Tokyo has done enough to correct yen

By Rory McCarthy

TOKYO (AFP): Japan has done enough to correct the yen's surge by stepping into the market but still has its work cut out to forge a recovery in the world's second largest economy, analysts said Wednesday.

In the past five months the Japanese yen has surged nearly 35 percent against the dollar, threatening to strangle exports which present the only hope of growth for an economy stuck deep in recession.

Finally the Bank of Japan intervened in the market on Tuesday to sell yen and pull the currency back down to more reasonable levels, the first time it has weakened the yen since August 1995.

Richard Jerram, chief economist at ING Barings, estimated the central bank spent a billion dollars, although one Japanese paper put the figure at five billion dollars.

"It is something of a mystery why they have allowed the yen to become this strong," Jerram told a presentation in Tokyo.

"Anything stronger than the yen at 120 presents a serious threat to prospects for a recovery over the next 12 months. We are surprised by the relaxed position of the Ministry of Finance on the issue."

Japan's central bank moved into the market a day after the yen hit a 28-month high against the dollar.

It was Japan's first intervention since June last year, when Tokyo stunned the market and, with help from Washington, propped up the falling yen.

By 5 p.m. (0800 GMT) Wednesday the yen traded at 111.53-57 against the greenback.

"This should be effective," Jerram said. "I think people thought the yen was a one-way bet in June and that the yen would go down for ever. Intervention then did stop it and some people lost a lot of money.

"Those memories are still quite fresh. People will be reluctant to take too aggressive a position against the central bank. If we get renewed monetary easing the yen should head back into the 120s over the coming months."

ING Barings has an unusually optimistic view of the Japanese economy over the coming months, forecasting 0.4 percent gross domestic product growth in the year to March 2000 while most analysts warn the economy will shrink.

"We think we can see some reasonable signs that things are beginning to stabilize," Jerram said.

But there was still a dangerous slide in capital spending that must be corrected, he said.

"We don't think this year is going to be a great year, we don't think next year is going to be a great year.

"We want to see much more aggressive monetary expansion, more aggressive fiscal easing and we would want to see more aggressive reform of the financial system including a debt forgiveness program."

He believes a major cause of the rise in the yen and the sudden surge in Japanese government bond yields in the last month is a problem of a lack of liquidity.

The central bank should be expanding the monetary base by up to 30 percent, while in reality the current expansion is less than 10 percent.

For many, the key to a recovery lies with the troubled banking sector, which is struggling under the weight of nearly 90 trillion yen (US$800 billion) in bad loans.

Japan has brought in new reforms to take over weak banks and lend taxpayers' money to the others to encourage them to clean out their bad loans and cut back failing businesses.

"We are cautiously optimistic that Japan is taking the first step towards finally resolving the bad debt problem which has plagued the financial system for the last six years," said James Fiorillo, senior analyst at ING Barings.

He warned resolving the problem will likely take another two to three years, as Tokyo wrestles with the demands of ending the short-term crisis and at the same time implementing structural reforms.

ING Barings' forecast is more cautious than last year when in April it bullishly promised strong growth and a stock market surge, neither of which ever materialized.