Koizumi to return to power by spring, says Rheinwald

CLSA analyst Stefan Rheinwald predicts a return to power for Koizumi by spring 2008 and the Nikkei to hit 23,000 points.
CLSA analyst Stefan Rheinwald predicted the demise of Yasuo Fukuda at the general election and a triumphant return to politics for Junichiro Koizumi at the third day of the CLSA forum in Hong Kong on Wednesday. Koizumi served as leader of the Liberal Democratic Party (LDP) and prime minister of Japan between 2001 and 2006.

Fukuda is the name of a candidate who has been touted as the successor of Shinzo Abe, who resigned last week on the back of disastrous personal approval ratings and ill health. The political schedule comprises an internal election for the party leadership, followed by a general election next year in spring for the post of president. As in the United Kingdom, the leader of the winning party becomes leader of the country.

ôKoizumi is one of the few politicians with the vision and creativity to push the country forward. Other Japanese politicians are too focussed on consensus,ö says Rheinwald. "In addition, Koizumi was brilliant at working the system. Even if it sometimes looked as if he was taking one step back for every two steps forward."

In a presentation focussing on the polarising trends in Japan at the end of ô15 years of restructuringö, Rheinwald said the picture was currently ôbasically flatö. ôThe restructuring programme has faded dramatically since Shinzo Abe took over as prime minister. HeÆs obviously had other priorities.ö

Rheinwald says Japan needs to move forward with the privatisation of the eight remaining state banks, institutions such as Japan Post and the Housing Loan Corporation (the Japanese equivalent of Fanny Mae and Freddy Mac in the US), as well as the rationalisation of the tax system.

With regard to the currency, Rheinwald says the fact that the yen had barely moved despite a large-scale unwinding of the carry trade reflects the systemic weakness of the currency. The yen has strengthened somewhat to 116 against the dollar and to 162 against the Euro û far smaller increases than market pessimists expected.

ôDomestic assets are pouring out of Japan at the rate of $10-$15 billion per month. That rate is actually increasing. As a result, the unwinding effect of the yen has been muted,ö he says.

From Ñ50,000 billion ($434 billion) in 1999, the amount of Japanese assets invested abroad had gone up to almost Ñ300,000 billion in 2006, and Ñ400,000 billion (estimated) in 2007. That means almost half of all Japanese savings in mutual funds are going offshore. ôAs a result, the yen has not strengthened as much as many people were expecting,ö says Rheinwald.

In tandem with this development, time deposits in the Japanese postal system have been haemorrhaging cash, down from a peak of Ñ200 trillion in 1999 to around Ñ100 trillion (estimated) in 2007. Yet despite these immense outflows, so vast is the pool of liquidity that the Japanese are sitting on, that total outflows so far only represent 3% of the populationÆs net financial assets.

Rheinwald explains that the voracious appetite of the Japanese for foreign, as opposed to domestic, equity assets is the result of the trauma inflicted by the collapse of the Nikkei225 index in 1989. The Nikkei plunged from a high of 40,000 points to around 8,000 points. It now stands at 15,500. The Nikkei225 is the only index in Asia that has not exceeded its previous highs. Hong Kong for example, has gone to almost 25,000 points after a previous record of 17,000 in 2000 û before it too collapsed during the dotcom crash.

As a result of this risk aversion, 80% of Japan's financial assets are in cash. The consequence is that Japanese equities are seeing little demand. ôYet Japanese equities are trading at a discount to fair value, with fundamental upside now again greater than 20%.ö

The Topix (Tokyo Stock Price Index), which is weighted based on market cap and includes all the companies on the main board, is trading at a price-to-earnings (P/E) ratio for 2008 of 15 times, and a price-to-book for 2008 of 1.6 times. These ratios are attractive by most standards, says Rheinwald. ôThe good thing about Japanese return on capital is that is has been improving almost continuously for the past 15 years. The bad thing is that the improvement line is almost flat.ö

Despite fabulous national wealth (the population is sitting on net financial assets of $10 trillion) the Japanese are experiencing increasingly polarised wealth levels, with 15% of workers being forced to borrow from consumer finance companies at sky-high rates. These rates have recently come under review, and Rheinwald fears that the measures imposed to cap rates and limit lending will have a negative effect on those segments of the population most in need of liquidity (one-third of Japanese workers live off $1,500 per month). This æhidden credit crunchÆ will knock off 0.4% of GDP in the next three years, he estimates.

ItÆs only thanks to JapanÆs massive private sector wealth, built up over 40 years of economic over-achievement since the Second World War that the tax burden is manageable, notes Rheinwald. ôThe official debt to GDP ratio of 160% drops to a more manageable 60% when you factor in private sector wealth.ö

However, that debt burden is a very good reason why Japanese interest rates are hovering close to zero, and why Japanese investors still continue to create global disequilibrium through the carry trade û since it doesnÆt pay for the Japanese to keep their cash in domestic fixed-income instruments. Such instruments would be the obvious choice for JapanÆs aging population. ôThe Japanese authorities knew that money moving abroad would become a problem once deflation was licked, since your money stops appreciating.ö

Ironically, therefore, the carry trade, which might be described as capital flight, is the result of solid achievements in JapanÆs economy since the reform programme launched under Koizumi. But the outcome for the government could be that, as domestic money continues to flow abroad, it will have to keep running the printing presses to fund the gaping holes in its finances.
¬ Haymarket Media Limited. All rights reserved.
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