, he said, because it's not easy in Japan as it is in the U.S. for households to achieve liquidity based on their real estate holdings, Japan will be looking to develop a more active reverse mortgage market.

--Katherine Hyde

 

Topics:  Business, Policy

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