A boom, a bust and the subsequent lost decades make up the familiar narrative of Japan's recent economic history, interest in which has been renewed, as many other developed countries face the prospect of ‘Japanisation’ and lost decades of their own. Japan is no longer the case study of what policy-makers did wrong but rather what they did right to keep unemployment relatively low, per-capita income steadily growing and to maintain the country's relatively strong global position, as the third largest economy in the world.
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International attention has also been drawn to the flurry of cross-border acquisitions being made by Japanese companies looking to take advantage of the strong yen and the opportunities left in the aftermath of the global financial crisis. But, while Japanese companies increasingly look outward, the country has a number of problems at home.
One of the major issues facing Japan is the structural change of its decreasing birth rate and population, says Koichi Miyata, president and CEO of Sumitomo Mitsui Financial Group (SMFG). “Japanese financial institutions really need to adjust to this change of business environment,” he says.
The ageing population is one of the defining characteristics of Japan’s economy and it has come to be used as an analogy to describe the country's steady recovery from its crisis in the 1990s. “Japan is like an old man struggling to its feet,” says Chris Scicluna, head of economic research at Daiwa Capital Markets Europe. After slowly getting back on in its feet, this 'old man' has been knocked back by the impact of the euro crisis, the March 2011 earthquake, tsunami and subsequent nuclear disaster at Fukushima, and the stress of strained relations with China.
Change of heart
The territorial dispute with China over islands in the East China Sea threatens Japan’s export industries and, in October 2012, it cast a shadow over Japan’s hosting of the International Monetary Fund (IMF) annual meeting. But, despite the absence of the Chinese central bank governor and finance minister from the IMF meeting, many senior Japanese figures viewed the event as an opportunity for Japan to take the lead in financial diplomacy, especially among its Asian neighbours.
Reflecting on the recent IMF meeting in Tokyo, Mr Miyata says that he can remember when the IMF meeting was last held in the city, in 1964, more than 48 years ago. Mr Miyata, who was still a boy at the time, says that Japan was in a period of high growth then, much as many Asian countries are now.
While Japan's economy has undoubtedly struggled in the past two decades, it can now use the benefit of its experience to pass on to the rest of the world. The country serves as a role model for emerging economies in Asia, and also for developed countries that are looking for ways to handle a sustained period of low growth.
“Global investors are more interested in learning lessons from Japan,” says Tomo Kinoshita, chief economist at Nomura Securities, because of Japan’s long period of deflation and low-interest rates. “The US and EU are headed in the same direction.”
The conventional view of Japan has changed in the mindset of many foreign observers, from a country that was criticised for its handling of the crisis in the 1990s to a country that has done well to avoid a major slump in unemployment. Even Paul Krugman, the Nobel Prize-winning economist who was once a harsh critic of Japan, jokes that those who were alarmed about the country more than a decade ago should now apologise to its emperor. In an interview with the Financial Times, he says that Japan has turned from a cautionary tale into a role model.
Taking notes
The way in which Japan dealt with its own financial crisis is increasingly being looked at as a number of economies around the world struggle to deal with the current economic downturn. The renewed interest in Japan is not just from policy-makers, who have been looking at the Bank of Japan’s unconventional policies for inspiration, for example, but also from bankers themselves. As the US and Europe prepare for a long period of low growth and low interest rates, the banking industry is having to rethink how it can compete in this new economic environment.
Japan’s banking sector was hit hard in the 1990s, and the banks were saddled with bad debts which took years to be resolved. One such bank was Resona Bank. The then-chairman of Resona Holdings, Eiji Hosoya, who passed away in November 2012, is often credited with leading the turnaround of the bank as well focusing on the bank’s retail business.
Akira Umebachi, general manager of the business process re-engineering promotion office at Resona Bank, says that the bank’s senior managers are now frequently asked questions at international meetings about how to survive in such difficult conditions. “The managers often tell them two things: they can do operational reform to reduce costs, and they can reduce the risk and volatility of their assets,” says Mr Umebachi.
Resona began a project of operational reform back in 2005, when Mr Hosoya was relatively new to the board. “He was reform-minded and gave the green light to the transformation project,” says Mr Umebachi. The project involved revamping the branch design and introducing self-service and cash-counting machines, a transformation that turned tellers into sellers. With this increased automation, operational costs were reduced and the increased back-office efficiency meant the tellers could go home earlier every day.
Shopping spree
While the repercussions of the current financial crisis have been playing out, Japan has been in a position of relative strength. Long rid of the bad loans on their books, Japanese banks have been able to step in where their competitors have been forced to retreat. “I think we are faced with opportunities while our international competitors have been slowing down,” says Mr Miyata at SMFG.
For SMFG, one such opportunity was the acquisition of the Royal Bank of Scotland’s aircraft leasing business, which was completed and began operating as SMBC Aviation Capital in June 2012.
According to Mr Miyata, SMFG is increasingly focused on its overseas business. “I really need to shift our weight more onto the regions of fast economic growth,” he says. In particular, he is looking to allocate more weight to overseas businesses in Asia. As European banks retreat from the region, Mr Miyata believes that one challenge for Japanese banks is how they are going to support the demand for infrastructure investment in markets such as Indonesia. His bank is aiming to strengthen financing capability for infrastructure demand through project finance and syndicated loans.
SMFG is not the only Japanese financial institution that is actively pursuing opportunities abroad; its notable acquisition of the RBS aviation business came in a year when there were record numbers of outbound mergers and acquisitions (M&A) by Japanese companies, many of which are cash rich and taking advantage of the strength of the yen. Also in the aircraft leasing business, Mitsubishi UFJ Financial Group’s (MUFG) leasing company bought US-based Jackson Square Aviation for $1.3bn in October 2012. And in another acquisition, MUFG, through its subsidiary UnionBanCal, agreed to buy Pacific Capital Bancorp for $1.5bn in March 2012.
Strategic moves
As well as making acquisitions themselves, there are numerous opportunities for Japanese banks to support their clients, an increasing number of which are expanding overseas as opportunities in the domestic market remain limited. “It is a good opportunity for Japanese companies to expand," says Mr Miyata, referring to the recent trend of cross-border M&A activity. "Particularly because of the yen’s appreciation.”
Mr Miyata says that domestic corporate clients are increasingly looking overseas and participating in cross-border M&As. “We need to prepare Japanese corporates for the international environment,” he says.
One of the most high-profile deals to come out of Japan in the past year was that of mobile operator Softbank, which in October 2012 agreed to buy 70% of US-based Sprint Nextel for $20.1bn.
“Large Japanese corporations are increasingly looking for opportunities globally,” says Jonathan Kindred, chairman of the International Bankers Association in Japan. He believes that there has been a change of opinion and that Japanese companies are now viewed as serious buyers, whereas before overseas clients would have taken some convincing.
“Today there is a realisation that Japanese companies are very smart, very attuned to the world, and they want to go international,” says Mr Kindred, who is also president and CEO of Morgan Stanley Japan.
A considered approach
It is easy to draw comparisons between this latest round of acquisitions and Japan’s fierce rate of expansion in the 1980s. “There were many trophy transactions then,” says Mr Kindred, adding that the current acquisitions are much more strategic and that Japanese companies are expanding internationally in a way that fits with their core companies. “These acquisitions are much more positive and more likely to be successful than was the case in the 1980s.”
One such example of an acquisition that provides a strategic fit for the acquirer is the Japanese advertising agency Dentsu’s acquisition of the UK advertising agency Aegis for approximately $5bn in July 2012.
According to Masatsugu Nagato, chairman of Citibank Japan, the country needs to become globalised and there needs to be a revival of the overseas business of Japanese banks. As the former head of the Americas at Mizuho Corporate Bank, Mr Nagato saw how many Japanese banks lost ground in the years following the country's financial crisis. He says that in 1989, Mizuho’s market capitalisation was $226.2bn compared to US-based JPMorgan’s $16.8bn, meaning that Mizuho was worth 13 JPMorgans. By 2003, their positions had changed and JPMorgan was worth 11 Mizuhos.
Such a significant decline in market capitalisation was typical of Japanese companies, which were at their peak in the glory days of the 1980s and suffered terribly once the bubble burst and asset prices plummeted.
Growing old
Although Japan's economy has grown slowly in the years following its economic crisis, it has at least performed steadily, and there are many positives to Japan’s economic story. “The little old man is still a wealthy old man,” says Daiwa's Mr Scicluna.
According to Morgan Stanley's Mr Kindred: “Japan remains an exceptionally large and attractive marketplace. The savings pool – institutional and individual – is extraordinarily large.” One of the issues for international bankers, he says, is how best to mobilise this savings pool, given the risk-averse appetite of Japanese investors, and whether its potential can be realised.
At an individual level, the savings of the older generation have had a wider impact on the economy. “The older generation keeps increasing its spending power and has become a major force in the consumer spending market,” says Nomura's Mr Kinoshita. This is one reason, he says, for Japan’s steady rise in consumption even though wages have not increased.
This is one positive side of Japan’s ageing population, which is often viewed as Japan’s biggest challenge for the years ahead. Mr Kinoshita says: “Most economies have to go through this but the timing comes early for Japan. Japan certainly has to deal with this.”
Running out of energy
Its aging population is not the only concern for Japan. While its corporations and banks are increasingly looking outward, there are a number of problems that are niggling away at home.
“Japanese industries have a lot of headaches,” says Mr Nagato at Citibank Japan. Among them, he explains, is a decreasing population, a shrinking gross domestic product in real terms, and excess capacity. Also, imports of energy resources have increased, while exports have decreased, which meant that Japan’s current account surplus between April and September 2012 reached a record low of Y2721bn ($33.17bn), down by 41% from the year before.
This decline in exports was part of the reason why Japan registered a current account deficit, the first time in more than 30 years, prompting fears that the country would buckle under the weight of its public debt.
The deficit also points to Japan’s energy issues, which have been looming over the country since the nuclear accident in Fukushima, following the earthquake and tsunami in March 2011. A reluctance to use nuclear energy following the accident has left Japan reliant on imported energy resources. “It has become abundantly clear that the problem of supply-side constraints caused by electric power shortages will strike a blow to the Japanese economy, not just in the short term but the medium and long term as well,” says Kazumasa Iwata, president of the Japan Centre for Economic Research.
“If we reduce the dependence on nuclear power, we must rely more on thermal power until renewable energy develops to fill the gap. The heavy reliance on thermal power implies a larger import bill of liquefied natural gas, oil and coal. Currently, the additional imports amount to Y3000bn to Y4000bn a year,” says Mr Iwata, who was formerly the deputy governor of the Bank of Japan.
Worse than Greece?
Another problem is that, even though Japan is wealthy, the country has a lot of debt. Japan’s debt-to-gross domestic product (GDP) ratio is high, and an issue that the IMF has warned it about. The country’s gross public debt is 236% of GDP, making it the world's most indebted country, and as many observers have pointed out, its public debt is much larger than that of Greece. The mitigating factor is that the debt is held domestically and as far as comparing the situation to Greece, Japan experts argue that Japan has an in-built demand for its own government debt because it is issued in its own currency, unlike Greece which shares its currency with other countries in the eurozone.
At the G-20 summit in November 2012, Japan’s budget deficit was highlighted as a major concern and the country was again warned that this was a major risk to its economy. Japan’s own version of the fiscal cliff was resolved when lawmakers passed a bond bill in the same month allowing an increase in debt issuance, which had been the subject of political wrangling.
Fiscal sustainability is cited as one of the risks posed to Japan and the proposed increase in consumption tax aims to address this, but again, it has been the subject of political wrangling, which had been made more intense because of the general election in December 2012.
The timing of the elections is difficult for Japan. Mr Kinoshita at Nomura Securities believes that the country is now in a recession – although official statistics have yet to confirm it – and he expects that it will be on the recovery path from the start of 2013.
The domestic economy has been struggling, especially as exports have been declining because of weakened demand caused by the woes in the global economy. And while the strong yen has aided those on their M&A shopping spree, Japan’s manufacturing industry is suffering. “The strong yen is damaging exports,” says Mr Nagato, who adds that exports have been the main engine for Japan’s economy since the bubble burst in the early 1990s.
Recovery process
With companies increasingly looking overseas for expansion and future growth prospects, there are fears that there will be a ‘hollowing out’ as companies will focus so much internationally that there will be nothing left in Japan. When asked if such a situation was likely to occur, Mr Nagato replies that “it is already here”. He says that many big Japanese corporations have witnessed growing revenues in their overseas operations while their revenues in Japan have been declining. Now the risk of hollowing out is affecting the smaller supporting companies.
For many companies focusing outwards, the major growth opportunities have been in China. But in recent months, anti-Japanese protests – in response to the dispute between Japan and China over the islands in the East China Sea – have caused disruption to Japanese businesses there, with anecdotal evidence that the companies are suffering as a result.
Mr Kinoshita notes that Japan’s exports to China, including Hong Kong, account for about 25% of total exports. He estimates that if the relationship with China does not improve, this could have a negative impact of 0.35 percentage points of GDP. “Next year’s forecast for Japan’s economy is 0.5% so it will wipe out the growth rate,” he says.
This would be yet another setback for Japan, which has been struggling to get back on its feet for years. While the 'old man' of Japan is being applauded by the international community for its experience in dealing with a crisis and handling low growth, there is no doubt that its recovery process has been slow. And while it is currently faring better on the international stage than many other developed economies at the moment, it is still grappling with a number of domestic problems.
