Japan hit by perfect storm

A stronger yen, record commodity prices and rising exposure to US subprime û can things get worse for Japan? Yes, the country could soon be without a central bank governor.
Just when a firm hand on the tiller is most important, that hand could be about to go missing. Toshihiko Fukui, the current Bank of Japan (BoJ) governor, is due to retire from his post on March 19, but the appointment of the governmentÆs candidate, deputy governor Toshiro Muto, is being stymied by the opposition party, the Democratic Party of Japan (DPJ).

The obstruction could not have come at worse time for the incumbent Liberal Democratic Party government. On Monday, the dollar dropped to 102 against the yen, a three-year low. The Japanese currency was also within a fraction of its weakest-ever level against the euro. The stockmarket suffered in tandem, with the Nikkei 225 Stock Average losing 4.5% to 12,992 points on Monday on fears that JapanÆs consumer lending companies were more exposed than expected to AmericaÆs subprime woes.

In essence, the government is looking powerless, just when the country is most looking for firm leadership.

The reasons behind the oppositionÆs blocking move are several. Local media report that DPJ leader Ichiro Ozawa is incensed that prime minister Yasuo Fukuda pushed through the 2008 budget and controversial tax reforms without greater consultation. The government has a majority in the more powerful lower house, and once laws are passed in the lower house, the upper house must approve the verdict within 30 days. Ozawa reportedly feels he should have been treated with greater respect during budget negotiations and is now exacting his revenge.

ôOzawa is using the governorship of the BoJ as a bargaining chip with the government,ö comments Susumu Kato, chief economist of CLSA, Japan.

Muto is also unpopular with the DPJ because he is a former official of the ministry of finance. One of the DPJÆs election promises is to ensure separation between monetary and fiscal policy û in other words, between the Bank of Japan and the ministry of finance.

The role of the powerful ministry of finance (MoF) is regarded with a great deal of suspicion by its opponents, of whom the DPJ is one. Until the BoJ was formally made independent in 1999, monetary policy was basically set by the ministry. Given JapanÆs sluggish economic record since 1990, the DPJ is anxious for the MoF to be kept at a distance. An alternative name being floated by DPJ insiders is that of Yutaka Yamaguchi, a former deputy governor. With no MoF links, he is a more palatable choice to the DPJ. Few people believe he will get the job, however û that will go to Muto, but in return for substantial concessions.

Kato estimates that Ozawa will try to use his leverage to obtain concessions on the unpopular gasoline surcharge law. This was extended for 10 years in the recent budget. ôIt would be good for Ozawa electorally if he could gain some concessions on this measure,ö points out Kato.

If a compromise candidate is not found before March 19, it is likely Fukui will stay on as an executive director, and act as de facto bank governor, says Kato, who believes the BoJ board will support him. The nine person board is composed of two representatives each from big business, academia and the financial sector. The bank governor and his two deputy governors comprise the rest.

ôThere will be no abrupt change in monetary policy whether or not Fukui is re-appointed,ö estimates Kato. FukuiÆs stance has been to ænormaliseÆ interest rates. This means having interest rates that are in line with JapanÆs trend economic growth rate, around 1.5% to 2%. In fact, interest rates are 0.5%, leaving the country awash with cheap money.

The stance of the MoF towards interest rate rises is neutral, according to Kato. One might think that the MOF would be strongly against interest rises, because they would make the interest rate burden on the government debt (currently 170% of GDP) more onerous. However, the MoF is also worried about low yields û since it means investors find Japanese government bonds less attractive.

ôThe MoF has major financing needs, so it needs to issue more bonds at an attractive price,ö points out Kato.

Hiroshi Shiraishi, Japan economist at Lehman Brothers, believes that ôinterest rate moves will reflect the state of the economy û and given the worsening global outlook and the exchange rate situation, itÆs unlikely we will be seeing a riseö.

The impact on the Japanese economy of the governorship debacle will not be direct. But it highlights JapanÆs deadlocked political system and will doubtless further frighten off foreign investors û who make up 70% of the stockmarketÆs trading volume.

Things are changing, but at a glacial pace. Incensed by a string of government gaffes, the electorate gave a majority to the DPJ in upper house (less powerful than the lower house) elections last year. This partly reversed the crushing LDP election victory of 2005, under popular leader Junichiro Koizumi. That was KoizumiÆs last election before stepping down in September 2006 in favour of Shinzo Abe, who resigned late last year under a heavy cloud, to be replaced by current prime minister Fukuda.

Ozawa is not an ideal opposition politician, by any means. Considered more market-friendly than the LDP, he is suspected of harbouring intentions of returning to the LDP û of which he was once a leading member. Last year, he was accused by his own party of having brokered a side-deal with the LDP, and briefly left the party. He is also by far the dominant personality in the DPJ, reflecting its lack of strength in depth. Partly because of the lack of an effective opposition, the LDP has been in power for most of the post-war period, and continuously so from 1955 to 1993.

The next lower house election is scheduled for the summer of 2009. The government can call the election any time before then, but this is unlikely, given its recent poor performance. With an opposition party as dysfunctional as the incumbent government, the country looks set for yet another period of political sterility.
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