Is recovery on - or not?

We’re all familiar with the Japan of the last decade following the bursting of the bubble. Stagnant markets and a stagnant economy. That’s been the story for so long that it comes as a refreshing surprise that maybe, just maybe, there’s a different tale to tell.
What’s the evidence? Exhibit one: economic growth that has “surprised on the upside”. Exhibit two: the Nikkei index at levels not seen for more than 15 months. So, maybe the tide has turned in Japan. After all, how long is it since the words growth and Japan could be found in the same sentence?
In September, the Organisation for Economic Cooperation and Development’s chief economist Jean-Philippe Cotis told the world: “In Japan growth has surprised on the upside.” And, for the first time in living memory, someone in Cotis’ position can say, with a straight face: “Japan has also been supporting rather than dragging down global activity.”
Indeed, gross domestic product was up 1% in the second quarter of this year – its fastest rate for two and a half years, compared to a 0.1% rise in the first quarter.
Cotis cited “some recent improvement in business confidence, helped by a rebound in corporate profits, progress in corporate restructuring, better US and Asian growth prospects and reduced global uncertainty, while household confidence is also higher”.
“In Japan, core inflation has been negative for half a decade, by we project it to gradually move towards zero, helped by strengthening activity and more active monetary policy.”
“In Japan, unconventional monetary policy is starting to work and should be pursued vigorously until deflation is eliminated.”
David Bowers, chief global strategist at Merrill Lynch agrees. “People see Japan as having a much more positive profit outlook. This is entirely consistent with cyclical expectations.” His colleague, strategy analyst Sarah Franks adds that Japanese fund managers are “buying into their own recovery”.
“After lagging other regions in economic optimism, Japanese fund managers are resoundingly bullish for their region,” Franks says.
A net 58% of managers polled by Merrill expected higher inflation in the next 12 months. And 84% of the panel expected the outlook for corporate profits to improve.
“This is a complete about-face,” Franks says. She says that 95% of Japanese fund managers that Merrill polled in its recent monthly survey of global fund managers are expecting a stronger Japanese economy. This compares to a majority of respondents just three months before who expected a weaker economy.
Merrill also surveyed views on the yen. More managers now see the yen as undervalued rather than overvalued at 116 to the dollar. “When traded-weighted yen last traded at this level back in the first quarter of 2003, everyone thought it was seriously overvalued,” says Bowers. “In our view its is the economic cycle that rehabilitated the yen into being something that investors actually want.”
For global fund manager Barclays Global Investors, there are some signs that further growth is in the pipeline. The group’s chief economist Haydn Davies says that despite a deceleration in industrial production, there has been a rise in orders for new machinery.
“Lately, Japan’s economy has been performing better than investors dared hope,” Davies says, citing the strong growth figures. But he said a growth in capital investment was unlikely to be sustained.
Exports are key, Davies observes. “As in so many times over recent years, an export-led recovery looks set to lift the whole Japanese economy and help investors to forget about the country’s underlying problems.”
And some people are putting their money where their mouth is. Standard Life Investments says it has increased its weighting of Japanese equities to “heavy” from “neutral” in part because of an improved export outlook. The firm says said it is favouring Japanese equities because more sectors of the market were becoming attractive. As well as the export outlook, it said Japanese corporate earnings had been beating expectations and were supporting stronger business investment.
However, at least one influential voice is saying that the Japanese recovery is not as clear-cut as it seems.
The IMF’s chief economist and director of research Ken Rogoff, speaking at the Group of Seven meeting in Dubai in September, says: “Japan’s situation, though clearly improving, remains clouded.”
He concedes that there has been “a remarkable up-tick in the GDP numbers lately”. As a consequence, the IMF has raised its forecast for Japanese growth for 2003 to two.
“However, it would be premature, to say the least, to declare that Japan is out of the woods,” Rogoff says. “Trade, with booming emerging Asia, including China, has helped fuel short-term growth, and so too has investment. But underlying problems with corporate and bank balance sheets, a soaring government debt, and entrenched deflationary expectations are all still major roadblocks to sustain strong growth.” The IMF sees “serious and interrelated problems” besetting the Japanese economy. “Sustained revival and an end to deflation are not yet in prospect.”
So either Japan is on a recovery path or it’s not. Considering it’s the second-largest economy in the world, it’s a question that needs to be answered one way or the other. Will we be looking back in a year’s time and saying this was where the whole thing turned around. Or will it turn out to be another false dawn in the land of the rising sun?

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