Indeed, while the political landscape has been chaotic, with the unexpected resignation of former Prime Minister Shinzo Abe over the summer, economically things looked more stable. The banking system û which is a source of panic in the US and Europe û is relatively unaffected by subprime exposure and high leverage. And the investments by Japanese banking giant Mitsubishi UFJ Financial Group (MUFG) in Morgan Stanley and French bank Credit Agricole, as well as the acquisition of Lehman BrothersÆ Asian and European operations by Nomura Securities, seemed to indicate that JapanÆs financials were in good health. However, not even bank stocks have been spared in the stockmarket sell-off. And that will reduce the likelihood of further overseas acquisitions of banking assets.
ôThe degree of the sell-off on Monday was surprising,ö acknowledges equity strategist Patrick Mohr at Nikko Citigroup in Japan. öThe response of the Japanese equity market was to indicate that we are about to enter a very serious recession. We donÆt subscribe to that view, so we believe this to be a good time for bargain hunting.ö
However, Mohr says that the Japanese economy does face some challenges. With domestic economic activity essentially flat, exports are the crucial factor for JapanÆs growth. ôJapan is a play on the global economy, so with a low global growth outlook, itÆs not surprising Japan got hit Monday and Tuesday,ö says Mohr, referring to the slowdown in Japanese exports that a global recession would bring.
Mohr also identifies the yen carry trade as a factor pushing down the market. ôThe yen carry trade has an amplifying effect, in both good times and bad times. In bad times, the carry trade is unwound and the yen strengthens, which is bearish for JapanÆs export profits,ö he says. Citi is forecasting Japan GDP growth of just 0.8% in 2008 and 0.7% in 2009, compared to 1.8% for the US in 2008 and 1.1% in 2009 û although Mohr reckons recent events could result in a downgrade to the US forecasts. The weakness in the US and EU banking sectors is beginning to affect the wider economy, meaning poor prospects for Japanese exports.
Developments in Europe over the past few days show that the situation there is as bad, or worse, as in the US û despite recent comments by European politicians that the continent has a safer model of capitalism than the US. But Mohr says that European banks have behaved as recklessly as their US counterparts. ôEU banks assumed a continuation of low volatility and stable growth, and as a result they took leverage to record high levels, with the results we now see,ö he says.
One Japanese financier told FinanceAsia that European banks are also more exposed to Asia than US banks, because the US banks could historically rely more on their fast-growing domestic markets, while EU banks were under greater pressure to find growth in Asia to offset the slow growth in Europe.
ôA slowdown of EU bank activity in Asia û whether of underwriting, loans, project finance, real estate investment or private equity û will hurt the region, and that will hurt Japan,ö he estimates. Thus, Japan would be facing an export slowdown to Asia, the EU and the US simultaneously û reason enough for investors to sell.
JapanÆs banking sector has certainly performed much better than its EU and US counterparts, with ôJapanese banks representing just 2% of the total credit-related write-offs announced so far, a mere fraction of the exposure of western banksö, according to Mohr. European banks have suffered only a fraction less than US banks in terms of credit write-offs.
However, Japanese banks are facing other negative factors. They are exposed to sinking stockmarkets and that is a concern, say analysts. ôThe reduction in unrealised gains in the Japanese banksÆ equity holdings will hit their tier-2 capital, since 45% of such losses/gains are counted against their capital ratios. If the gains swing to a loss, it will affect their tier-1 capital,ö warns Reiko Toritani, Japanese bank analyst at Fitch Ratings.
ToritaniÆs counterpart at Standard & PoorÆs, Naoko Nemoto, says it will be key whether the Nikkei drops below 9,000 points: ôThat would represent a critical level of losses for the Japanese banks.ö
The other important point about the major Japanese banks (the five æmega-banksÆ that dominate the market) is that their capital levels were not that strong to start with, according to Toritani. ôIn March 2007, the Japanese mega-banks had tier-1 ratios of 7.13%. ThatÆs not especially high. At that time, the EU and US banks in the double-A ratings range had tier-1 capital of over 8%.ö In other words, the Japanese banks donÆt have much of a cushion if events take a turn for the worse.
While the EU and US are worried about a crisis rippling out from banking sector weakness to the real economy, Japan is worried about the opposite û a slowdown in the broader economy eventually affecting their earnings.
ôA major concern is the deteriorating assets of the Japanese corporate sector on the back of a Japanese export slowdown. The domestic sector is already weak, and the small companies which supply Japanese export blue-chips could be hurt. In turn, that would cause non-performing loans at Japanese banks to pile up. That could crimp their lending, accelerating a downturn,ö says Toritani.
Such developments could also hamper plans for further expansion abroad, despite the high liquidity they currently enjoy, with loans running at less than 100% of their loan book.
The Japanese financier mentioned earlier also told FinanceAsia that the Japanese market would partly recover if investors were confident that the US and EU could solve the short-term funding crisis on their respective continents. ôThat could lead to a technical rally in Japan of 30%. But the market will then go down again because the world is in for growth rates which will be lower than what we have enjoyed for the past several years. That is the inevitable outcome of de-leveraging, at least until emerging markets make up for the growth slowdown in developed markets,ö he says. Bottom line, the outlook for Japan looks bleak.
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