Japan's financial role in the 1990s - presented by the author at the 32nd Annual Meeting of the National Association of Business Economists, September 23-27, 1990 - International Perspective

Business Economics, Jan, 1991 by Takeshi Ohta

Japan is experiencing the best economic performance among the major industrial countries. The effects of the Gulf Crisis on Japan may be less severe than in the 1970s. After considering near-term concerns, the author discusses longer-term challenges of declining savings, an aging population and a falling savings ratio. From an international point of view, future problems include financial market fragility, regional integration and the transition to market economies of Eastern Europe and the Soviet Union. International policy coordination will be necessary, with particular emphasis on fiscal discipline.

BEFORE DISCUSSING Japan's financial role in the 1990s, I would like to make a brief comment on recent developments and provide some perspective on the Japanese economy.

THE JAPANESE ECONOMY IN PERSPECTIVE

As you have seen on the World Economic Outlook issued by the IMF, the Japanese economy has been showing the best performance among major countries - maintaining the highest growth rate ( 5. 1 percent for 1990), the lowest inflation ( 1.5 percent for 1990) and lowest unemployment, while the balance of payments surplus is steadily declining ( $47.5 billion for 1990; in the GNP terms, 1.7 percent from 2 percent in 1989).

In spite of some concerns that corporate investment and private consumption might slow, because of the so-called "triple decline" in some financial assets' prices (stock prices, bond prices and the yen's exchange rate) in the earlier part of this year, the performance of the real economy had not been affected.

It is almost impossible to predict at this stage the impact of the Gulf Crisis on the Japanese economy in the precise terms. However, a general perception exists in Japan that the impact is expected to be smaller or less severe than earlier ones in the 1970s. Higher oil prices will weaken economic growth somewhat and cause inflationary pressures to increase, but it is generally expected that, provided the price of oil remains within the range of $27-$30 for the rest of 1990 and the duration of the crisis is rather short (say six months), the growth rate of the Japanese economy would be pushed down by 1/2 percentage point (from 5 to 4.5 percent) and the inflation rate might be pushed up by 3/4 to 1 percentage point (from 1.5 percent to more than 2 percent). At any rate, the impact will be less severe than in the previous two oil shocks.

The Japanese economy has undergone significant structural changes in response to previous oil shocks. Conservation of oil consumption has progressed and stockpile of oil is high (at least 158 days). In addition, inflationary expectations of both corporations and household have been so far contained, and there has been no conspicuous speculative move in both corporate and household sectors.

NEAR-TERM CONCERNS

Having said that, I did not mean that things will continue to go well. There are several sources of concern for the future:

1. Labor shortages and rising unit labor costs

2. Continuing high rate of growth of the money supply

(in terms of M2 CDs, money supply is still more

than 11 percent higher than the previous year's

level, although it has started to decelerate very

recently)

3. Possible resurgence of an increase in commodities

prices (in particular, oil prices).

Under these circumstances, the Bank of Japan decided to raise its official discount rate by 0.75 percent to 6 percent on August 30. Since then, the stock and bond markets have shown a certain instability. Particularly, the decline in stock prices bas been rather pronounced. But such a decline is still widely considered as a correction of past financial bubbles. The causes of the recent fall in stock prices are considered to be the following: 1. Market concerns about a further outflow of funds

from the stock market, reflecting prevailing expectations

of higher interest rates. 2. Market concerns about the negative impact of the

Gulf Crisis on Japanese economic fundamentals,

particularly, fears of outbreak of war and resultant

stoppage of the supply of oil from the Gulf. 3. Significant increase in program trading of equity

stocks and various arbitrage operations, which did

not trigger the decline but must have accelerated

the process of decline. Fortunately, however, these developments in the stock market have not affected the performance of the real economy, Corporate fixed investment and private consumption are firmly sustaining a robust growth of the economy, and the yen's exchange rate has been strengthening. But if the recent weakness of the stock market continues, corporate (investment) behavior may change somewhat in the future, because raising low-cost funds through new issues of equities would remain almost closed for a while; some financial institutions are already beginning to feel a certain negative impact of these development on their business performance and their plans to strengthen the capital base. We can't be too optimistic.

Coinciding with these developments in the financial markets and steady decline in the current account surplus, there are interesting discussions going on in Japan whether "The sun also sets" or "The sun is still high." No doubt the sun will set in the end, but, insofar as the above-mentioned discussions are concerned, the truth is somewhere in between, as is often the case.