[A-List] difference between Japan and Argentina? -- 5 years

[Mark Jones <mark.jones@xxxxxxxxxxxxx>]

FT Editorial comment: Risky tango in Tokyo
Published: December 30 2001 18:39 | Last Updated: December 30 2001 18:44

A grim joke is doing the rounds in financial circles. What is the
difference between Argentina and Japan? Five years.
Just like Argentina, Japan faces immense problems with deflation, debt and
elusive economic growth. But unlike Argentina, Japan still has some time to
address them. Where should Junichiro Koizumi, the prime minister, focus his
energies next year? The ominous sucking sound emanating from the country's
banking system provides a strong clue.
The collapse last week of the regional Ishikawa bank under a pile of bad
loans is a telling reminder of the dangers of deflation in a debt-laden
financial system. As the Japanese economy has slid back into its third
recession in a decade, it is a story that is likely to be repeated. The
fear is that more bank collapses will further knock the public's
confidence, risking a systemic crisis.
The promise to eliminate the blanket deposit insurance scheme from April is
already jangling nerves. Government ministers are doing their utmost to
prevent any run on the banks and are talking of pumping public money into
failing institutions to restore confidence. This has resulted in a public
sigh of relief and a run-up in bank shares. But the Bank of Japan's aim
should be preventing fires rather than just fighting them. This will still
require a radical policy overhaul.
It may be tempting to blame the continuing problems of Japan's banking
system on the excesses of the bubble economy. It is undoubtedly true that
the bursting of that bubble inflicted terrible pain on many Japanese banks.
Few lessons learned
But the alarming aspect of the Japanese financial condition is that banks
have continued to generate bad loans in recent years, suggesting that bank
managers have learned few lessons from the 1990s. Unless the Bank of Japan
is able to reverse deflation, the debt-servicing capability of corporate
Japan will continue to weaken, wreaking further damage on banks' balance
sheets.
The first priority, therefore, must be for Mr Koizumi to devise a credible
macroeconomic policy that meshes measures to combat deflation with
purposeful structural reforms. The Bank of Japan appears finally to have
accepted the chief tenet of every central bank, namely that it can affect
price levels. It is time to create some inflation by whatever means are
necessary.
Explain to the public
The second priority should be to recognise the severity of the problems in
the banking sector and to explain publicly how to counter them. The
Japanese banking sector is liquid but not solvent. Loan losses need to be
fully acknowledged and addressed. Otherwise, capital will continue to be
misallocated on a gargantuan scale. This will only result in the propping
up of bad companies, the harming of the good, and the further impairment of
economic growth.
Given the scale of the problems, it would, as many Japanese officials have
argued, be dangerous to liquidate every bad loan overnight. But a
transparent and systematic plan for recapitalising the banking system needs
to be developed even if this involves the outright nationalisation of some
banks.
The third element should be steadily opening up the banking sector to real
market forces. The ending of deflation and the emergence of higher nominal
interest rates should help banks differentiate corporate credit risks and
channel capital into the more productive sectors of the economy. The
encouragement of foreign banks to expand in Japan would also help restore
public confidence and raise professional standards.
Mr Koizumi is undoubtedly a politician of great intuition who has a unique
opportunity to transform Japan. But he urgently needs to put those skills
to the test in challenging vested institutional interests and overcoming
Tokyo's policy paralysis. Disaster can still be avoided, but only with
swift action. Without it, the spectre of Argentina looms.