Japan's micro-change point to future growth

By Linda Sieg

TOKYO (Reuters): Trying to assess Japan's economic future? Then forget public spending and monetary policy.

Changes at the micro-level -- where managers are targeting returns on investment, bankers are pondering credit risk and planned new exchanges promise capital for attractive start-ups -- could spell the start of a new era in which capital finally flows to efficient users and lays the basis for sustainable growth.

That, at least, is the view of some "micro-optimists" who say that, while changes afoot spell short-term macro-economic pain, the process is picking up steam and looks likely to foil gloomy forecasts of another decade of corporate dithering.

"There is a new set of interactive incentives working in corporate boardrooms which will prepare people for a better allocation of capital," said Robert Feldman, chief economist for Japan at Morgan Stanley Dean Witter. "It can be messy, but...I sense this will be a relatively quick process."

Misallocation of capital -- the flow of funds to inefficient firms rather than those that generate growth -- looms high on the list of structural faults blamed for Japan's economic stagnation.

After nearly a decade of huge fiscal packages and years of easy credit that has brought interest rates close to zero, a lack of money is hardly the problem.

"The irony is that there is tons of capital," said Goldman Sachs strategist Kathy Matsui. "The problem is finding ways of getting it into the hands of people who will use it efficiently."

Japan's real rate of return on capital has fallen steadily for three decades, from about 20 percent in 1960 to two or three percent last year, said HSBC Securities economist Peter Morgan.

Part of that problem is being addressed by a high-profile wave of restructuring as corporations cut jobs and capacity to boost profitability. The new trend was dramatically illustrated on Monday by a drastic cost-cutting program unveiled by Nissan Motor Co at the prodding of its French partner, Renault SA.

Nissan's plan to halve its list of suppliers highlights the unraveling of Japan's keiretsu corporate ties which ranked old- boy relationships above hard-nosed profit calculations.

The massive restructuring sweeping Japan's banking sector should also make capital allocation more efficient, although many warn that substituting market-driven credit risk analysis for lending based on long-standing ties will not come easily.

"How quickly will banks really change and absorb the market mechanism into their thought processes and begin to use it?" questioned Russell Jones, chief economist at Lehman Brothers.

"I think it might take a decade."

Optimists, however, are encouraged by signs that keiretsu ties are being cut in the banking sector itself.

A plan by Sumitomo Bank and Sakura Bank unveiled last week to merge by April 2002 will bring together two leading banks at the core of rival keiretsu groups.

Banks, less bound by tradition than in the past and under pressure from global competitors and domestic non-financial firms, will now be reviewing their assets with a keener eye for risk and return.

"Increasingly, efficient corporations will have no problem finding capital," said Darrel Whitten, head of research at ABN AMRO Securities.

Plans for new ways to help start-up firms with bright growth potential procure funds -- such as Nasdaq Japan, which Internet pioneer Softbank Corp and the National Association of Securities Dealiers Inc of the United States intend to have up and running by the end of 2000 -- are also good news.

The Tokyo Stock Exchange has also said it will launch a new stock market for companies with growth potential but which fail to meet its current listing criteria.

And the Tokyo metropolitan government, meanwhile, plans to launch a bond market for smaller firms around March of next year.

"These are aimed at funneling Japan's huge personal assets into young growth companies to help savers get better returns and give companies the capital they need," Whitten said.

All of which does not mean that all the barriers to efficient capital allocation are vanishing.

Skeptics fear government is the biggest obstacle of all.

The large role public institutions still play in the financial system, where they account for some one-third of all lending, and foot-dragging on politically tough deregulation have pessimists worried that change will take far too long.

"We're moving, but let's not get carried away," said Lehman's Jones.