Japan economy: Can it hold its own weight?

TOKYO, Japan — Could this be the year the Japanese economy confounds expectations and mounts a recovery worthy of the name?

The world’s third-largest economy has encountered so many false dawns in recent years that caution has become the default setting among many commentators.

Yet, say leading economists, there are signs that despite the perennial problems of massive public debt and deflation, corporate and consumer confidence are returning.

The apocalyptic language that informs public debate on the economy is proof of the scale of the feat facing the prime minister, Naoto Kan.

"Japan is mired in a severe crisis now," Kan told a news conference after rejigging his administration recently. "I reshuffled the cabinet so that it will have maximum strength to overcome the crisis."

As Kaoru Yosano, Japan’s new economics minister, warned, the country’s debt will lead it into a “fiscal dead end” in the absence of urgent tax and fiscal reforms.

Japan’s public debt — at 200 percent of GDP, the highest in the industrialized world — is twice the size of its $5 trillion economy and is expected to reach 210 percent of GDP in 2012.

The measures under consideration include raising the 5 percent consumption (sales) tax, in part to pay for soaring social security costs, which have risen 60 percent since 2000.

It is telling that Kan’s reshuffled cabinet has warmed to reform now that issuing government bonds to fund spending plans is no longer sustainable.

While the government’s record 92.4 trillion yen draft budget includes a cap on new debt issuance, borrowing will still exceed tax revenues this year. No one expects a Greek-style crisis in Japan, where 95 percent of debt is held by domestic investors, but Kan nonetheless made debt a priority when he became leader last summer.

Japan is in the midst of a moderate recovery, but according to the Bank of Japan’s governor, Masaaki Shirakawa, "growth seems to be pausing. After a pause in improvement, Japan's economy is seen returning to a moderate recovery path.”

Last week, the cabinet office upgraded its view of the economy for the first time in seven months, but added that slow growth remained a concern. "Although the economy appears to be pausing, some movement towards a pick-up can be seen," it said. "However, the economy remains in a difficult situation."

The consensus is that growth will slow as the effects of stimulus packages wear off. March also marks the end of a successful incentive scheme to boost sales of eco-friendly electronics.

Other data are far from encouraging. Consumer confidence worsened in December for the sixth month in a row, and unemployment, at just over 5 percent, hovers close to a postwar high as companies fail to match increased production and profits with more job openings.

Exporters continue to suffer as a result of the yen’s strength against the dollar. Japan’s trade minister, Banri Kaieda, said “every possible measure” should be taken to slow the yen’s rise. “Japan's small- and medium-sized companies lack the resilience to withstand yen strength,” Kaieda told the Wall Street Journal. “We must use every possible step to correct rapid rises in the yen. There are a number of things we can do, including monetary easing and monetary policy. Not just intervention."

Few expect the dollar to make significant gains against the yen and ease pressure on Japan’s exporters, but the yen’s impact on corporate profits has not been as catastrophic as some had feared, according to Hiromichi Shirakawa, chief economist at Credit Suisse Securities Japan.

“The cash flow of Japanese companies has increased quite meaningfully,” he said. “It is astonishing that even at 80 to 85 yen to the dollar, companies are making money.”

The biggest challenge is finding a way to turn bigger profits into higher wages and new jobs, particularly for the 40 percent of unemployed people who have not worked for a year or more, Shirakawa said. “We are worried about the continuing deterioration of human capital.”

Unless wages rise to match an expected increase in the price of imports, deflation will persist, he added. “I can’t see how Japan can raise wages. Aging demographics, global competition and the shift to the service economy are all structural deflationary factors.”

Jesper Koll, managing director of JPMorgan Securities Japan, is more upbeat, predicting that 2011 will be the year Japan mounts a recovery spurred by exports and, more contentiously, stronger domestic demand.

Koll cited the first increase in the size of this winter’s bonuses as proof that corporate profits were making their way into the pockets of “Mr. and Mrs. Watanabe,” adding that property purchases — a key indicator of economic health — were moving in the right direction.

“I am bullish on the Japanese economy,” he said. “Consumer spending, real estate and corporate investment will be big sources of recovery. We can worry ourselves sick about the long term, but we know that in the long term we’ll all be dead.”

Amid talk of a cross-generational conflict between well-paid older workers and their poorer, younger counterparts, Robert Feldman, managing director of Morgan Stanley MUFG Securities, set out his antidote to deflation: “The wages of younger workers should be increased, most of all because they consume more. How to do that is the key question.”

If Kan’s cabinet, now packed with allies, is singing from the same hymn sheet, he is still hobbled by the political deadlock resulting from his Democratic Party of Japan’s defeat in upper house elections last summer.

While the party’s control of the more powerful lower chamber is decisive in passing bills, opposition parties in the upper house can delay the passage of legislation needed to enact the budget for the next fiscal year, which begins in April.

There is cause for optimism for Kan, however: the reshuffle has lifted his government’s approval ratings to 34 percent from 25 percent last month, according to one poll.

Whether or not his reformist cabinet can achieve a similar improvement in Japan’s outlook will determine if his poll ratings endure or, like previous signs of an imminent turnaround for the economy, they are simply flattering to deceive.