Toshihiko Fukui: Economic activity and recent financial developments in Japan
Summary of a speech by Mr Toshihiko Fukui, Governor of the Bank of Japan, at a meeting with
business people in Nagoya, 3 September 2003.
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I. Current situation of the Japanese economy and policy focuses
A. Current conditions
Economic activity as a whole has been flat since February this year, as has been described in the
Bank of Japan's Monthly Report of Recent Economic and Financial Developments. Recently, however,
we have gradually begun to observe some signs of improvement. For example, machinery orders and
the second-quarter GDP have turned out to be better than anticipated, and stock prices continue to
rise.
Such domestic developments should be understood in a global context, as economic globalization
progresses and the Japanese economy deepens its ties with overseas economies even further.
As you all know, during the first half of this year, the world economy was mired in the adjustment
process that followed the IT boom of the 1990s, which came to an end in the fall of 2000. Furthermore,
uncertainty about the economic outlook was amplified by the war in Iraq and severe acute respiratory
syndrome (SARS) in East Asia. Uncertainty about the financial system problem in Japan persisted,
and the fall in stock prices, including bank shares, became rather marked.
Fortunately, these uncertainties have decreased since the early summer. The actual operation of the
war in Iraq concluded relatively early, and the effects of SARS have been less than many people
feared. We have even begun to observe some signs of recovery in the demand for IT-related goods,
although we have not yet fully confirmed the extent of their adjustment.
In these circumstances, pessimistic views on the economic outlook have receded, and an increasing
number of people have become confident about a rebound of world economic growth from the second
half of this year.
For example, in the United States the so-called central tendency of projected real GDP growth for
2003 among members of the Federal Open Market Committee (FOMC) has been revised upward, to
2.5 to 2.75 percent. This projection implies that real GDP growth would rise to the 3 percent level for
the second half of 2003, from around 2 percent for the first half. For 2004, the FOMC members predict
further acceleration of real GDP growth to 3.75 to 4.75 percent. In Asia, China is most likely to return
to a stable growth path after overcoming the negative impact of SARS. With higher dependence on
information technologies, the NIEs will expand production as the global demand for IT-related goods
recovers, in the United States in particular. There is little likelihood that Europe will be a drag on the
global economic recovery, although its economic outlook still seems rather unclear.
Given these overseas developments, the Japanese economy is expected to gradually increase
exports and production. In addition to the possible increase in external demand, domestic demand
also shows some favorable signs. Planned business fixed investment for fiscal 2003 at the moment is
the largest since fiscal 2000, against the backdrop of a substantial increase in corporate profits.
Moreover, we see a slightly favorable change in direction in the job and income situation of the
household sector, although the situation remains severe.
B. Policy focuses
Such a path for Japan's economic recovery has been within our standard scenario since this spring,
and it appears increasingly likely that this scenario will be realized.
However, questions remain as to the strength and breadth of the economic recovery once it is
achieved, as well as the risk that the standard scenario may not be realized. In tackling these
questions, we should keep three points in focus.
The first focus is the outlook for overseas economies, the U.S. economy in particular. In this regard,
we should also pay attention to the global demand for IT-related goods.
Although the U.S. economy is on a mild recovery path led by private consumption, business fixed
investment and production generally remain weak, and the labor market condition continues to be
severe. With residual adjustment pressure after the bursting of the IT bubble, firms are still rather
restrained in their business expansion. In spite of these subdued conditions, we have recently begun
to see changes and hopes for improvement. Global demand for PCs, semiconductors, and other
IT-related goods is increasing. People strongly hope that a substantial tax reduction and monetary
easing will work to accelerate recovery. We will monitor how these changes and hopes are translated
into improving business activity and the labor market condition in the United States, and subsequently
whether such an improvement has a positive impact on the world economy.
The second focus is the financial market in Japan. Stock prices rebounded from around May, and the
Nikkei 225 Stock Average regained the 10,000 level after August 18 as views about the economic
outlook turned slightly more favorable. Long-term interest rates also rose. In my view, these
movements could be interpreted as the correction of overly pessimistic market expectations in the first
half of 2003 amid various uncertainties.
Fundamentally, stock prices and long-term interest rates reflect market views about the economic
outlook, so we should strive to correctly understand these views. Having said this, it is also true that
markets can often move irregularly in response to a variety of factors. For example, in the United
States, the 10-year long-term interest rate rebounded to the mid-4 percent level after falling to around
3 percent in June. As factors behind this gyration, many point to the deterioration of the fiscal balance
and the hedging activity of investors in mortgage securities, in addition to changing views about the
economic outlook. In Japan, people have already begun to talk about the possibility of overshooting of
long-term interest rates, which cannot be justified by economic fundamentals. We will closely monitor
financial market developments, including the possibility of large swings in long-term interest rates due
to factors other than economic fundamentals.
The third focus is the extent of economic recovery spurred by exports and production amid the
persisting problem of excess debt and labor.
The problem of excess debt differs from firm to firm, and industry to industry, but broadly speaking, it is
largely a problem for the nonmanufacturing industry. For example, the ratio of net debt to sales has
been declining significantly for the past ten years in the manufacturing industry, but remains high in the
nonmanufacturing industry due to the delay in adjustment. The nonmanufacturing industry tends to
retain various inefficiencies mainly because it has been traditionally less exposed to international
competition than the manufacturing industry.
The manufacturing industry is the driving force behind the economic recovery if it is led by exports and
production. But, to achieve sustainable growth, it is critically important whether such an initial recovery
will lead to the dynamic and forward-looking improvement of the nonmanufacturing industry.
The problem of excess labor is important when we judge whether the recovery of the corporate sector
might lead to an increase in private consumption through a rise in income. The Tankan (Short-Term
Economic Survey of Enterprises in Japan) has been showing a consistent pattern of excess labor for
both the manufacturing and nonmanufacturing industry since the bursting of the bubble economy.
Recent labor statistics also show a continued decline in regular employment. These data suggest
persistent pressure for labor market adjustment and continued severe conditions for employment and
income.
Looking closely at the latest statistics, it should be noted that we have begun to observe some signs of
favorable changes in the labor market. The level of employment ceases to fall if part-time workers are
included, and the decline in wages is bottoming out if bonus payments for the summer are taken into
account.
II. Conduct of monetary policy
In these economic conditions, the Bank has been conducting a quantitative easing policy, maintaining
financial market stability and strengthening the momentum for recovery by flexibly providing ample
liquidity. Since I became Governor, the Bank has raised the quantitative target for the outstanding
balance of current accounts held at the Bank twice, in April and May. Faced with a number of
uncertainties, including the war in Iraq, SARS, stock prices, exchange rates, and the problem related
to Resona Bank since this spring, we have taken a preemptive approach to monetary policy so that
these uncertainties do not jeopardize the not very robust foundation for economic recovery.
The Bank has also made a strong commitment to continue the current monetary easing until the
year-on-year increase in the consumer price index (CPI) becomes stably zero or above. This
commitment strengthens the policy effect on interest rate stability, as participants in financial markets
can anticipate monetary easing as long as the year-on-year increase in the CPI remains negative.
Furthermore, the Bank has been strengthening the transmission mechanism of monetary policy so that
the effect of monetary easing permeates through the economy. As part of such efforts, it began
purchasing asset-backed securities in August. Underlying assets included not only receivables but
also lease and loan assets, which we hope facilitate the funding of small to medium-sized firms. It was
quite unusual for the central bank to directly assume the credit risk of the private sector, but we
thought such a measure was necessary in light of the prevailing economic conditions, and the state of
the financial system and markets.
The Bank has been taking necessary measures, without undue regard for precedent, to return to
sustainable growth and overcome deflation, and it will continue to do so.
We should also emphasize stronger global linkage when we examine the problem of deflation, in the
same way as economic activity.
Inflation has been declining globally, due mainly to the appropriate conduct of monetary policy and the
increasing penetration of emerging countries into market economies. This phenomenon is termed
"global disinflation." Even if the world economy recovers, there is a strong possibility that inflation will
stay at a relatively low level, while the growth rate will increase. In fact, various private-sector forecasts
show that for 2004 growth will be higher compared to 2003, and inflation will remain under 2 percent in
the United States, Europe, and Asia. In such circumstances, central banks have been implementing
monetary policy with more attention to the risk of deflation. For example, the Federal Reserve Board
announced in its FOMC statement in August that "policy accommodation can be maintained for a
considerable period."
Japan is suffering from deflation, a worse problem than disinflation. This makes a stronger case for the
Bank to continue implementing an easy monetary policy, compared to other central banks.
III. Revitalization of the corporate sector
Stronger global linkage has some bearing on the commonly observed facts that business sentiment
has been slow to improve and fixed investment has not become as active as anticipated in various
countries under monetary conditions that are easier than in the comparable stage of past business
cycles.
This partly reflects residual pressure for adjustment. But it also reflects more intensified competition in
the corporate sector together with the progress in globalization, as well as increasing difficulties firms
face in sustaining pricing power under the new conditions in which prices are being determined. We
may be approaching a stage where corporate profits can only be increased by creating new
value-added goods and services, and the investment opportunities for such creation are becoming
more difficult to find.
For example, in Japan, the corporate management and economic framework established during the
high-growth period are so firmly embedded that it is a very difficult and challenging task to transform
them.
In this regard, I have been advocating three directions for firms to pursue with a view to building a new
framework for the Japanese economy. The first is to boost their competitiveness and generate new
consumer demand by creating new value-added goods and services. The second is to increase their
business activity in the expanding Chinese and other Asian markets, and further deepen economic
interdependence with them. And the third is to address global challenges such as the development of
sustainable energy sources and environmental protection. If firms can make positive contributions in
these directions, they will certainly be able to expand the frontier of innovation to revitalize the
Japanese economy. I hope that such efforts will place the Japanese economy in a unique position in
terms of the sustainable development of the world economy.
IV. Current situation of the financial system and challenges
The Japanese financial system, although still facing severe conditions as a whole, is steadily moving
toward restoring its effective functioning.
Since last fall, there has been a growing recognition among financial institutions and related parties
that an appropriate evaluation of the economic value of nonperforming loans (NPLs), and higher
provisioning and more aggressive write-offs of these loans based on such an evaluation, are important
in accelerating the disposal of NPLs. Further efforts have been made in this direction. In fiscal 2002,
Japanese banks recorded a large net loss for the second consecutive year. This result clearly
reflected the severe conditions faced by the Japanese financial system. At the same time, it signified
the aggressive disposal of NPLs as shown by the substantial decrease in NPLs outstanding at major
banks.
The time has now come to move to the final stage to restore the effective functioning of the financial
system, keeping in mind the complete removal of blanket deposit protection scheduled in April 2005.
This removal, in my view, should not be perceived simply as a change in the type of coverage of
deposit insurance protection. Instead, it should be recognized as a turning point for financial
institutions in the reform of their management. Protection has been provided as a temporary buffer to
avoid potential confusion. Following the complete removal, financial institutions must pursue a
dynamic management strategy based on their own judgment.
To this end, it is the financial institutions themselves, not the regulatory authorities, that should take
the initiative in dealing with NPLs. Moreover, they should redouble their efforts to strengthen their
earnings power besides accelerating the disposal of NPLs.
V. Disposal of NPLs and corporate revitalization
In addition to the appropriate evaluation, higher provisioning, and more aggressive write-offs in the
disposal of NPLs, increasing attention is being paid to the importance of corporate revitalization from
the viewpoint of promoting the reform of industrial structure.
The Industrial Revitalization Corporation of Japan (IRCJ), which began operation in May this year,
recently decided to support four firms. The IRCJ will subsequently purchase the loan assets of these
four firms from lenders other than their main bank, decide on a restructuring plan and then implement
it. Individual financial institutions, major banks in particular, are establishing a subsidiary specializing in
corporate revitalization. Moreover, we observe an increasing number of cases in which financial
institutions set up an internal section specifically devoted to corporate revitalization, and form an
alliance with outside experts like lawyers and certified accountants.
The success of corporate revitalization requires a speedy and decisive response on the part of both
firms and financial institutions. Some firms with useful technology and expertise find it difficult to
improve their business performance because of the large financial legacy from the past. Often these
firms, in collaboration with financial institutions, can solve their problem by boldly eliminating
unprofitable businesses and concentrating their managerial resources on core businesses. In this
regard, it is mutually beneficial for both firms and financial institutions to promote a sufficient dialogue
and reach a shared recognition about the present and future of the firms' management.
To smoothly promote corporate revitalization, we need to improve and expand the market for loan
asset liquidation, including NPLs. The expansion would help banks take NPLs off their balance sheets,
but it would also invite a variety of investors with diversified risk preferences and expertise into the
corporate revitalization business. If the market expands and prices for loan assets are formed
efficiently, these prices will indicate the market's evaluation of corporate revitalization.
VI. Earnings power of financial institutions and a stronger capital position
When the effective functioning of the financial system is finally restored, major banks will enjoy strong
international competitiveness, and local banks will be able to provide new financial services for
regional development. These benefits will only be possible with the strengthening of earnings power.
To strengthen earnings power, individual financial institutions must form their own judgments on a
number of issues. For example, how should they change their traditional practice for transactions?
What kind of new businesses should they develop? How should they reorganize their business model?
The Bank would like to support the efforts of financial institutions toward this end by providing
appropriate advice through on-site examinations and daily monitoring.
In this process, financial institutions must ask themselves whether their capital position is sufficient to
pursue a new business model, and if not, they of course need to boost their capital position. Needless
to say, financial institutions should raise capital in the markets. In the limited time before the complete
removal of blanket deposit protection, however, some may not be able to do so sufficiently. In this
case, fundamentally there are two options: either reducing their business scope in line with their
existing capital position or accepting the public injection of capital. I think the latter option is desirable
under the current conditions in Japan. In other words, we should facilitate the process of restoring the
effective functioning of the financial system through a new system of capital injection, which differs
from the existing system that seeks to preempt crises.
Conclusion
A number of developments indicate that the Japanese economy is moving in a desirable direction,
even though it continues to face severe conditions. I believe it is the competitiveness of the private
sector, both firms and financial institutions with progressive technology and expertise, that will bring
about the reemergence of a truly strong Japanese economy. The Bank stands ready to provide full
support to the private sector's efforts toward this end by maintaining an easy monetary policy.