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Back to square one

Ajay Jaiswal

CONCERNS over Japanese economy have resurfaced again this fortnight. The events are akin to a horror movie in which the hero vanquishes the villain, only to find him rising again from dead. It's ironic that the pall of gloom should happen a few months af ter Bank of Japan showed confidence of a strong recovery and moved away from the zero interest rate policy.

These concerns have led to a sharp depreciation of Japanese yen against dollar. Dollar has broken above the psychological level of 110 and touched a high of 111.42 last week. Political ramblings in the ruling LDP coalition led to the no-confidence vote.

Prime Minister Mori survived the vote by forcing the dissident factions to fall in line. His continuation is a negative for the economy. A weakened leader would not be able to demonstrate Government's commitment to fiscal reforms and consolidation. There is a need of a strong leader who could steer reforms at this juncture.

The political uncertainty could not have come at a more inopportune time. Financial markets are already in a bear grip. US presidential election stalemate has kept the equity markets weak. Dow lost over 3 per cent and NASDAQ lost almost 10 per cent of it s value over the last fortnight.

Earning warnings for the next quarter from technology companies have affected the sentiment more than lack of policy direction in the US. Equity markets have remained underpinned by growth concerns in US.

Nikkei is hovering above the critical 14000 level. Its clear that a significant amount of investment has moved from equity markets to Japanese Government Bonds. Data indicates that from Jan-Oct 2000 there has been a net foreign inflow of Yen 7.7 trillion (USD 70 billion) into the bond markets.

There was a foreign outflow of Yen 1.1 trillion from the bond markets last year. Foreign currency returns on fund parked in debt markets would have started dwindling with the depreciation in the value of yen. Weakness in yen would feed on it self. Yen is likely to stay above 110 in the short-term and test the resistance of 111.75 level seen in February this year.

Bank of Japan and the Economic Planning Agency have toned down their upbeat projections. Interestingly BOJ had admitted in its November report that foreign demand was slowing down and net exports were likely to level off in the short-term.

Rising bankruptcy rates, stagnant consumption and persistent unemployment indicate that only limited segments of economy may be showing signs of recovery. Bankruptcy rates are currently at the highest rates seen in this decade.

News of trouble at Mitsui Construction and the supermarket chain, Daiei last week indicate that more failures may be on the cards. Domestic consumption rates also remain sluggish.

The threat of slowdown in US has complicated the matters for Japan. In case the asset meltdown continues, it would also impact the Asian region. Korean Won came under pressure and lost 4.2 per cent of its value in the last fortnight.

In such an environment it would be difficult for Japan to `export' out of trouble. Japan has 70 per cent of its exports to America and Asia. Outstanding domestic debt has risen to a level that has triggered downgrade of Japan's domestic issues by S & P. Any change in weights of Japanese assets in the Morgan Stanley Capital Index could also lead to outflows. Global portfolio investors look at this index for making investment decisions.

Euro remains in a downtrend in spite of intervention by European Central Bank. The last few attempts at intervention were made by ECB without any assistance from Federal Reserve. It is obvious that interventions succeed if the market holds predominantly speculative positions.

Eurozone continues to invest overseas and unless this continues there would not be any respite for Euro. Euro has broken below its earlier low of 0.8437 and touched a low of 0.8301 last week. ECB has been unable to protect Euro from falling below the low seen before the concerted intervention.

This is quite bearish and a move to 0.8200 cannot be ruled out. Euro is also bearing the brunt of indecision in US. Clear differences in the views of the US presidential candidates on dollar strength put further pressure on the unit.

Financial markets do not like stalemates and hopefully there would be a new US president and clear policy direction in the next fortnight. It is testing time for Japan and it certainly needs to usher in strong fiscal reforms to get out of the mess.

(The author is Senior Manager, Corporate Treasury Sales - Southern India for HSBC. The views expressed herein are his own and not necessarily those of his employer.)