Rising rates may imperil recovery in Japan

Kan Tsutagawa The Daily Yomiuri Asia News Network Tokyo

The Japanese economy is well on its way to recovery. But it is when the going is good that we should be most alert to future dangers. Lately, a dark cloud has been gathering in otherwise blue skies: The prospect of interest rate hikes in the United States and China.

The overall picture for the Japanese economy is very bright. Backed by strong external demand, mainly from the United States and China, Japan's exports are steadily expanding. Domestically, consumer spending has been picking up on the back of popular new consumer products and an upturn in overtime pay and bonuses.

Stock prices have climbed 40 percent after dipping to their lowest post-bubble level in April last year. The appreciation of the yen against the dollar, which had become a cause of concern, has slowed.

The upturn in the economy was underlined by the Tankan survey released by the Bank of Japan in April. The index of business sentiment among nonmanufacturers rose from zero to plus 5, marking the first time during the current recovery that it had gone into positive territory. The indexes for retail trade, real estate and individual services, registered plus 12, plus 13 and plus 6, respectively, testifying to the improvement in all sectors dependent on personal consumption. The index for small businesses also improved, illustrating that confidence is growing in all sectors.

The recovery in corporate earnings also is remarkable. Listed companies are seen likely to report record profits for the year ending in March, for the first time in three years, partly driven by the effect of restructuring.

Economists predict that companies will report a 40 percent increase in current profits and a 70 percent rise in net profits, reflecting higher stock prices and a strong performance in core businesses.

Projections by nine major private sector research organizations put growth of the Japanese economy at an average 3.7 percent during the January-March quarter of this year. There is growing confidence in industrial circles that the current recovery, the third since the bursting of the bubble, is genuine and different from the previous two.

But, while there is no doubt that prospects look bright, are there dangers ahead?

At the Tokyo Stock Exchange, the Nikkei Stock Average fell ahead of the Golden Week holidays and posted a plunge of more than 500 points on Monday. The biggest factor in the selling is concern over possible rises in interest rates in the United States and China.

Employment in the United States picked up significantly in March and April, underlining a rebound in the economy. U.S. Federal Reserve Chairman Alan Greenspan, who previously had been concerned about deflation, now is worrying about possible inflation. Speculation is rife that Greenspan will raise interest rates, maybe as early as June. On the New York Stock Exchange, investors have been selling on interest rate fears, with declines in the Dow Jones triggering similar selling on the TSE.

Meanwhile, the People's Bank of China has decided to raise interest rates on loans to commercial lenders for the first time in nine years.

The Chinese economy grew 9.7 percent in the January-March quarter, with asset investment (investment in capital and construction) expanding more than 40 percent year on year. If the current overheating is left unattended, China probably will see acceleration of inflation and a bursting of its bubble. Against such a background, the People's Bank of China appears to be shifting to a tighter monetary policy.

However, a major deceleration in the Chinese economy could have devastating consequences for the Japanese economy, pouring cold water on industries such as steel that have been making a strong comeback thanks to vigorous demand from China.

If the United States and China raise interest rates, other countries, including those in Asia, will be likely to follow suit. In Britain, the Bank of England has already started raising its benchmark interest rate.

The era of deflation that began with the shift to a market economy by the former Soviet-bloc countries is coming to an end, and the days of global monetary easing are numbered.

Countries around the world are preparing to raise interest rates, and the excess liquidity that has flowed into stock markets is set to dry up. Japan has no choice but to make a comprehensive review of prospects for a sustained recovery.

If the continuance of Chinese demand is one uncertainty, so are crude oil prices, now hovering at around US$40 per barrel. Rising raw material prices may add to pressure on corporate earnings. Any renewed strengthening of the yen or rise in long- term interest rates will add to concerns.

Now Japan needs to show that while the going is good, it is alert to future dangers.