Dear readers,
In the past few weeks, there was the announcement of the restructuring plan by Daiei, Japan's largest supermarket chain, and the request for debt forgiveness by Mitsui Construction. I would not be too surprised by my foreign friends asking the question "what's going on?" Here are my thoughts on these matters.
Is this bad news for the Japanese economy? Not necessarily. We have to look at these events in perspective. The balance sheets of the Japanese financial sector and the non-financial corporate sector were badly damaged as a result of the burst of the bubble and the subsequent decade-long sluggish growth. The retail sector and the construction industry, as well as the non-bank sector and the real estate industry were the sectors with the balance sheets most badly damaged. The companies with balance sheets damaged beyond recovery through annual profits had to be either reorganized or liquidated eventually. The two events are merely the inevitable to surface. Compared with postponing the inevitable, these events can be viewed as "potentially" positive steps. However, the restructuring plans must be drastic enough to ensure revival of the companies and not just trying to buy time. It is the contents of the restructuring plans that matter.
Due to the debt restructuring of more companies, would the financial system fall into a panic just as it came close to two years ago? I do not believe that we would have a repeat of 1997-1998. Many things changed for the better between 1997-1998 and 2000. We now have a 70 trillion yen war chest in place to ensure stability of the financial system. More than 9 Trillion yen of public money has been injected to strengthen the capital of banks. The banks have already recorded losses of more than 30 trillion yen to write off or to provide reserves for non-performing loans since 1997. The total amount of such losses since 1992 is more than 65 trillion yen. (Please refer to the attached graph 1.) It would be unfair to argue that there has been little progress in the resolution of non-performing loans considering the substantial amount of write-offs and reserves. Furthermore, the annual loss associated with write-offs and reserves for the non-performing loans was reduced last year to about a half of the peak level and is expected, this year, to be less than a third of the peak.
Well, then, is the non-performing loan problem resolved? Do we now have a strong and sound financial system back in place? The answer, I regrettably have to admit, is no. The level of non-performing loans to be managed for possible risks, defined by the relevant legislation, is not getting any lower, staying at around 30 trillion yen, in spite of substantial write-offs every year. (Please refer to graph 1.) It appears like a race between write-offs and new bad loans emerging. We can also see the potential of non-performing loan problem remaining by checking the ratio of outstanding loans by banks to the GDP. (Please refer to the attached graph 2.) The level was more or less stable around 70% before the ratio started to explode in the 80's. The ratio hit its peak of 110% in 1990. Although the ratio has gradually dropped, the ratio is still 94%, quite higher than the "standard" level before the 80's. The gap, 24% of the GDP, can be showing the possible "excessive lending," part of which may turn into non-performing loans.
I believe that we need to look at the other side of the coin as well. The balance sheets of the borrower side have largely been left damaged. The excessive debt on the borrower's side has negative effects on the ability of the borrower to engage in vigorous activities. Uncertainty about the credit worthiness of business partners has resulted in the shrinking of transactions among companies. These effects would have a negative impact on the economy as a whole as well. We call this the "debt overhang" problem. At MITI's Research Institute, we hypothesize that this debt overhang problem may have been one of the major causes for the long years of sluggish growth. We also believe that the damage in the balance sheet of the corporate sector as well as the financial sector was one of the major reasons why continuous fiscal stimulus and extremely expansionary monetary policy had little lasting effects.
With this recognition in mind, the Research Institute sponsored an international conference on November 8th. The title of the conference was "The Economics of Balance Sheet Restructuring." We had Mr.Shiozaki, a reformist LDP Diet member, Mr.Richard Gitlin, an attorney from Bingham Dana Murase, Mr.David Asher from AEI, among others, joining us as speakers.
The brief summary of the discussions at the conference was as follows. There was a unanimous consensus that the balance sheets of the financial sector and the corporate sector need to be restructured as expeditiously as possible to revitalize the economy. It was argued that delaying the necessary restructuring would further destroy the value of the companies with excessive debt and hence destroy the value of the loans to these companies. It was stressed that the financial regulator should take the initiative in assessing the true value of the loan portfolio of the banks and take the necessary remedial actions for banks with insufficient capital. There was also a strong expectation for the politicians, such as Mr.Shiozaki, to be the driving force to initiate the necessary restructuring process. I wish I could share with you the enthusiasm and the energy at the conference. I believe that the conference should contribute to the better public understanding of the balance sheet problem.
In line with the discussions at the conference, MITI has already started its efforts to put into place policies to accelerate balance sheet restructuring. In the economic policy package announced in October, we were successful in incorporating some small but positive steps. The Government committed itself to further improve the bankruptcy / corporate reorganization procedures and to expand the scope of "servicers" who help collect loans repayment. These steps would help the process of debt restructuring. While stressing the positive steps, we are fully aware that we have substantial homework left. I believe that if we do our homework right and fast, restructuring the balance sheets of the financial sector and the corporate sector, we would finally be able to get out of the ten year long tunnel of sluggish growth.
In my second letter, I wrote about IT, arguing that IT investment was spreading from the IT manufacturing and infrastructure industries, consisting 19% of the total capital investment, to the IT investment by non-IT industries, consisting 16% of the total capital investment. But the remainder, non-IT investment by non-IT industries, is the largest, with 65% share of the total capital investment. To have a fully revitalized economy, in addition to spreading the IT revolution which would certainly generate high growth in investment, we need to put this part back to soundness. This is exactly why the balance sheet restructuring is so vital for the economy. Through the restructuring of balance sheets we can unleash the latent dynamism of our private sector. To me, keys to the Japanese economy are "IT" and "BS!"
While we would try our best to accelerate this process of restructuring, I have two requests to the readers of this letter. First, please do not be shocked or disappointed to hear news about more bankruptcies and other debt restructuring efforts. These are inevitable steps and I believe can be very positive as well. Second, I hope that further big government spending would not be insisted upon Japan without addressing the core issue of the balance sheet problem. It is my belief that without curing the underlying disease, i.e. damaged balance sheets, painkillers, i.e. fiscal stimulus, would not in themselves save the patient.
Nobuo Tanaka
MITI/RI
Executive Director
