Tokyo Takes

The Mice Fight Back: Japan's Regulators Versus Global Speulators

2009-12-16T10:12:00.003+09:00

The cat and mouse game between Japan's new Democratic Party of Japan (DPJ) and global hedge funds, other speculators has gotten more interesting. In other words, the DPJ and the BoJ (the mice) are reluctantly fighting back. Since it's inauguration, the DPJ has had a credibility problem with the financial markets. Numerous public statement bloopers won the new Cabinet's inexperirenced ministers the title of "minister of disruption" (Financial Times) and global agencies like the IMF were predicting an even more rapid balooning of Japan's already massive goverment debt, with no apparent game plan to, a) get Japan's economy back on a sustainable growth path, and b) perceived benign neglect of a soaring yen, which was killing off what little profitability remained in Japan's still falling exports.

Foreign investors were becoming increasingly despondent as Japanese stock prices continued to waffle downward, amidst continued rallies in global (particularly Asian) stock markets. Hedge and global speculators (cats) were emboldened by evidenced of a double dip developing in Japan's economy, a strong yen and a rush to issue new capital beginning with Japan's megabanks. They shorted JGBs as well as major export-related and major bank stocks, which are ill-prepared for the new、more stringent capital requirements agreed upon by the Basil Banking Committee.

The Mice Fight Back

But to the speculator's surprise, the Mice (DPJ and BOJ) are trying to fight back. The DPJ has passed a supplementary budget with expenditures of some JPY7 trillion, while the BOJ's announcement of a JPY10 trillion program to provide additional liquidity appeared to have more impact, as it signaled a new attitude by the BOJ of cooperating with the DPJ instead of obstinately claiming its independence and appearing to be a mere observer. The reaction of Japan's stock market and the Yen was immediate. The Nikkei 225 rebounded from a low of 9,076.41 on November 27 to a recent high of 10,126.61 (11.6%) and the yen quickly sold off from a 14-year high of 84.81 on November 27 back to a recent low of 90.76.

The mice are not done yet. Japan, France and Germany have apparently been lobbying very hard to delay the deadline for introduction of the new more strict core capital requirements agreed upon by the Basil Committee. Japan's Nikkei economic journal is reporting that Japan, the US and Europe have effectively agreed to extend the transition period for full implementation of the new capital requirements by over 10 years, from the original 2012 target date to after 2020, ostensibly because bank efforts to meet the requirements could dramatically squeeze already tight credit for the small and medium-sized companies that need it most.

While an early introduction by US and UK major banks could still defacto establish the new standards by getting their core capital up to the new targets by 2012, news of the relaxed introduction period had the predictable immediate impact on the stocks of the big three megabanks. On December 16, the stocks of all three banks, Mitsubishi UFJ (8306), Sumitomo Mitsui (8316) and Mizuho Financial (8411) opened the December 16 session in Tokyo 4%~16% higher.

US, Europe and Japan Back Off Stricter Bank Capital Requirements

2009-12-16T09:08:00.003+09:00

The major countries in the Basil Banking Committee (i.e., the US, Europe and Japan) have reportedly delayed the introduction of stricter bank capital requirements by allowing for at least a 20-year "transition" period to complete introduction. In other words, the Committee has basically pulled out all of the teeth in the agreement and let global banks off the hook. If however the US and UK major banks and their regulators nonetheless move for introduction by 2012, the capital requirements will become the defacto standard.

With the agreements by Wells Fargo and Citigroup, all of the major US banks have moved to repay TARP (US troubled asset relief program) funds, meaning that only some $500 billion of Hank Paulson's $700 billion "bazooka" of TARP funds for US banks was actually used. So far, financial institutions up to Wells Fargo and Citigroup have paid or are moving to repay $135 billion of TARP funds, about a year after the program began.

As a countermeasure against future financial meltdowns, the Basil Committee agreed in September to introduce stricter "core capital" requirements, a) a minimum shareholders' equity of 8%, and b) to emphasize a narrower definition of core (Tier 1) capital. The definition of "core" capital is to be defined by the end of this year, while the minimum requirement for this capital is to be determined within 2010, and the new guidelines are ostensibly to be implemented from 2012. However, the recent talks have produced a very slow conversion period of 10 years for complete adoption.

While a December 16 Nikkei article did not indicate how much pressure was put on the committee by Japan for the relaxed introductory period, protests by Japan with the first BIS capital requirements allowed Japanese banks to use their unrealized gains on securities holdings to bolster "Tier 2" capital. This time, the pressure to delay the introduction was apparently coming from Japan, Germany and France, which gives an indication of how far below the suggested capital requirements these countrys' banks are. Again, when the going gets tough, the banking sector pressures their regulators to simply change or relax the rules.

Further, Japanese banks' Tier 1 capital still contains government-owned preferred stocks and other equity equivalents, while common stock equity and retained earnings of some of Japan's megabanks is still noticeably lower than their global peers. Thus the big rush to procure more capital by Japan's banks within 2009, early 2010 to bring core capital up to the expected new requirements, which has been a big weight on Japanese stocks.

The argument for the relaxed introductory period is that banks not immediately able to procure the capital to boost their core equity ratios would ostensibly have to reduce their risk assets, i.e., tighten credit and lending, and choke off what is still a tentative economic recovery.

Positive Market Reaction
The reaction in Tokyo was immediately positive, as stocks of the three megabanks, Mitsubishi UFJ (8306), Sumitomo Mitsui (8316) and Mizuho Financial (8411) were all bid up on short-covering, with Mizuho being considered to have the weakest capital position.

Improvement in Japanese Business Sentiment Wanes, But Asia Demand is a Bright Spot

2009-12-15T18:45:00.003+09:00

Japanese business morale improved more slowly in the fourth quarter and large manufacturers surveyed in the BOJ's Tankan business survey planned record cuts in capital spending--lending credence to the risk of a double dip in Japan's economy. The BOJ's diffusion index of large corporations came in at -24 in the December quarter and represented the third quarter of recovery in big business sentiment.

However, the pace of improvement in sentiment slowed from the Q3 (September) survey, which showed a 15 point improvement compared to 9 points this time. The foward DI (for the March survey) was still minus 18.

The highlight of the survey was that large corporations plan to slash capital expenditures this year by 28.2%, or the largest amount in the history of the survey. The plunge in business sentiment this recession has been worse than at any time since the 1970s oil shocks, and deeper than 1998, when Japan was in the midst of its own financial crisis.

Not All Gloom and Doom

But not all is gloom and doom. Sales for the 430 Japanese companies reporting geographical segment breakdowns shows that Asia sales during the April-September 2009 period, while down 2% from the October-March 2009 period, reached JPY16.2 trillion and surpassed sales to the US (which were JPY15.8 trillion and down 7% during the same period). Further, operating profit on Asian sales was JPY763.8 billion, up 49% from the previous half-year. On the other hand, sales to Europe were only JPY10.9 billion and down 10% from the previous half year. As a result, the major Japanese companies were losing JPY39.8 billion on European sales.

What this means is that investors should be keying on those Japanese companies with Asia sales that are higher than US/European sales. For example, Rohm's Asia sales were JPY186.7 billion and up 45% from six months before, Funai Electric's were JPY104.4 billion and up 95%, Nitto Denko's were JPY231.4 billion and up 30%, Daihatsu's Asia sales were JPY161.9 billion and up 37%, while Nihon Densan's sales were JPY231.4 billion and up 30%. Toyota, Honda, Denso, Suzuki and other automobile related companies are seeing their China sales soar 60%~70% from the second half of FY2008, while Komatsu's FHFY09 China sales were JPY104.5 billion, versus North American sales of JPY67.8 billion.

Operating profit on Asia sales for the major electronics firms rebounded three-fold to JPY308.1 billion, while operating profit for the major auto sector companies on Asia sales jumped 17% to JPY189.4 billion. Conversely, operating profit on US sales accounted for only 11% of total overseas sales, while Asia operating profits accounted for some 46% of sales.

Granted, it is still going to take a lot of growth in sales and earnings in Asia to cover weak US/European and domestic demand in Japan. However, as US/European demand stabilizes and Japan demand stops shrinking, the growth in Asia revenues and earnings will clearly be the driver of financial performance and valuations for Japanese companies.

Government Policies Encouraging Japanese Companies to Move Offshore

2009-12-13T13:00:00.003+09:00

The government's powerful tax advisory council is set to change Japan's tax policy for so-called tax havens in FY2010.

Japan presently has one of the highest effective corporate tax rates in the OECD. Further, it treats Japanese corporate earnings in countries with corporate tax rates under 25% as "tax havens", and considers these earnings as part of the parent company in Japan in assessing corporate taxes. In other words, earnings from overseas subsidiaries in Hong Kong, Singapore, Russia, Viet Nam and other emerging markets are taxed at domestic rates. According to a survey by METI, Japanese companies presently have some 17,000 overseas subsidiaries, of which approximately half are in countries the Japanese tax agency considers "tax havens".

Under the revised standards, earnings from such overseas subsidiaries will taxed at around 20%, in response to the rapid increase in investment in emerging economies and because many of these emerging economies are attracting investment by offering lower corporate tax rates.

At the same time, Japan's tax agency will be cooperating more closely with the G20 countries under an agreement at the Pittsburg Summit, where an agreement was inked between the G20 nations to more closely monitor and exchange information on tax avoidance in tax haven areas, and will be strengthening penalties under the Financial Transaction Law.

However, by relaxing taxation standards on earnings of subsidiaries in overseas subsidiaries in emerging markets while at the same time abolishing the practice of hiring part-time factory workers, raising the mininmum wage, promising a 25% reduction in Japan's greenhouse gases and implementing other "stealth" tax hikes, the Japanese government is effectively pushing its most internationally competitive companies offshore, which will only work to further deteriorate the Japanese governments tax revenue base at a time when fiscal expenditures required just to service Japan's growing debt are already some 60% of tax revenues, and to raise unemployment in Japan.

Thus the lack of coordination of tax policies with an as yet non-existant medium strategy to restore economic growth in Japan only makes it more difficult for the Democratic Party of Japan-led government to revive Japan's economy and contain what is becoming a dangerous spiral of government debt.

Shifting the Goalposts: Japan to Adopt New Accounting Rules

2009-12-13T11:10:00.003+09:00

For many years, the global benchmark for accounting standards was the SEC, or US GAAP (generally accepted accounting principals). However, in keeping with the true globalization of economies and corporations, US GAAP is increasingly seen in other countries as a parochial system. As a result, over 110 countries have now adopted what are known as International Financial Reporting Standards (International Accounting Standards, IAS, as established by the International Accounting Standards Board.

The Economic Union (EU) has used IAS as the required accounting standard for companies listing within the EU, and these standards are increasingly being adopted in emerging markets as well. Japan's accounting regulators have been working since 2007 to harmonize J-GAAP (Japanese generally accepted accounting principles) with IAS standards, with the aim of reaching harmonization with IAS by June 2011. Last week, Japan's Financial Services Agency released an official directive for corporate annual financial disclosures, and is moving toward the formal adoption of IAS consolidated reporting standards by fiscal 2015, or some five years from now.

Heretofore, the FSA has allowed Japanese companies to file consolidated accounts in US-GAAP, but the new directive means that companies currently filing under US-GAAP will also have to adopt IAS standards by F2015, meaning that the 24 or so Japanese companies listed in the US will also be required to adopt IAS standards. Once the conversion is made, these companies will also be required to restate the past two~three fiscal accounts according to the new standard.

Japanese companies with large exposure to overseas markets are already moving to adopt the IAS standards. Nihon Dempa Kogyo (6779), for example, will be adopting these standards from the March 2010 fiscal year. Nissan (7203) will be adopting IAS as early as the March 2011 fiscal year, Japan Tobacco (2914) will be adopting from the March 2012 fiscal year. Japan's Keidanren business lobby has created a prepatory committee consisting of 21 listed companies and the big four accounting firms.

A Tokyo Stock Exchange survey of 1,416 listed companies shows that 90% prepare consolidated statements and 25 prepare US-GAAP consolidated statements, while 205 companies prepare financial accounts based on foreign accounting standards and 160 prepare financial accounts based on foreign stock exchange regulations. Further, 592 of these companies have overseas parent, subsidiary or affiliated companies. The survey shows that some 875 of these companies are studying the adoption of IAS standards, with 523 of these looking to adopt by 2012.

The reasons given for those Japanese companies planning early adoption include,
(1) overseas fund procurement (12.5%), (2) improvement of international credibility (35.7%), (3) in expectation of strong demands from investors (21.4%) and (4) for more efficient global accouting and accounting systems (73%).

What is different from US or Japan GAAP about IAS? Adoption of IAS standards will result in different accounting for goodwill amortization, recognition of sales and new methods of stating earnings including "total earnings", that will make Japanese company accounts more comparable with their global peers in terms of international comparisons and M&A.

However, the FSA's policy is not yet set in stone, as the agency will make a final determination in 2012 whether to make adoption of IAS standards mandatory. If the history of Japan's accounting standards is any guide, complete adoption of the new stndards will take many years and could result in the mixture of Japanese GAAP, US GAAP and IAS reporting companies, i.e., alot of apples versus oranges comparions of financial data.

Japan's accounting standards to date have been very much focused on the bureaucratic presentation of forms (form) over substance, and on achieving the most tax-efficient accounting method, particularly for non-consolidated accounts.

For publicly listed companies, accounting standards have effectively been determined by three organizations, i.e., the MOF's Corporate Accounting Standards Committee which issues "corporate accounting principals" and related guidelines, while Japan's Financial Accounting Standards Board creates standards which become "MOF directives" under "Financial Disclosure Regulations", and of course the Securities and Exchange Law. In lease accounting for example, fianancial statements prepared under the Securities and Exchange Law must als be in compliance with the above three group's opinion statements, guidelines and regulations. Further, annual securities reports filed with the MOF are reviewed according to "financial disclosure regulations", consolidated financial disclosure regulations" and "interim financial reporting regulations".

Under IAS, the major differences with Japanese GAAP to date are;

1) Total earnings, including net income from operations plus unrealized losses and gains on marketable securities and real estate. This standard is expected to have a significantly negative impact on cross holdings between companies, and between companies and their main banks.

2) The abolition of goodwill amortization, which will boost stated net income. On the other hand, as strict asset impairment test will also be applied, investors will be able to directly evaluate corporate M&A strategies.

3) Different revenue recognition standards, which will requre a review of contracts, operations and systems, which should be a boon to accounting firms and IT companies supplying accounting software packages.

While the required adoption will most likely be limited to consolidated accounts and parent-only tax-minimization accounting methods will most likely continue. the new international accounting standards coming into effect are expected to result in significant reduction of cross-holdings, as valuation losses on these holdings will have to be reported under the new rules.

Daiwa Research Institute estimates that the aggregate cross-holding ratio for Japanese companies has fallen in value from 13% in 2000 to 8.2% in 2008. In 1995, 91% of Japanese companies had cross-holdings with the banks. This ratio fell to 55.8% in 2005, but was still nearly 51% in 2008. In 2008 alone, some JPY1.56 trillion of cross-holdings were sold, and these unwindings are again increasing after the global financial crisis and the anticipated introduction of new international accounting rules. Ostensibly, a complete unwinding of these cross-holdings (which is not likely) would affect 8% of the Japanese equity market's total market capitalization of some JPY279 trillion (or JPY22 trillion).

A full-scale unwinding of cross-holdings will probably be felt most by the banks, who still have a significant amount of cross/strategic holdings with their corporate clients.

The Japanese Stock Market's Supply-Demand Problem

2009-11-26T11:22:00.003+09:00

The Nikkei 225 has already fallen nearly 12% from a peak of 10,630.38 in the week of August 10, before the election of the new Democratic Party of Japan (DPJ) government. The reasons Japan's equity market is increasingly de-linking from global equity markets usually include, communication problems with new government and financial markets (i.e., the FT's "ministers of disruption"), the DPJ's lack of a growth vision (i.e., how do they plan to grow their way out of a growing mountain of government debt?), and of course the incessantly strong yen in the face of substantial volume declines in exports.

On a more basic note, however, the Japanese equity market has a major supply-demand problem. Domestic institutions continue to be persistent net sellers, while foreign investor buying is significantly more tepid than before the global financial crisis. Given already weak buying demand, what is becoming a rush of new stock issues has become a serious weight on stock prices.

Firstly, investors are most leery of the inevitable second round of large capital calls by the major banks. Mitsubishi UFJ FG has already announced a JPY1 trillion monster issue, and it is expected that Sumitomo Mitsui FG as well as Mizuho FG will be close on MTB UFJ's heels. Japanese companies have already procured some JPY3.48 trillion of equity capital so far this year, which is up 10-fold from last year, an amount which is more than the current market capitalization of Nissan, and could go as high as Honda's current market cap of JPY5 trillion. Major electronic firms like Hitachi and NEC also lined up to procure capital.

The problem with these issues is that they virtually ignore shareholders. Usually, companies shy away from issuing capital that represents more than 20% of dilution. In recent cases, however, these issues are representing massive dilution of 30%~40%.

In the case of the big three megabanks, the massive consolidation over the past 20 years, so-called restructuring and reduction of cross-holdings has not brought up these bank's capital ratios to where they really need to be. Standard & Poor's recently ranked 45 US/European/Japanese banks in terms of risk-adjusted capital ratios, and ranked the big 3 Japanese megabanks at the bottom because a large amount of their capital is "hybrid", i.e., something other than core equity capital. Mitsubishi UFJ FG has a core Tier 1 capital ratio of some 6%, which while the highest among the big Japanese megabanks, is still lower than global peers such as JP Morgan Chase, which has a core Tier 1 capital ratio over 8%. Sumitomo Mitsui FG's core capital ratio is around 5%, while Mizuho FG's core capital ratio is under 4%. This after these banks already procured JPY400 billion (MTB), JPY860 billion (Sumitomo Mitsui) and JPY530 billion (Mizuho) earlier this year. These banks were supposed to have weathered the global financial crisis in much better shape than their global peers.

While the DPJ government has recently re-initiated "zombie financing" by legislating that banks need to give financially struggling smaller companies a break on their loans, the big 3 megabanks were already backing away from SME (small and medium-sized enterprise) finance, with outstanding loan balances of JPY3.85 trillion and the end of September already down nearly 7% YoY. Several years ago, these banks tagged SME finance as a major growth area, but the only thing they got for their efforts to date from this finance are buckloads of NPLs (non-performing loans).

Like other struggling Japanese companies, major electronic firms are seeing their stock prices fall to 20-year lows as investors are pissed off about their highly dilutive issues, and the fact that they are strategically falling farther and farther behind their US/European and particularly Asian rivals in terms of new product and capacity expansion.

Finally, new international accounting standards coming into effect over the next couple of years are expected to result in significant reduction of cross-holdings, as valuation losses on these holdings will have to be reported under the new rules. Daiwa Research Institute estimates that the aggregate cross-holding ratio for Japanese companies has fallen in value from 13% in 2000 to 8.2% in 2008. In 1995, 91% of Japanese companies had cross-holdings with the banks, which fell to 55.8% in 2005, but was still nearly 51% in 2008. In 2008 alone, some JPY1.56 trillion of cross-holdings were sold, and these unwindings are again increasing after the global financial crisis and the anticipated introduction of new international accounting rules. Ostensibly, a complete unwinding of these cross-holdings (which is not likely) would affect 8% of the Japanese equity market's total market capitalization of some JPY279 trillion (or JPY22 trillion).

For those Japanese companies rushing to procure new equity capital, these issues are a strategic imperative and considered necessary for future survival. What Japanese corporate management ignores, however, is the unspoken agreement between they as shareholder capital users and shareholder capital providers--i.e., investors invest their (or their sponsor's) savings in a company with the expectation of earning a competitive return on their capital.

If the company (issuer) cannot provide a decent return on shareholder capital, there is no reason for an investor to purchase that company's shares. Despite the fact that the Nikkei 225 is still some 76% below 1989 highs, and the market capitalizations of an increasing amount of companies continues to shrink and demoting them from "large cap" to "small cap" companies, the majority of Japanese management still do not get the joke, i.e., you have to offer a competitive return and/or capital appreciation potential if you want your investors to continue to support your stock. As their market cap continues to shrink, they cannot understand why an increasing number of domestic and foreign institutions are finding they are now too small to be included in big funds requiring a minimum of market capitalization and market liquidity.

East Asia Economic Bloc to Surpass the Euro Nations in 2010

2009-11-04T19:28:00.003+09:00

The combined economies of the ASEAN 10 nations of East Asia, Japan, China and South Korea are set to surpass that of the Euro nations by 2010, just as China's economy is eclipsing Japan's.

According to IMF forecasts, the East Asia group's combined GDP in USD will reach 12.668 trillion by December 2009, and account for 21.1% of the global economy. In 2010, these economies as a group are expected to growth 6.8% and exceed the aggregate GDP of the Euro nations (USD12.7133 trillion). By 2014, these economies should be USD17.3445 trillion and approach the US economy (USD17.4194 trillion) in scale.

At the same time, the relative importance of Japan in the region continues to shrink. Japan's share of East Asian GDP was 42% in 2009, but will shrink to 33% by 2014, while China's share rises to 39% in 2009 and on to 48% by 2014.

Tokyo Office Rents Continue to Fall

2009-11-04T19:20:00.002+09:00

Japan's deepest recession in the postwar period is taking its toll on Tokyo commercial property prices and rents. If you are searching for office space, its a buyer's market, with older buildings in areas like Shibuya offering rents over 30% lower than those for tenants who have been in place for a couple of years. Owners more desperate to get their office space leased are also offering "free rent" periods of up to six months to offset the cost of restoring existing office space to its original condition and the cost of moving to a new location.

A Nikkei survey of Tokyo and Osaka office rents taken in mid-October shows even Tokyo office rents for newly completed buildings declining for two consecutive years, while rents for new buildings in Osaka are the lowest since August 1998. Average rent levels for both cities are approaching the lows seen in 2000. If you are observant, you can see the empty floors in office buildings throughout Tokyo.

Japan's Online Brokers Consolidate

2009-11-04T18:55:00.002+09:00

As one indicator of the health of Japan's equity market, the top five online brokers (SBI Securities, Rakuten Securities, Matsui Securities, Kabu.com Securities and Monex Securities) have seen their combined trading values implode from nearly JPY200 trillion in the March '06 fiscal year back to JPY50 trillion or so in the first half of FY09.

In FY03 (to March 2004), the five online majors had combined trading values of a "modest" JPY50 trillion-plus. As Japan emerged from the Heisei Malaise with the Nikkei 225 bottoming in Q2 2003 and the reformist cabinets led by Junichiro Koizumi had evidently ended the financial crisis and was on its way toward re-invigorating Japan, individual investors returned to the Japanese equity market in droves, and migrated to the online brokers. As trading values for the major five were hitting nearly JPY200 trillion in FY05, a trading commission war broke out, with the online majors scrambling to provide the lowest trading commissions.

At the same time, the FSA (financial services agency) moved to force these brokers to greatly increase their investment in systems to accomodate the surge in trading volumes, while the Tokyo Stock Exchange upped their membership fees because online trading was beginning to effect the TSE's capacity to handle trades as well.

Things however went downhill from there. In January 2006, the Livedoor scandal hit the JASDAQ and emerging markets hard as investors began to question just how good the accounting was at these firms. On closer inspection, other emerging companies also had loose accounting, and a succession of bankruptcies scared individual investors away from wheeling and dealing in newly listed venture companies.

The combination of falling volumes and falling commissions per trade, increased fixed costs with mandated system investments was deadly. Online brokers have coped by offering forex trading as well as foreign securities, but the financial crisis post the Lehman Brothers failure has sent individual Japanese investors scurrying for safety.

Monex Group (8698:J) saw its revenues drop 37% between the March 2006 and March 2009 fiscal years, while ordinary profit imploded 79% and net income slipped into the red by JPY2.1 billion. The Company, a start-up began by an ex-Goldman Sachs partner, first tried to find solace in merging with Nikko's retail broker arm, Nikko Beans, but the Company has recently announced a merger with Orix Securities to get even larger scale merits. After the merger next May, the combined new entity will be second only to SBI Securities. SBI Securities is not impressed, claiming that the merger of two online brokers with very different commission schedules will only lead to a loss of customers.

At the very least, the merger of the two will mean more restructuring in Japan's broker industry, the headcount of which has continued to shrink. Retail giant Nomura Securities tried to hold back the tide of the online brokers by establishing its own online subsidiary Joinvest Securities, but the venture has been an absolute flop, so Nomura is merging the operation. Industry veterans such as Matsui Securities' president see more consolidation, including the possiblity that Monex will eventually merge with Rakuten Securities.

Japanese Corporate Profits Show 2nd QTR of Improvement

2009-11-03T11:08:00.004+09:00

The Ministry of Finance's survey of aggregate corporate profits of large companies (over JPY1 billion in capital) shows that the JPY404 billion operating profit loss in the January~March quarter of calendar 2009 was the first aggregate operating profit loss in at least 50 years. Since then, however, Japanese corporate profits have been staging a "V-shaped" recovery.

A Nikkei aggregation of the July^September operating results of 527 major March fiscal year Japanese companies accounting for some 63% of market capitalization shows that consolidated ordinary profit has rebounded to around JPY2, 202.1 billion in the July~September quarter following an unprecedented operating deficit of nearly JPY3 trillion in Q4 FY08 (January~March 2009). This is the second quarter of sequential improvement in Japanese corporate profits.

While aggregate ordinary profit for the group was positive in the April~June quarter (at JPY974.9 billion), the manufacturing sector was still showing a JPY254.7 billion deficit. Most of this improvement has come from draconian cost-cutting, but there was sequential growth in sales of 10% YoY in Q2 FY09 (July~September) on 12% revenue growth in manufacturing. Year-on-year, however, this group's Q2 FY09 sales are still down 23% YoY and earnings are down 42% YoY. From Q3 FY09 (October~December), however, YoY comparisons will suddendly become much easier, and Japanese corporate profits could double YoY in the quarter, even though the forecast for full FY09 is for ordinary profit to decline some 10%-plus YoY.

The profit recovery has helped support Japanese stock prices to date, but has done nothing for Japan's consumers, because the profit recovery in large corporations came at the expense of worker salaries/bonuses, employment and cost reductions that slashed the revenues of SME (small and medium-sized enterprise) suppliers.

Excess Debt: Investors Should be Worrying About Japan, Not the US

2009-11-02T18:40:00.004+09:00

The UK's Telegraph (Ambrose Evans-Pritchard)is warning that global investors and governments should be worrying about Japan's debt more than the US debt.

The scenario is that Japan is drifting helplessly toward a fiscal crisis. Simon Johnson, former IMF chief economist, reportedly told the US Congress that Japan's debt path is essentially out of control, and that there is a real risk of Japan ending up in a major default. According to new IMF forecasts, Japan's public debt is seen ballooning to 218% in 2009 from a prior 197% or so, rising further to 227% in 2010 and to a whopping 246% by 2014. This level of indebtedness is unprecedented in peace time economies.

Heretofore, the bulk of Japan's public debt has been absorbed by the private sector through excess savings. But Japan's savings rate has plunged from 15% in 1990 to 2%. Japan's (and the world's) largest pension fund, the GPIF, has become a net seller of JGBs to fund pay-out obligations, and the Japan Post Bank is baulking at adding more JGBs to their $1.7 trillion outstanding balance. If bond rates in Japan were to rise to 3%~4%, it could shatter the government's finances. JGB yields were at 2% as recently as 2007.

Carl Weinberg of High Frequency Economics, always one to not shy away from hyperbole, is quoted as saying that the Japanese debt situation is irrecoverable, with the potential outcome being fiscal shutdown, lost pensions and bank failures. Japan is also again on the verge of a deflation spiral that will exacerbate the debt burden.
Financial markets are beginning to discount this risk, with CDS on 5-year debt jumping from 35bps to 63bps, or above and away global peers like Germany, France, the US and the UK.

More Japan Passing: Tokyo No Longer a Major Financial Center

2009-10-30T13:03:00.002+09:00

A Bloomberg survey of 1,452 users reveals that the leading financial centers in the eyes of Bloomberg users is New York (29%), Singapore (17%), London (16%) and Shanghai (11%), while only 1% named Tokyo. London is slipping because of a 50% tax rate on higher earnings and impending EU regulations on hedge fund borrowing, while Japan has all but fallen off the radar screen.

UK/European investors are also turning negative on Japanese stocks, with Standard Life and ING Investment saying they are underweight Japan because of the troubling signals that the new DPJ government is sending investors, i.e.,

1) Statements by the finance minister that Japan will tolerate a strong yen
2) A loan moratorium on smaller company loans
3) The un-privatization of Japan Post
4) No signs of a willingness to take on structural change
5) The need for the big Japanese megabanks to raise an additional JPY1~JPY2 trillion of capital,
6) Changes in maximum rates chargeable by consumer finance companies and an effective open liability for "excess" interest rates previously charged.
7) P/E multiples at 37X average for Japanese stocks, which is noticeably higher than global peers, even though Japan is trading at a relatively cheaper PBR.

India Second in Asia to Attempt an Exit Strategy

2009-10-27T14:13:00.006+09:00

Bloomberg There is much talk among traders these days about possible exit strategies of central banks when they become confident enough in their respective economic recoveries to begin removing the excess liquidity that is now driving global stock prices.

India’s central bank has ordered lenders to keep more cash in government bonds, signaling the start of monetary tightening in Asia’s third-largest economy as inflation accelerates. India's central bank added some 5.85 billion ruppes of cash (nearly 9% of GDP) since September 2008 to protect the Indian economy from the global financial crisis. The increase in the liquidity ratio is aimed at draining some of this excess liquidity. according to some analysts, the move points to imminent interest rate action as inflation pressures are building.

India is the second country in the Asia-Pacific region after Australia to initiate an exit strategy. Thus it appears that central banks in the region with healthier economies are now turning their attention to inflation, and to managing the recovery instead of the crisis,including asset price inflation, as strategists are beginning to suggest that the next "bubble" could be in Asia/emerging markets.

Given the strong 8.9% YoY growth in China's Q3 GDP, analysts at Credit Suisse AG and UBS AG, who are among those predicting that China’s authorities will raise banks’ cash reserve requirements as soon as by the end of December, while Morgan Stanley's Stephen Roach insists that China will continue to err on the side of caution (continued stimulus).

Have Japan's JGB Yields Seen Secular Lows?

2009-10-16T14:23:00.002+09:00

From the onset, investors had misgivings about the new DPJ-led government’s ability to implement their campaign promise spending plans without resorting to a significantly higher level of JGB issuance.

The Hatoyama Administration was able to terminate JPY2.926 trillion of programs included in the JPY14.7 trillion supplementary budget implemented by the LDP-led Aso Administration, versus a goal of JPY3 trillion savings. For the FY2010 budget, however, at least four ministries ended up asking for more money, despite instructions from Finance Minister Hirohisa Fujii to keep spending, except for campaign promises, below levels in the initial fiscal 2009 budget.

The ministries have evidently used the DPJ campaign promises as an excuse to pork up their budget requests. The Welfare Ministry’s requested FY28.88 trillion, up some JPY3.7 trillion (over 14%) from the initial budget for FY2009. It also withheld spending figures for 11 budget items that it plans to review by year’s end, leaving open the possibility of another increase of JPY1~JPY2 trillion in its budget. The Ministry of Agriculture, Forestry and Fisheries requested JPY2.75 trillion, or 7.5% more than its share of this fiscal year's initial budget. The Ministry of Internal Affairs and Communications wants a 4.8% increase to JPY18.59 trillion On the other hand, the Ministry of Land, Infrastructure, Transport and Tourism, meanwhile, was able to shrink its budget 2.6% to 6.19 trillion yen by slashing spending on public works and in other areas. The Environment, Defense, and Foreign Affairs ministries are also among those turning in smaller budget requests.

The news that the FY2010 budget could well exceed JPY90 trillion is making JGB investors skittish, as the Japanese government may need more bonds financing than initially planned to finance what is expected to be a record budget for the fiscal year starting in April 2010. The other part of the picture is that tax revenues are likely to fall short of government projections by a wide margin.

As the FT has pointed out, Japan’s bond market (already the biggest in the world) could get a whole lot larger if the new DPJ-led government is not able to reign in spending. FY2009’s budgeted increase in JGB issuance was already a whopping JPY130 trillion on top of JPY846 trillion outstanding even before there was any suggestion that additional issuance will be needed. Prime Minister Yukio Hatoyama is already hedging by suggesting that more deficit-covering bonds “may be unavoidable” to offset tax revenue shortages. Japan's Ministry of Finance has requested JPY21.9 trillion yen for debt-servicing costs in the budget for 2010/11, starting next April 1, which is up JPY1.6 trillion yen YoY.

Since JGB yields were trading as high as 2% as recently as 2007 versus around 1.25% at present, we would not be at all surprised to see a return to a 2% handle on the 10-Year JGB in the next couple of years. However, a full scale crash is unlikely even if the DPJ-led government has to resort to more deficit-covering bond issues. JGBs were bid down to current levels because of evidence that deflation is accelerating, and on forecasts for a continued strong yen, which at least once currency strategists sees surging to JPY50/USD. With central governments also significantly diversifying away from USD in their forex reserves into the Euro and the Yen, JGBs could continue to be supported by cash-rich domestic financial institutions, foreign government purchases and foreign investors looking to hedge what they see as structural weakness in USD.

Cash is Now Trash

2009-10-15T17:18:00.002+09:00

Market Watch The Bank of America Merrill Lynch survey of global investment managers shows that global investors went underweight cash for the first time in five years in October. Investor risk appetite is at its highest in three years, and asset allocators are now shifting more money out of cash and into equities. A net 39% of surveyed money managers think profits will rise by at least 10% in the next 12 months, up from the 25% who were of that view in September. A net 65% of respondents report believing that a global recession is unlikely in the next 12 months, up from 47% a month earlier.

* Investment managers are now putting more money into European equities, which they see as undervalued. The net 30% saying European equities are now undervalued is the highest since April 2001.

* The dollar is seen as undervalued and the yen as very overvalued, implying central-bank intervention in currency markets could prove successful

* A net 36% of respondents also said they would most like to overweight emerging markets in the next year.

* Conversely, Japan confidence has continued to drop over the past couple of months. A structural underweight in financials is sapping other sectors, making Japan left out of a generally upbeat global view.

Yen to Appreciate to JPY50 per USD!?

2009-10-15T16:46:00.003+09:00

Bloomberg is quoting a Sumitomo Mitsui Banking Corp. chief strategist as saying the USD could fall to JPY50/USD next year and eventually lose its role as the global reserve currency. He also sees a likely double dip in the US economy, seeing it deteriorating into 2011 as the effects of deleveraging excess debt take hold. Ostensibly, the USD won't stop falling until there's a change in the global currency system. The strategists believes the big wave of USD weakness can no longer be contained--even with coordinated intervention. The strategist, who is an Elliot Wave chart watcher, sees the USD as being in wave five of a 40-year cycle.

This would appear to be an unmitigated USD crash and burn scenario, not to mention Japan's export sector, which would be devastated by a rough halving of USD vs JPY. If the strategist really believes his call, I hope he has bought his farmland, several months of supplies and guard dog.

Rising Fears of a Double Dip in Japan

2009-10-05T10:31:00.002+09:00

Last week, the Nikkei 225 took a bearish turn, falling below all three key moving average levels with a close below the 200-day MA.

The most selling pressure is coming from domestic institutional investors, who have dumped over JPY1 trillion of Japanese stocks since July, almost completely offsetting the JPY1.45 trillion of net buying by foreigners, who have turned net sellers in the last couple of weeks.

Recent pronouncements by Japan's newly installed DPJ-led government are spooking investors and Japanese CEOs. Some 40% of CEOs now fear a double dip in Japan's economic recovery, according to a Nikkei survey of 100 Japanese CEOs. Nearly 40% of these CEOs now see a "high to somewhat high" chance of a double dip in Japan's recovery, with over 69% seeing the impact of stimulus wearing off, over 38% seeing a negative impact from the strong yen and 36% blaming the possible double dip on the new government's policies.

Japan Airlines: Japan's GM

2009-09-21T17:28:00.003+09:00

Japan Airlines (JAL) is Japan’s flagship airline. JAL is the carrier of choice for Japanese government officials, be they the prime minister or Diet politicians on overseas junkets. But JAL is in deep financial trouble.

As a reflection of the national flagship’s finances, Standard & Poor's is considering downgrading JAL and subsidiary Japan Airlines International Co’s L-T corporate credit and senior debt ratings. JAL and its 100%-owned subsidiary are already rated a speculative B+, and a downgrade would drop this by more than one notch. Ratings would already be poorer if it were not for implied government support for the carrier. Now that the DPJ is in power, even implicit government support is being reviewed.

The rating agencies are carefully reviewing the stance of financial institutions currently supporting JAL, medium-term business plans being drafted to maintain this support, as well as transportation ministry-prodded negotiations with foreign carriers about possible capital tie-ups. American Airlines Inc., British Airways Plc and Qantas Airways Ltd. have made a joint offer of assistance in a bid to supplant Delta Air Lines Inc. The foreign carriers are reportedly offering extensive financial assistance, such as debt guarantees, introducing JAL to banks, providing restructuring consulting services; merging some of the companies' offices; and adjusting the numbers of their transpacific routes. In addition, American Airlines is considering investing in JAL, possibly taking a stake worth several tens of billions of yen.

JAL is currently under a state-supervised rehabilitation process. Incoming transport minister Seiji Maehara has publicly stated that bankruptcy is not an option for JAL, as he apparently sees JAL and All Nippon Airways (ANA) as the two pillars of Japan’s aviation industry. Maehara has also said he wanted to scrap the Transport Ministry-affiliated panel designated under the previous government to review the plan. The uncertainty lies in the fact that the DPJ and Mr. Maehara have been vocal critics of the collusive relations between the Liberal Democratic Party and business. Senior management from JAL ,ANA and the transportation ministry were all unable to gain an audience with a senior DPJ lawmakers immediately after the Aug. 30 general election swept the DPJ to power.

In this holiday-shortened week, transport minister Maehara will reportedly meet with Haruika Nishimatsu, president of JAL, senior JAL officials, personnel from the Development Bank of Japan and the vice ministry of the transport ministry to review the Company’s restructuring plan before it is finalized by the end of this month.

JAL is beset by a raft of intractable problems, including a crippling debt load, heavy pension obligations and the negative effects of spreading swine flu infections. JAL’s current turnaround plan draft reportedly aims to eliminate more than two dozen domestic flights and shed nearly 7,000 jobs, but creditors are skeptical about the plan’s effectiveness. The carrier told creditors it needs JPY300 billion in new capital to stay afloat through the current fiscal year (FY09). Private lenders however have been dragging their feet on fresh loans unless the company implements radical restructuring and wins financial aid from the government,

The guessing game on the fate of JAL is likely to continue until the new government clarifies is policy on the issue.

Details of the carrier’s revival plan due out late this month ostensibly include the ending of flights to Rome, Mexico City, Amsterdam, Brisbane, San Paulo, Kaohiung, Hanzhou, Xiamen and Qingdao. Services at seven domestic airports ostensibly will be discontinued, and partial cutbacks initiated for other cities—including 21 international routes and 29 domestic routes—or essentially all money-losing routes.

Also reportedly included in the plan are reduced pension benefits to current and former employees as well as a spreading out of PFO (pension fund obligations) over a longer period, to generate an extraordinary profit of JPY88 billion for the fiscal year ending March 2010. JAL hopes to lower the benefit rate to below 2% for 17,000 current employees.

The government-owned Development Bank of Japan and Japan's three top banking groups already lent JAL JPY100 billion yen in June. Government guarantees covered part of the DBJ's portion of the syndicated loan. This financing however was little more than a band-aid for the national carrier’s problems.

JAL’s megabank lenders seem to believe that JAL has not fully committed to restructuring. Concerned, they are urging the airline to take more drastic restructuring. The Transport Ministry under the LDP regime however had maintained that a major route restructuring would run counter to national interests, saying that the top priority should be maintaining flights to remote islands and between regional airports and foreign cities. Thus the restructuring of JAL, as with GM in the US, has become a bit of a political football.

JAL has historically had rocky relationships with its union, as represented by the Japan Federation of Aviation Workers' Unions (Kokuren). Kokuren comprises 53 aviation unions, including 21 from JAL and its affiliates. The carrier is likely to face fierce labor protests in its effort to whittle down annual operating costs 30% through an early retirement program, cuts in flight services and the use of smaller airplanes. Moreover, it is already the world's worst major operator by almost any metric you care to mention. JAL's gross margins are about half the global peer group average; none can compete with a six-year average return on equity of minus 17 per cent. Net debt to equity was 346% at the end of March, comfortably the worst in class. Management, contemplating the latest in a series of cuts to staff, hubs and wages, expects more red ink this year.

Thus even if JAL can secure the necessary capital to survive the current fiscal year through March 2010, concerns will still linger about the airline's capital needs in the next fiscal year and beyond. The continued rise in fuel costs should also represent ongoing pressure on margins. The Company lost JPY82 billion last year, and is expected to lose another JPY108 billion in ordinary profit this year.

The stock has completely missed the rebound rally to date, and since the stock prices is already so depressed, could see a nice bounce on news of a credible restructuring program as well as an agreement with foreign carriers for a possible capital infusion. This rally however is likely to run out of gas between JPY200 and JPY220, as there is a substantial amount of cumulative trading volume in this zone that represents potential selling pressure. From this standpoint, the current stock price represents a nice short-term 50%~80% trading turn, but don’t overstay your welcome.

The Hatoyama Cabinet: Focus on National Strategy, Finance, and Administrative Reform

2009-09-17T14:58:00.002+09:00

The Hatoyama cabinet has been formed. We believe the credibility of the DPJ's election promises as well as the Hatoyama administration will hinge on a few key posts and their appointed ministers.

(1) Naoto Kan, deputy prime minister and state minister in charge of national strategy, economic and fiscal policy. With his experience fighting bureaucrats, Kan is considered a good choice for the planned National Strategy Bureau, which will oversee policies and the budget.

(2) Hirohisa Fujii, minister of finance. Mr. Fujii is a recognized expert on the national budget and tax issues, and was the finance minister for the Hosokawa and Hata administrations from 1993 to 1994. His knowledge of the national budget and his connections in the Ministry of Finance will be important in achieving a smooth transistion for the budget formation process from finance ministry bureaucrats to the DPJ.

(3) Akira "Mr. Nenkin" Nagatsuma, minister of health, labor and welfare. Mr. Nagatsume is energetically committed to administrative reform, and has been a sourge of the bloated Social Insurance Agency. The MHLW in particular is ripe for administrative reform, but Mr. Nagatsuma will have to successfully deal with the powerful doctor's lobby.

(4) Seiji Maehara, minister of land, infrastructure, transport and tourism. Mr. Maehara has also been a vocal critic of the "amakudari" practice of ex-senior bureaucrats landing cushy jobs in government-sponsored corporations, as well as the historical waste in public works expenditures.

(5) Yoshito Sengoku, state minister in charge of administrative reform. Mr. Sengoku's predecessor in the LDP, Michio Watanabe, resigned in disgust and frustration after running into brick wall after brick wall in the Aso Cabinet's LDP-led regime. Prior state ministers in charge of administrativve reform under other LDP-led cabinets such as the Koizumi Cabinet also encountered fierce resistance to administrative reforms.

Mr. Kan will be in charge of forming the National Strateg Bureau (NSB) will be tasked with crafting key national policies including budget guidelines and a basis for a new foreign policy. It will replace the LDP's Council on Economic and Fiscal Policy, which was headed by the prime minister, and similar in function to the US Office of Management and Budget (OMB), although very likely alot smaller in terms of staffing. The NSB will be a bellwether indicating how successful the DJP will be in reducing the role of Japan's powerful bureaucracy's to "experts on tap but not on top".

Mr. Sengoku will be the point person for the formation of The Administrative Reform Council (ARC), whose task will be to assess budgets and programs with an eye toward squeezing out up to JPY10 trillion of wasteful spending over the next three years.The ARC will be similar to the US OMB in function although nowhere near as large, and will report to the prime minister instead of the Diet. The re-allocation of funds and cost savings achieved by the ARC are expected to be a major source of the funding needed for the DPJ's up to JPY16 trillion aimed at improving the livelihoods of Japanese consumers.

Finally! Cheap? & Fast Money Transfers in Japan

2009-09-09T16:31:00.003+09:00

Welcome Relief for Foreign Residents

Wiring money abroad in Japan through "normal" channels has been an expensive and time-consuming chore. The choices were either postal money orders or bank branch offices, but only at select postal or bank branch offices. The paper work was a hassle and the exchange rates were a rip-off.
But don't rush down to your local post office or bank branch just yet. Changes in Japan's fund settlement law was enacted in June, but won't be in effect for some time.

The legal change will end the banks' and post office oligopoly on fund transfers in different currencies overseas. It can cost nearly JPY5,000 to wire JPY10,000, and costs more than the amount being sent if the amount is smaller. The new law will allow "anyone who registers" to provide wire transfer services. As always detailed regulations will be decided by government ordinances, i.e., the bureaucrats, but the new fund transfer services will be able to handle amounts up to JPY1 million.

Who Benefits?

Foreign and domestic firms are positioning themselves to capture demand from foreign and Japanese residents. Western Union Co., is considering expanding into Japan, while convenience stores, should benefit the most, as will credit card companies.

Since last year, foreign banks in Japan have been allowed since last year to offer the same services they do abroad at their Japanese branches. This includes wire transfers.

How Linked Is China's Shanghai Composite to Other Equity Markets?

2009-09-02T09:59:00.005+09:00

China's Shanghai Composite has cracked, falling through its 50-day moving average at 3,100, and then showing a bearish head & shoulders at 2,800. Next stop on the downside is its 200-day moving average at around 2,500, although some China bears say 2,000 is possible.

US and Japanese investors are concerned that the selloff in China stocks is a precursor to selloffs in the US, Japan and other global equity markets. But just how correlated is the Shanghai Composite to other global equity markets?

Running a simple excel correlation calculation on the Shanghai Composite's the correlation of weekly closes compared to the S&P 500, the Nikkei 225, FTSE 100, WTI crude oil, the BDI shipping index and the S&P 500 VIX volatility index shows the highest correlation between the Shanghai Composite and the BDI shipping index (0.56), followed by the Nikkei 225 (0.43), while the correlation with S&P 500 is the lowest (0.15). However, a falling Shanghai Composite does increase the fear factor among S&P 500 investors, as the correlation between the Shanghai Composite and the S&P 500 VIX volatility indicator is -0.75.

Focus Turns from DPJ Victory to National Strategy Bureau

2009-08-31T11:07:00.002+09:00

After a quick 207 points jump at the opening after the Democratic Party of Japan's historic victory, the Nikkei 225 quickly turned minus as the yen rose to JPY92/USD and investor attention quickly turned to the DPJ's first 100 days.

The current Aso administration's term officially lasts until September 30, while the DPJ is expected to announce their choice for Prime Minister and a new cabinet by September 14. The DPJ has stated they will be forming a National Strategy Bureau. Tasked with crafting key national policies including budget guidelines and a basic foreign policy framework, the National Stategy Bureau could become the major political force in the new administration. Consequently, investor attention could well focus on when and how the new bureau takes over the reigns of power.

DPJ party head Yukio Hateyama plans to name all members of the new Bureau after he is elected prime minister. The administrative order/legislation to clear the way for the new Bureau could come in October at the earliest, leaving two months of uncertainty about the new Administration.

Voters Throw the LDP Bums Out

2009-08-31T08:48:00.004+09:00

As widely predicted by the Japanese media, the Democratic Party of Japan trashed the Liberal Democratic Party of Japan by single-handedly winning an absolute majority of over 300 seats in the upper house elections of Japan's Diet over the weekend.

According to the Asahi newspaper count as of early Monday August 31, the party/coalition strengths in both houses of Japan's Diet were as follows.

Japanese voters have clearly voted for change, and have given the DPJ a comfortable enough majority to actually effect policy in their image. Without Japan's proportional representation system where representatives are elected from multi-seat districts in proportion to the number of votes received even if they lose the majority vote that gave a second life to a number of LDP candidates, the landslide victory for the DPJ would have been even more impressive.

With expectations running high, the new Hatoyama Administration, which is expected to be formed by mid-September, needs to hit the ground running in much the same way that the Obama Administration did in the US. To really be effective, however, the new ruling party will have to engage Japan's bureaucrats, who have held the power to effect LDP policy for the last several decades. During the LDP rule, politicians ostensibly in charge of key Japanese ministries relied heavily on bureaucrats for policy ideas and drafting legislation, particularly regarding the national budget.

To gain control of the policy creation and implementation process, the DPJ plans to,

a) Put at least 100 lawmakers in top ministry posts.
b) Create a National Strategy Bureau reporting to the Prime Minister. The new Bureau will be comprised of public and private sector members.
c) Ban the practice of "amakudari", where retired ministry bureaucrats continued to heavily influence policy with key posts in quasi-public ogranizations/companies.
d) Introduce a performance-based evaluation system for key bureaucrat posts.

To be effective, the DPJ will have to successfully engage the bureaucracies (especially the MOF) while gaining control over them. Leading up the the elections, the bureaucrats for their part were busily wooing key DPJ politicians.

Everyone is aware of the policy challenges of the new Japanese government, which include,

1) Revitalizing Japan's economy. Fiscal spending under the Aso Administration's JPY15 trillion-plus stimulus plan was partially responsible for the 3.7% Q-Q pop in Japan's latest quarterly GDP, while the DPJ says they will can a lot of what they consider wasteful in this plan not already implemented. The programs already announced through the party's manifesto however approximate a similar level of expenditures, but substantially re-allocate where the money will be spent. In terms of scale, economists say the DPJ expenditures could boost Japan's GDP by 1% point over the next two years.

2) Putting talk of a hike in VAT (sales taxes) on hold until they can effect significant administrative reforms to pay for promised expenditures.

On the other hand, as many of the leaders of the LDP's infamous factions were voted out of office, the LDP faces the real possibility of disintegrating. As the only reason for the factions' existence was to distribute power within the LDP, they no longer have a reason for existence, and without the balance and censensus they provided for these factions, there is a possibilty the LDP will simply collapse.

Many key LDP politicians have already switched horses, beginning with Ichiro Ozawa and Yukio Hatoyama, the core of the current DPJ leadership, in the early 1990s, followed by pre-election defections like Makiko Tanaka, the daughter of Kakuei Tanaka, who was arguably the main architect for the factional system as well as the old "iron triangle" between the LDP, the bureaucracy and big business.

For Japan to have a true two-party system that offers a real choice to voters, we believe a properly chastized LDP needs to survive as a viable opposition party, if nothing else to keep the new leading party honest.

Weak Export, Price and Employment Data on the Eve of Japanese Elections

2009-08-28T17:45:00.002+09:00

Japan's exports for July were still plunging 36.5% YoY versus a 35.7% YoY fall the previous month and even declined 1.3% month-to-month on a seasonally adjusted basis for the first time in two months--implying that the upward momentum in exports that helped Q2 GDP rebound is sputtering. Exports to China (19.5% total) were down 26.5% YoY, followed by a 38.9% YoY drop in exports to the US and a 43.9% plunge in exports to Western Europe.

With export-oriented and domestic companies like retailers continuing to reduce head counts, unemployment hit a record 5.7%, the highest since this stat began in the 1950s. The jobs-to-applicants ratio was 0.42.

Consequently, deflation is deepening in Japan, with core CPI falling a record 2.2% in July for the third month of record declines and the corporate services price index also falling a record 3.4%.

This on the eve of Japan elections on Sunday (August 30) for the lower house of the Diet, in which the Democratic Party of Japan is expected to trounce the LDP, which is the current ruling party, and which has been in power all but for a few months in 1993/1994 since the 1950s. While good news for Japan stocks, the widely expected victory is probably already baked in, and this week's string of economic data underscores the task ahead for the DPJ in reviving Japan's domestic economy.

Wide Expectations that Dividend Repatriations Will Boost the Yen

2009-08-27T19:05:00.003+09:00

Changes in Japan corporate tax rules now means that 95% of dividends received by Japanese companies from overseas subsidiaries from April (the new fiscal year) are now tax free. However, tax breaks on dividends from companies in tax havens with tax rates of 25% or lower will be delayed a year.

Heretofore, Japanese companies preferred to keep these dividends overseas to avoid additional taxes on the difference between overseas and Japan tax rates. For example, if the effective overseas tax rate on dividends is 20%, Japanese companies would have to pay the difference with this rate and Japan's effective tax rate, which is 40%.

According to METI figures, retained earnings held by overseas subsidiaries of Japanese companies were about JPY20 trillion in 2007, and Japanese companies repatriated about JPY1 trillion of this as dividends. JP Morgan Chase bank estimates that the tax rule changes could result in overseas dividend repatriations of up to JPY4 trillion, and this is a reason why yen forex traders keeping talking about a stronger yen. There is evidence that large companies like Mitsui & Co. Daiichi Sangyo, Seiko Epson and others are moving to individually repatriate hundreds of billions of yen in dividends.