Japan's Stimulus: Doing Anything to Restore Growth

Following a quarter where Japan's GDP plunged an annualized 12.1%, the IMF, the World Bank and the OECD have slashed their estimates of Japan's GDP growth in 2009 to between 5%~6%, compared to domestic private sector economist estimates of minus 4.3% and the BOJ's minus 2%. Why the apparent disconnect between the international agencies and estimates within Japan? We believe the international agencies have largely ignored the three stimulus packages already introduced by the Aso Administration, as well as the latest proposed package.

The BOJ has taken action every month since October of last year, when the global financial crisis erupted, and has moved increasingly aggressively in using its balance sheet to ensure that the impairment to Japanese bank balance sheets from losses on toxic oversesa asset-backed securities and valuation losses on domestic stock holdings do not choke off the crucial supply of credit for both major as well as medium- and small-sized enterprises. These actions have pushed down short-term rates significantly, with the average yield on three-month commercial paper (CP) dropping to 0.66% in March from 1.48% in November. The Bank have even utilized Japan's forex reserves to provide foreign currency loans to international firms that are having trouble procuring USD financing at other than "distressed" rates.

While credit remains tight for smaller firms, the government launched an emergency program to provide credit guarantees to small and midsized firms via credit guarantee operations. Some JPY9.9 trillion yen of such loans have already been extended. In addition, three stimulus packages have already been introduced by the Aso Administration since August of last year will reach JPY27.4 trillion in actual fiscal expenditures and a nominal commitment of JPY132.3 trillion with the latest stimulus plan. The Japanese government is hoping this stimulus will boost Japan's GDP by 2 percentage points and provide from 1.4 million to 2 million jobs.

The three keys to the success of these stimulus packages are a) that they renew Japan's economic viability and restore medium-term growth, b) they are not politicized to become re-election pandering, and c) restore consumer and business confidence.

Rebooting Japan's economy with stimulus of some 3% of GDP will have fiscal repercussions. The Japanese government has been forced to abandon its commitment to achieve a basic fiscal balance by 2011 as government bond (JGB) issuance in FY2009 will reach JPY43 trillion versus a prior commitment to keep annual issuance capped at JPY30 trillion. Debt-to-GDP for Japan could exceed 200% over the next couple of years, and the government has made no secret of the fact that they intend to raise VAT (consumption taxes) significantly once the economic recovery is perceived to be on solid footing. Significantly higher bond issuance will be negative for the yen, but a weak yen will be a welcome respite, creating windfall profits for Japan's struggling international blue-chips, and boosting Japan's export competitiveness.

Fiscal expenditures of JPY27 are aimed at closing what is estimated to be a JPY20 supply-demand gap, but if the IMF forecast of minus 6% growth is accurate, the supply-demand gap could be more like JPY50 trillion. Consequently, Japan's GDP could still fall 4% in 2009 even with the stimulus. However, compared to the 12.1% annualized GDP decline in Q4 2008 and a similar decline in Q1 2009, even minus 4% growth in 2009 implies sequential improvement in GDP in the second half of 2009, with positive annualized as well as year-on-year growth in the final months of 2009 from a very low base in Q4 of 2008.

Consequently, the rally in Japanese stocks, which have rallied some 28% from a low near 7,000 on the Nikkei 225 to 9,000, is more than a mere "dead cat" bounce, or a knee-jerk reaction to the rally in US stocks. Rather, Japanese stocks are beginning to discount the prospect of a bottoming-out and recovery in Japan's economy.