No one doubts that Japan’s banks are saddled with a huge level of bad debts. But just how big are they and how bad? Fears about the real extent of these loans is putting extra pressure on an already severely burdened domestic equities market, say strategists.
Japan’s top financial regulator, the Financial Services Agency (FSA), said in November that the bad loans held by banks were ¥13,000bn (E107bn) more than the banks themselves had said.
Figures published in mid-November showed that bank lending in Japan had in October fallen to its lowest level in more than 10 years. Economists have predicted that lending will fall even further in the next few months.
The Japanese fiscal year ends in March and that is the point at which the true extent of the problem of non-performing loans will come to light, says Naoki Kamiyama, Japanese equity strategist at Morgan Stanley in Tokyo. It will then be clear how the banks themselves are going to deal with the bad debts and whether there will be an injection of public money to help them.
“By the end of the fiscal year, we will see what is really going on,” he says. Until then, however, the market will be burdened by the uncertainty of the problem, he says. “In April, I expect to see a stronger market, following a shakeout in February and March.”
But before then, and in the absence of unexpected events, strategists see no significant directional changes for the Japanese stock market before the end of the year.
“I think the market is stable for the time being to the end of the year, but then I see a downturn between March and April,” says Kamiyama.
Yukiko Kawamoto, head of equities at HSBC Asset Management in Tokyo, sees little danger of a renewed downturn before the end of the year. “It is at its historical low already, and the supply /demand balance of the market is improving.” But into the new year – in January and February – there will be seasonal selling pressure, she adds.
At the root of the non-performing loans issue, is the fundamental overcapacity which spreads right across Japanese industry, affecting the construction, retail and machinery sectors particularly. “It’s a big reason for deflation,” says Kamiyama.
It has been taken as a good sign by the market that current government ministers have noticed this as a problem, whereas predecessors have not, he says. This perceived new awareness of politicians gives the market hope, he says.
What is now needed, says Kamiyama, is for the economy to deal with the crippling overcapacity. “Some companies must downsize, and the number of companies must be reduced to get better bargaining power with suppliers.” The number of steel companies has already declined and as a result of this their selling prices are higher than before.
The Japanese government’s most recent fiscal package aimed at dealing with deflation and the non-performing loans was less thorough than the market had expected.
Kathy Matsui, chief strategist at Goldman Sachs in Tokyo said in a report that unless the anti-deflation measures led to a sustained improvement in returns on capital, the market was likely to resume a downtrend. The search for a true ‘bottom’ to the 12-year bear market would continue, she said.
Further out, she said, investors should shift back towards quality companies with sound balance sheets, stable earnings and valuation support. Based on Goldman Sachs’ assumptions that global growth would resume in 2003, but that Japanese growth would remain sub-par, and that the bias toward a weak yen was likely to continue, Matsui said she would focus on select exporters such as Nidec, Canon, Nintendo and Bridgestone.
Kawamoto says that looking at the economic fundamentals, deflationary pressure does not seem to be much worse than it was before, but the market has deteriorated.
However, she says there are concerns in the market that when the bad loans are settled, this could lead to a worsening of the deflation situation. “It’s becoming clear that deflation is a global problem, not just a domestic one.”
Kawamoto says she believes the domestic economy is becoming frailer. “The market has been so disappointing, we think the economy is weakening. The risk premium is high these days,” she says. The market is not just weakening as part of a cyclical pattern, but stocks have been sold off quite heavily as a result of a deterioration in long-term growth prospects.
The economy in Japan is not in a position to give the market any upside impetus, so hopes are being pinned on action from the government side. Market participants are looking out for any positive announcement from the government on fiscal policy to lend some support to sentiment.
Stock valuations are underpinning the market to some extent, says Kawamoto. “As a whole, earnings are not that bad. Companies are making a lot of effort to restructure, but the economy is not helping.”
“There isn’t much upside,” says Kawamoto. “Not just domestically, but globally, conditions are not bright.”

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