COVER STORY • 3

Impact of Covid-19 on Financial
Markets – Japanese Economy
Peaked Prior to the Virus
Author Koichi Kurose

By Koichi Kurose

Nations around the world have suffered dramatic economic
slowdowns caused by the coronavirus pandemic, starting around thespring of 2020. Japan, however, had already been in a recession since
2018, caused by two different shocks. Chart 1 shows, along with theprice index of the Nikkei stock average, the economic diffusion index
released by Japan’s Cabinet Office, which clearly indicates the general
direction and size of the economy.
The first shock was the US-China trade war that began in 2018.
Global trade volumes peaked and began to decline as a result of
increased tariffs that the US and Chinese governments imposed oneach other. Japan’s economic structure makes it highly vulnerable tochanges in foreign demand, and as a result the Japanese economy
reached a ceiling in October 2018 and entered a recessionary phase
thereafter.
The second shock was the Japanese government’s hike of theconsumption tax rate from 8% to 10% in October 2019. The
Japanese have an expression for this – “tax pain”. Because tax pain
happens every single time a consumer spends money, a higher
consumption tax automatically leads to lower consumption. Thistendency is fairly unique to Japan, as it is not often seen in othercountries. In fact, the exact same phenomenon was observed during
the last tax hike, when the consumption tax was raised from 5% to
8% in April 2014.
In addition to these two shocks, a third shock was the coronavirus.
The number of people per 10,000 infected with the virus (as of

Policies Fail to Revitalize Japanese Economy

CHART 1

Diffusion index & stock prices
110
105

Economic peak (2018/10)
Diffusion index (left axis)

100
90
85

(¥)
30,00025,00020,00095
Nikkei stock average (right axis)

80
75

15,00010,0005,000

7002012 2013 2014 2015 2016 2017 2018 2019 2020
(Year)
Note: The diffusion index is published by Japan’s Cabinet Office. Stock prices are monthly
averages.

Source: Resona Asset Management Co., Ltd. compilation based on publicly available data fromHaver Analytics

14 Japan SPOTLIGHT • November / December 2020

August 2020) was low in Japan at five or six, compared to 50-180 per
10,000 in the United States and developed European countries. Still,in observance of the government’s pandemic guidelines, Japanesepeople have tended to stay home, resulting in a significant negative
impact on the economy.
Meanwhile, the current situation is that the economic slowdown
caused by the coronavirus was so great that it required fiscal policy
involving huge sums of money to address it. This very likely led to arecovery phase after the economy bottomed out in May-June 2020.
However, despite the trend toward recovery, the level of economic
activity remains far lower than before the coronavirus pandemic.
According to the updated IMF World Economic Outlook released inAugust 2020, the Japanese economy grew at a rate of +0.7% for2019. Projections for 2020 and 2021 were -5.8% and +3.4%
respectively. The general government fiscal deficit to GDP ratio stoodat 3.3% for 2019, while projections for 2020 and 2021 climbed to
14.7%, and 6.1% respectively.
In the US, Jerome Powell, chairman of the Federal Reserve Board,
speaking at a press conference following the Federal Open Market
Committee of July 2020, remarked that the economic outlook remains
extremely unclear and will largely depend on how well thecoronavirus can be controlled. This statement is also true of Japan.
Projections will very likely be upwardly revised if a vaccine issuccessfully developed, or downwardly revised if governments fail tocontain the virus.

Since the launch of the second administration of Prime Minister
Shinzo Abe in December 2012, the Japanese government has steered
economic policy with a view not only to recovery but to an ambitious
revitalization of the Japanese economy. To this end, theadministration devised the “Three Arrows” policy, with specificambitious goals. The first and second of these arrows – dramatic
monetary easing and a robust fiscal policy – were intended to boost
the economy, while the third arrow, growth policies to stimulate
private investment, which included deregulation and other measures,
has also been implemented. In all, the Three Arrows comprised a
scenario designed to jump-start the economy and achieve selfsustaining economic growth.
In reality, however, as government bond and stock purchases were
deregulated as part of monetary policy, fiscal policy was financed bymassive government deficit. The result of the two arrows of monetaryeasing and robust fiscal policy resulted in a long-term economic
https://www.jef.or.jp/journal/

COVER STORY 3

recovery, spanning 71 months of expansion from December 2012
through October 2018.
Put conversely, however, without the monetary and fiscal policiesof the Three Arrows, the recovery would not likely have been viable.
In other words, because the economic growth during the period ofDecember 2012 to October 2018 was not self-sustaining, theexpansion that occurred over this period cannot be deemed asuccessful economic recovery. This is evident in the World Bank Easeof Doing Business index.
Japan dropped in the rankings from No. 17, at the outset of thesecond Abe administration in 2012, to No. 29 in 2019 – belying thepledge Abe made when he won the general election to “top the list”.
The Cabinet Office conducts a periodic survey of stock market-listedcompanies regarding their projections for real economic growth overthe next five years. The results of the 2019 survey were the lowest
since the survey was first conducted in 1989 (Chart 2, which excludes
Japan’s asset price “bubble economy” period).
Further, the coronavirus pandemic and the restrictions keeping
people from going out, revealed the fact that virtually no progress had
been made in areas such as online classes, telehealth and online
administrative procedures over the past 20 years. This was despite
the fact that online initiatives had been assigned priority following thedestruction of schools, hospitals, and administrative offices following
the Great East Japan Earthquake in March 2011. In the wake of thecoronavirus pandemic, a major policy shift is expected to help resolvethese issues.
Inbound tourism had been the government’s most successful areaof growth strategy. The number of foreign visitor arrivals in Japanrose from 8 million in 2012 to 38 million in 2019. These tourists
brought in added revenue of ¥3.8 trillion (0.7% of GDP). The tourism
sector was dealt a heavy blow when travel to and from Japan byforeign nationals was virtually halted during the coronavirus
pandemic.

CHART 2

Economic growth rates: performance& projections(%)

Japan’s real GDP growth rate (left axis)
Japan’s real growth rate Listed companies
Five-year projection (right axis)

6.0
4.0

2

2.0

1.5

0.0

1

-2.0
-4.0
-6.0
1995

(%)
2.5

2000

2005

2010

2015

(Year)

Long- & Short-Term Financial Markets
Prior to the coronavirus pandemic, Japan was already
implementing broad-based monetary easing on a scale never seen
before. The Bank of Japan (BOJ) began monetary easing subsequent
to the second Abe administration. The government entered into anagreement with the BOJ, setting the goals of overcoming deflationary
trends and an inflation rate of 2%. BOJ Governor Haruhiko Kuroda
proceeded to significantly alter monetary policy by instituting whatbecame known as a “reflation” policy. Prior to the coronavirus
pandemic, the BOJ had guided the key interest rate to -0.1% andyields on 10-year government bonds to around 0%.
The BOJ calls this guidance method Yield Curve Control. Other
major monetary easing techniques include quantitative easing
through government bond buying, and lowering risk premiums bybuying stock ETFs and REITs. The annual target for ETF buying was¥6 trillion.
In responding to the coronavirus pandemic, the total value of stock
ETF buying was increased from ¥6 trillion to a maximum of ¥12
trillion. At this time, new purchasing of CPs and corporate bonds was
also launched with a maximum purchase value for each of ¥7.5 trillion
through March 2021. A special program providing cash flow support
for private corporations was also established with a total budget of¥110 trillion.
However, markets continued to look for deeper negative interest
rates and lower 10-year bond interest rates. In addition, thedetermination of guideposts for 20- and 30-year government bonds
incited expectations of lower interest rates. However, this did notmaterialize. As indicated in Chart 3, the 10-year government bondinterest rate fell deeper into the negative range for a limited time, but
recently has tended to hover around zero.
The main reason the BOJ chose to avoid lower long-term interest
rates was the inherent disadvantages of lower interest rates. Regionalbanks, whose sales shares of international and securities businesses
are low, face severe business conditions, while the price book-value
ratio (PBR) at many banks remains low at 0.2-0.3. Book value per
CHART 3Long-term interest rates & TSE REIT
(J-REIT) index
(%)

0.3
0.2

2,500
2,200

0.1

1,900

0
1,600

-0.1

0.5

-0.2

0

-0.3
2017

Source: Resona Asset Management Co., Ltd. compilation based on publicly available data
issued by the Cabinet Office

10-year government bond interest rate (left axis)
TSE REIT index (right axis)

1,300

2018

2019

1,000
2020 (Year)

Source: Resona Asset Management Co., Ltd. compilation based on publicly available data fromHaver Analytics

Japan SPOTLIGHT • November / December 2020

15

COVER STORY 3

share (BPS) is also known as the liquidating value of a company.
Theoretically speaking, a PBR of less than a value of 1 means that thebusiness is no longer viable. The shares retain greater value if thecompany chooses to liquidate and distributes the remaining assets toshareholders.

Avoiding “Japanification” – a Global Issue
Japan’s monetary policy has been criticized by some analysts forbeing incapable of stopping the deflationary cycle from 1990 through2010. At the same time, the central banks of numerous developed
countries around the world have implemented monetary easing via
asset buying and have also adopted negative interest rates. This is anindication that Japan is now viewed not as behind the times but rather
as a pioneer of this strategy.
This perspective can be considered a test of Modern Monetary
Theory (MMT), which suggests that as long as government bonds areissued in the currency of the issuing country, then large deficits
should not be seen as problematic.
Meanwhile, it remains highly likely that central banks of many
developed countries will consider the issue of how to avoid following
the experience of Japan or “Japanification” in responding to thecoronavirus pandemic.

The Stock Market
Chart 1 shows trends in the Japanese stock market. In reality, theprice movement of the Japanese stock market is linked to the US
stock market, except in cases where there is a determining factor very
specific to Japan. This has been the case since the launch of thesecond Abe administration, and these trends are unlikely to change
significantly following the pandemic. Regarding current stock pricelevels, the recovery of stock prices had been considered too fast toaccurately reflect the real state of the economy. This is true of both
the Japanese and US markets.
It should be noted, however, that the international distribution of
earnings of Japanese companies differs greatly. As the process ofglobalization has intensified, there is less of a correlation between theJapanese stock market and the Japanese economy. A current topic ofinterest is the discrepancy between consolidated and nonconsolidated
financial statements at Japanese companies.
Nonconsolidated financial statements include only companies inJapan, while consolidated financial statements include Japanesecompany affiliates and subsidiaries overseas. Even where
nonconsolidated financial statements show a deficit, in many cases
consolidated financial statements may indicate large surpluses. Thisphenomenon is a clear indication that while some Japanesecompanies have lost the ability to earn large sums in Japan due to thenation’s dual issues of low birth rates and a rapidly aging population,
they are able to prosper overseas, particularly in developing nations.
The decline in revenue opportunities in Japan has led to fewer
investment opportunities and is a reason why companies have chosen
to accumulate cash or shareholder equity. On the basis of the Tokyo
Stock Price Index (TOPIX), the total amount of shareholder equity has
increased, from ¥303 trillion in January 2013 to ¥525 trillion in
16 Japan SPOTLIGHT • November / December 2020

January 2020. Accumulating cash or shareholder equity was notconsidered aggressive corporate management during normal times
but has been successfully employed as a risk-lowering measureduring the coronavirus pandemic.

Corporate Governance Reform at JapaneseCompanies
Increasing capital stock is considered the flip side of a company’s
lack of enthusiasm on shareholder returns, capital expenditure, andso forth. For this reason, the Abe administration promoted a policy ofcorporate governance reform with a view to striking a balance amongcorporate stakeholders. Over the past few years, a governance code,
similar to that of the United Kingdom, has been adopted as a listing
requirement for the Tokyo Stock Exchange (TSE). Rules include
mandatory independent directors, specific Return on Equity (ROE)
goals designed to clear the international standard of 8%, and more.
Though the pandemic has cut into corporate revenues on a practicallevel, governance reform has nonetheless been steadily implemented.
Chart 4 shows PBR (vertical axis) and ROE (horizontal axis) for
TOPIX companies. Figures as of 2002, after the burst of Japan’s
economic bubble and resolution of the bad debt problem, are plottedon the chart. The vertical axis shows how PBR, which stands around0.8, has reached the lower limit. During the height of uncertainty
surrounding the pandemic, around March-April 2020, stock prices
plummeted, but the lower limit remained approximately 0.8. ROE
shown on the horizontal axis, meanwhile, improved from 4.3% inDecember 2012, at the outset of the Abe administration, to 6.7% in
December 2019, prior to the pandemic.

J-REIT & Real Estate Markets
Japan’s real estate investment trust (J-REIT) market, as shown inChart 3, was trending higher due to the robust real estate market prior
to the coronavirus outbreak. The reason for the popularity of J-REITs
was their high dividend yield of 4% on average. However, due to thepandemic the market lost liquidity, resulting in violent fluctuations inmarket prices. Breaking it down into market segments, distribution
facilities such as warehouses trended higher thanks to increased
Internet shopping, while buildings such as offices and condominiums– concentrated in urban areas – were also robust. The hotel segment,
however, declined dramatically as a result of sharp drops in inboundtourism.
The government has privately requested real estate owners,
included REITs, to reduce or exempt rents to help real estate rental
companies to survive the pandemic, resulting in lower dividends
across the board. The severity of the cuts will depend on how the
pandemic plays out.
Some analysts take the view that demand for urban center officeand condominium buildings will fall over the long term due toincreases in the number of people working at home. According to one
survey, if 10% of people make the shift to telework, the office vacancy
rate in urban centers will surpass the 2009 peak of 9.1% to rise to14.4%. The rate was 1.7% for 2019.
In Tokyo, however, despite problems with overconcentration –COVER STORY 3

CHART 4

Verification of earning power(TOPIX, consolidated financial statements, 2002 onward)
PBR (share price/net assets)

2.5

Prior to coronavirus pandemic: 12/2019
PBR 1.2, ROE 6.7%

2.0
1.5
1.0
0.5
0.0

Launch of second Abe administration: 12/2012
PBR 0.8, ROE 4.3%

0%

2%

4%

6%

8%

ROE (earnings/net assets)

Source: Resona Asset Management Co., Ltd. compilation based on publicly available data fromHaver Analytics

especially evident after the 2011 Great East Japan Earthquake – thepopulation rose 7% from 13.09 million (2010) to 13.85 million(2019). A significant number of analysts project even further
overconcentration of the population in Tokyo when the pandemic
comes to an end with a vaccine or some other solution.

Currency Markets
Since the “reflation” policy was explicitly adopted in 2013 by the
BOJ, the long-term trend of the rise of the yen – dating to the “Nixon
shock” of 1971 – came to a close. As of 2017, the yen-dollar rate hasremained within the core range of ¥105-¥115.
In Japan, when the global economic risk is high, the demand forsafety assets is higher, and thus the yen trends higher. The primaryreason is that the yen is considered a safe haven. At the end of 2019,Japan held the world’s highest volume of net external assets at ¥364
trillion. During times of crisis, Japan repatriates overseas assets,engendering massive yen buying and increased demand, which
pushes the yen higher.
Since 2000, such crises include the 9/11 terrorist attack of 2001,
the Great Financial Crisis of 2007-2008, and the Great East Japan
Earthquake of 2011. During the pandemic of 2020, the yen
temporarily neared ¥100 to the dollar, but the rate has generally
remained in the ¥105-¥115 range.
As long as extreme uncertainty with regard to the stability of thedollar, which is often associated with the surge of gold or Bitcoin, isabsent, the yen-dollar rate is generally seen to remain in the ¥105¥115 range.

Long-Term Outlook After Covid-19
The outlook for the economy and financial markets for the next few
years, as Fed chairman Powell has said, depends on the outcome of
the coronavirus pandemic. The problem should be resolved within a
few years depending on a vaccine and herd immunity.

The pandemic is often compared to a war. It is true that on thefinancial front, during wartime, the budget deficit was inflated tofinance war operations, and monetary policy was placed under
government control. A somewhat optimistic view is that the pandemic
is actually a winnable war. Still, even when the war against thecoronavirus is won, there will be no direct reparation. In this sense,
the real question is what will happen when the pandemic is over.
For comparison purposes, let’s look at the US during World War II.
Due to wartime procurement spending, the budget deficit to GDP ratiorose from 38% in 1941 – when the US entered the war – to 111% in
1945 when the war came to a close. Under the government-controlled
monetary policy of the time, three-month short-term government
bonds (Treasury bonds) and 10-year government bonds were guided
by the artificial fixed interest rates of 0.25% and 2.5% respectively.
Yet the real test was steering the postwar economy. Government
spending after the war, primarily military procurement, fell by onethird. Real GDP for 1946 stood at -11%, while consumer prices rose
by 8%. In 1946, real GDP improved to -1%, yet consumer prices roseby 14%. Finally, in 1948, real GDP rose by 4%, while consumer prices
climbed 8%.
The cheap money policy was abandoned due to rising inflation,such that both short-term interest rates and long-term interest rates
were reverted to the free market in 1947 and 1951 respectively via
agreements between the Fed and the Department of the Treasury.
There was a three-year period of instability after the war as the shift
was made from a wartime to a peacetime economy. An additional
three years were required to fully restore the market economy.
Stock prices during World War II rose after the decisive Battle ofMidway was won in 1942 and after the Normandy landings of 1944.
Adjusted for the consumer price index, real stock prices generallyrose during the war. However, with the exception of a short-term
increase at the end of the war, stock prices took eight years – until
1954 – to fully recover. A long wait was also required for wartime
debt consolidation, normalization of monetary policy, and the shift
from the wartime economy, which had been powered largely by
military equipment demand, to the peacetime economy.
It is possible that the coronavirus pandemic, which is often likened
to a war, could play out the same way. From the perspective of themonetary economy, the equivalent of winning the critical battles
would be controlling the coronavirus infection rate, formulating
treatment protocols, and the development of a vaccine. A war on thecoronavirus ending in victory will mean widespread use of a vaccine
and the development of herd immunity, both of which could take anumber of years to affect the entire world.
A number of issues will need to be resolved following the war on
the virus, including government debt consolidation, corporate debt
repayment, and normalization of monetary policy. A sound investment
strategy would be to go with the flow while taking this whole big
picture into consideration.

Koichi Kurose joined Resona Bank in 1987 and has been an investment
strategist since 1999. He is presently chief strategist and chief economist at
Resona Asset Management Co., Ltd. He is the author of “Reading the Invisible
Crisis of the Times – Where Will the Market Land?” (Keio University Press,2020).

Japan SPOTLIGHT • November / December 202017