Toshihiko Fukui: Recent economic and financial developments in Japan
Speech by Mr Toshihiko Fukui, Governor of the Bank of Japan, at a meeting in Fukuoka,
8 December 2003.
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I. The current economic situation and the route to sustainable growth
Largely in line with the standard scenario in the Outlook and Risk Assessment of the Economy and
Prices published at the end of October, Japan's economy is starting to recover gradually, after a
period of generally flat economic activity that lasted up until around summer. With corporate earnings
improving, business fixed investment continues its gradual recovery. Against the backdrop of an
improvement in overseas economies, exports, which had been flat until summer, have started to turn
upward. Production, whose recovery had been somewhat delayed due to the unusually cool summer,
is starting to increase recently.
The fact that the rise in exports and business fixed investment has led to a recovery in production
suggests that cyclical momentum for a recovery is kicking in, and that the Japanese economy is at last
settling onto a recovery path.
From the second half of fiscal 2003 through fiscal 2004, a moderate recovery is expected to continue.
Exports and production are likely to continue increasing against the background of high growth in the
United States and Asia, particularly in China, with a recovery in global demand for IT-related goods. In
Europe, it is becoming more apparent that the economy has bottomed out. There is a greater
probability that these increases in exports and production will promote further business fixed
investment along with the improvement in corporate earnings.
The pace of the recovery will most likely be contained to a moderate clip, considering ongoing
structural adjustment pressures as well as not so favorable prospects for employment and income.
The corporate sector, especially non-manufacturing, is still suffering from excess debt. With no clear
signs of improvement in employment and income, personal consumption is expected to continue
following a generally flat trend. It will be quite some time before we can eliminate the word "moderate"
from the description of the current recovery.
After decreasing constantly for five and a half years, the consumer price index excluding fresh food,
which we refer to as the core CPI, increased by 0.1 percent year-on-year in October. This was partly
due to a hike in rice prices caused by the unusually cool summer, in addition to factors such as the
rise in medical treatment costs and the tobacco tax.
Although the core CPI may fluctuate due to temporary factors, its underlying trend is expected to be
for a slight decline during the rest of fiscal 2003 and throughout fiscal 2004 since aggregate demand is
projected to remain short of potential supply capacity.
Naturally, this standard scenario entails various uncertainties, or what we term risk factors. Among
them, we pay particular attention to the global demand for IT-related goods, the U.S. economy, the
domestic financial system, and financial market developments. These risk factors may cause the
Japanese economy to deviate from the standard scenario laid out in the Outlook and Risk
Assessment, either upward or downward.
To overcome deflation and return to a sustainable growth path, a cyclical recovery alone is not
sufficient. Structural problems must be dealt with, and expectations of higher growth must be formed.
We need to address excess debt in the corporate sector and weakness in the financial system. We
need to raise expectations of growth among firms and households, who seek for new value added, so
that these may be translated into brisker spending.
In the corporate sector, steady efforts have been made, stretching over more than 10 years, to solve
problems such as excess debt and labor. In fact, large manufacturers have largely succeeded in
eradicating these excesses. As break-even points have been lowered, the ratio of current profits to
sales for such firms has improved to its highest level since the bursting of the bubble.
Some manufacturers are aggressively pursuing improvements in productivity by investing in newly
growing businesses and constructing a more efficient international division of labor. Spread of such
movements throughout the corporate sector, including to non-manufacturers and to small and
medium-sized firms, is one of the key factors to enhancing expectations of growth generally and
reinvigorating Japan's economy.
II. Conduct of monetary policy
The Bank of Japan is continuing to provide ample liquidity, targeting an outstanding balance of current
account deposits at the Bank under its quantitative easing policy. Since the beginning of the year, the
target has been significantly raised twice, in April and May, in light of risk factors such as the war in
Iraq and severe acute respiratory syndrome.
Furthermore, in October, the Bank raised the upper limit of the range for the target balance of current
account deposits. This was intended to reinforce the nascent recovery by enhancing the flexibility of
money market operations when providing liquidity to the market. With the economy in an incipient
recovery phase with its concomitant uncertainties, there is the potential for subtle fluctuations in the
expectations of market participants and changes in funding needs. The Bank has sought to respond
flexibly in its market operations to any possible changes of these sorts, so that it can reinforce the
current stirrings of recovery.
The outstanding balance of current account deposits now stands around 30 trillion yen, having risen
from around 20 trillion yen at the beginning of the year. The Bank conducts market operations
centering on this balance by carefully monitoring daily market conditions.
In order to help the effects of monetary easing through the provision of ample liquidity to permeate the
whole economy, the Bank is taking measures to strengthen the transmission mechanism of monetary
policy in corporate finance. In August, the Bank began the purchase of asset-backed securities
collateralized by assets mainly related to small and medium-sized firms. The Bank recently decided to
accept syndicated loans as eligible collateral.
In addition to their immediate monetary policy implications, these measures will also contribute, over
the long run, to establishing a new shape for corporate finance, better compatible with Japan's future
economy. We hope that our initiatives will act as a trigger, spurring the private sector to explore
various new market-based funding channels to supplement the traditional bank lending channel.
III. Enhancing transparency in the conduct of monetary policy
There are two points that are of pivotal importance when conducting monetary policy. One is to
implement effective policy in a timely manner. The other is to provide the public with a lucid
explanation and promote their understanding of the Bank's evaluation of economic and price
developments as well as the thinking upon which it bases its policy decisions.
The new Bank of Japan Law stipulates that the Bank, which has been given independence to conduct
monetary policy at it own discretion, must make efforts to be more accountable for its decision. We
think that the greater the public understanding of the thinking behind monetary policy, the more
effective that monetary policy will be.
Bearing these points in mind, the Bank made two major decisions to enhance the transparency of
monetary policy at the Monetary Policy Meeting in October.
First, measures were taken to provide the public with a lucid explanation of the Bank's evaluation of
economic and price developments in a timely manner. In addition to the semiannual report on the
Outlook and Risk Assessment of the Economy and Prices in April and October, the Bank decided to
carry out interim assessments of economic and price developments in January and July, and to
release the result of its discussions accordingly. These interim assessments are designed to
investigate possible deviations of economic and price developments from the standard scenario
presented in the Outlook and Risk Assessment three months before.
Second, the Bank published a more detailed description of its commitment to maintaining the
quantitative easing policy. The Bank had already committed to maintaining the current policy until the
core CPI registers a stable year-on-year rate of increase of zero percent or above. In October, it
decided to clarify the meaning of the phrase "registers stably a zero percent or an increase
year-on-year" in a more concrete manner.
Specifically, quantitative easing will be continued until the following two conditions are met.
First, not only must the most recently published core CPI register a year-on-year rate of increase of
zero percent or above, but this tendency must be confirmed over a few months.
Second, the year-on-year rate of increase in the prospective core CPI must not be expected to register
zero percent or below. In other words, the majority of Policy Board members need to make the
forecast that the core CPI will register a year-on-year rate of increase greater than zero percent during
the forecasting period. This forecasting period is roughly a year starting from April in the April Outlook
and Risk Assessment, and roughly a year and a half, which is the second half of the current financial
year starting from October and the whole of the next financial year ending in March, in the October
Outlook and Risk Assessment.
The above two conditions are necessary conditions. However, we have also announced that there
may be cases when the Bank will judge it appropriate to continue with quantitative easing even if
these conditions are fulfilled.
Since its announcement, we have received a few questions about this detailed description of the
commitment. Let me answer two major questions.
The first question is why the Bank does not carry out interim assessments of economic and price
developments every month. Since the economy is changing constantly, perhaps, theoretically
speaking, we should carry out the interim assessments every month, or even every week.
Against this theoretical possibility, we judge it appropriate that the Outlook and Risk Assessment and
interim assessments should be released roughly every three months in light of their objective to
present a basic view of how the economy will develop over a reasonable period of time. We cannot
revise the basic view about the economy and prices in an appropriate manner without sufficient
accumulation of critical data. Also we may confuse the market if we release assessments based on
insufficient data or if we change our assessments too frequently. Actually, many central banks abroad
release their monetary policy reports or inflation reports every three months.
This does not, of course, imply that the Bank will make policy changes only every three months.
Although conducting the basic evaluation roughly every three months, we need to closely examine the
ever-changing state of the economy and prices and to carefully deliberate on the need for policy
changes at every Monetary Policy Meeting. As has always been the case, if the need arises, the Bank
will adjust its policy in a timely and appropriate manner, regardless of the frequency and timing of the
release of the Outlook and Risk Assessment and interim assessments.
The second question concerns the risk that more detailed description of the commitment to
maintaining the quantitative easing policy may affect the Bank's ability to conduct monetary policy in a
flexible and timely manner in future. It may be natural to ask this question, because it is extremely
unusual for a central bank to link its future policy conduct to a particular economic indicator, such as
the core CPI in the case of Japan.
While paying due attention to this kind of risk, we have come to the conclusion that, with a number of
obstacles still confronting Japan's economy as it seeks to overcome deflation and settle onto a more
solid recovery path, such a detailed description of the commitment is necessary at the current time.
This detailed description is a manifestation of our strong determination regarding the future conduct of
monetary policy.
IV. Current state of the financial system
On the whole, the current state of the financial system in Japan remains severe. It should be noted,
however, that at some financial institutions, especially major banks, efforts to improve financial
conditions have gradually begun to bear fruit.
For the financial year ending in September, profitability improved significantly at all major banks,
except for Resona Group, which received an injection of public funds. This was mostly thanks to
successful reductions by all major banks of losses from nonperforming loan disposals, on a
year-on-year basis at the end of September 2003. These reductions were partly due to large capital
increases and higher provisioning in the previous financial year ending in March 2003. After registering
a record high at the end of March 2002, the amount outstanding of nonperforming loans continued to
decrease as progress was made in the removal of nonperforming loans from balance sheets.
Major banks improved stability of their profitability by reducing their shareholdings, which had been
blamed for large fluctuations in profits. In fact, banks' shareholdings had decreased to levels well
below Tier 1 capital at the end of September.
To strengthen profitability, major banks made efforts in cutting costs and increasing fee incomes.
These efforts have gradually begun to be reflected in their financial results.
Moving on to conditions surrounding regional financial institutions, let me first touch on the recent case
of Ashikaga Bank. Last month, Ashikaga Bank informed the government that it had negative net worth
at the end of September, and that there was a risk of suspending repayment of deposits. Considering
the significant financial role played by Ashikaga Bank in the region, including Tochigi Prefecture, the
government judged that a serious disruption of the financial system in the region might occur if no
measures were taken. The Prime Minister summoned the Financial System Management Council, of
which I am a member, and decided upon the temporary nationalization of Ashikaga Bank, pursuant to
Article 102 of the Deposit Insurance Law at the end of last month.
As a temporarily nationalized bank, Ashikaga Bank will continue normal operations, and all of the
bank's obligations, including deposits and interbank borrowings, will be met smoothly. A new
management team will carry out appropriate business operations, while seeking to transfer its
business to an assuming financial institution as soon as possible. As part of this process, the Bank of
Japan will provide liquidity, including the extension of special loans pursuant to Article 38 of the Bank
of Japan Law if necessary.
Fortunately, at present, no other regional financial institution faces conditions of comparable severity.
In fact, financial statement at the end of September 2003 showed improvements at more than a few
regional financial institutions as losses from the disposal of nonperforming loans were reduced.
Regional financial institutions, however, seem to lag behind major banks in addressing tasks, such as
appropriately evaluating the economic value of nonperforming loans, making provisions accordingly,
and working toward corporate revitalization. While land prices continue to decline, small and
medium-sized nonmanufacturing firms, which dominate regional economies, find their business
recovering only too gradually. In these difficult circumstances, it is increasingly hoped that regional
financial institutions will play an active role. We at the Bank will do as much as we can to support their
efforts in this regard, through supervision and other means, whenever the occasion presents itself.
V. Issues for 2004
2004 is the final year of preparation for the removal of blanket protection of demand deposits in April
2005. This removal, in my view, should not be perceived simply as an adjustment of the extent to
which deposit insurance protection is applicable. Rather, it should be recognized as the last hurdle
before the management of financial institutions becomes truly independent from regulatory authorities.
At the end of March 2005, major banks are expected to reduce their nonperforming loan ratios to
about half autumn 2002 levels. At the same time, the Industrial Revitalization Corporation of Japan will
cease its purchase of loan assets. From April 2005, fixed asset impairment accounting rules will be
introduced.
Firms continue to strengthen their business structures and competitiveness. Initiatives based on the
private sector's creativity and vitality will be the driving force for Japan to achieve steady economic
growth under global competition.
Together with firms, financial institutions also play an important role in supporting the Japanese
economy. Dynamic expansion of the economy will not be possible if financial institutions remain
dependent on regulatory authorities and generous safety nets. Not only firms but also financial
institutions will be confronted with frequent new entries to and withdrawals from the market, as well as
consolidation and reorganization in their respective industries. This makes it all the more critical for
financial institutions to demonstrate their firm intention to stand on their own feet, and enhance their
credibility in the market.
In this regard, let me point out some of the major tasks to be addressed in 2004. In order to achieve
reform of the economic structure and a sound financial system more rapidly, financial institutions,
especially major banks, must work harder with firms to revitalize the corporate sector, while expediting
the disposal of nonperforming loans. It is true that some financial institutions have already established
subsidiaries specializing in corporate revitalization. Further efforts, however, are still required in areas
such as the more effective use of the Industrial Revitalization Corporation of Japan and the Resolution
and Collection Corporation.
In corporate revitalization, regional financial institutions basically face the same problems as major
banks. There are more than a few borrower firms with competitive technology and expertise, which
find it difficult to improve profitability because of the financial legacy of past borrowing. For this reason,
the strategically important issues that many regional financial institutions address include the provision
of detailed consultation services to borrower firms, the extension of greater assistance to borrower
firms, and the prompt realization of business revival. We hope that their efforts will bear fruit.
Financial institutions also have an important role to play in helping the corporate sector to develop the
new businesses that will underpin Japan's future economy, while at the same time supporting ailing
business firms. Regional financial institutions in particular are expected to play an active role in
generating new businesses in their region. We observe the first shoots of new regional businesses in a
variety of areas: biotechnology and other advanced technologies, new industrial clusters linked to
recycling and other environment-related technologies, as well as regional city revival, sightseeing,
medical care, and nursing services.
To strengthen such trends, regional financial institutions are expected to play a new role in their
regions. In this regard, the thinking behind their business decision-making in the past needs to be
radically overhauled. For example, decisions about whether or not to assume particular risks should
be based on a close examination of the nature of projects at hand rather than depending unduly on
traditional collateral or guarantee-based methods. They should also raise their levels of expertise at
providing advisory services relating to the smooth management of projects. This in turn will lead to the
revitalization of regional financial institutions themselves.
Once the blanket protection of demand deposits is removed, financial institutions will no longer be able
to count on support from the authorities. In principle, they will have to rely entirely on their own
intellectual resources and creativity in dealing with the tasks facing them, including the nonperforming
loan problem.
It is conceivable, however, that there may be financial institutions, which are keen to rebuild their
financial base, but which may not be able to strengthen their capital positions within the limited time
frame without outside assistance. To deal with this possibility, injections of public funds which may be
executed without reference to systemic risk should be considered apart from the measure stipulated in
Article 102 of the Deposit Insurance Law.
I am aware of a variety of learned opinions calling for caution in establishing another system of capital
injections. Bearing these opinions in mind, I hope that we will somehow manage to find a way to
design an appropriate new framework - one that will function as the last public support to the efforts of
the private sector.
In closing, let me reiterate our determination to support the efforts of the private sector and to exert
ourselves to the full to achieve sustainable growth.