Japan

Term Project:
Analysis

Angeline Taylor, Jeffrey

Richardson, Martin
Solorzano
Introduction
Japan has faced many obstacles in the past two decades. They have experienced two
financial crises: the first in the early nineties and the recent 2008 global financial crisis that
impacted the world. Japan has also has been impacted by many unavoidable troubles such as
earthquakes and tsunamis. Even though it took Japan a full decade to recover from the first crisis,
they have had increasing growth and improving statistics in all major areas such as exports,
annual GDP growth, and current account surplus. They developed new banking regulations and
policies with the intention of not repeating the first crisis. On the other hand, Japan still suffers
from negative economic indicators such as a high government budget debt, increasing public
external debt and government external debt, and continues to hold a deficit in their trade balance.
There are many controllable factors in Japan that need improvement, but there are also various
external uncontrollable elements in their economy. Our team has analyzed Japan’s banking sector,
Japan’s association with the foreign exchange market, and their current account and capital
account. As a result, we have highlighted numerous potential country risks and strengths that
could cause another possible financial crisis.
BANKING (Angeline)
Banking Sector

The Bank of Japan (BOJ) is the central bank and they act as the lender to other banks as a
last resort in times of need. The major banks in Japan are: Resona Holdings, Inc., Nomura
Holdings, Inc., Mizuho Financial Group, Mitsubishi UFJ Financial Group, and Sumitomo Mitsui
Financial Group. Commonly under each Financial Group there are numerous sectors: banks for
consumers, corporate banks, trust and banking (trust funds and asset management), and securities.
The banking sector is regulated by the Financial Services Agency (FSA), who is in
charge of regulating securities, insurance, and other financial instruments. In the past, up until
1998, the Ministry of Finance was responsible for the regulations of the Japanese banks. Now,
they no longer have the authority over the financial institutions; the MOF oversees Japan’s
financial stability issues. In order for a bank to conduct banking business, they must remain in
accordance to the Banking Act. Under the Banking Act banks must follow three main guidelines:
Principles, Inspection Manual, and Guidelines for Supervision. Principles are a set of codes and
behaviors that are established for the banks to follow and respect. If, in any event, the FSA
suspects a bank for misconduct, the Commissioner of the FSA has the right to suspend the bank’s

2
operations or revoke the bank’s license. The Commissioner has the authority to request banking
reports and materials in relation to financial or business conditions of the bank. The Inspection
manual is the handbook used by the FSA inspectors during the conducting of inspections. The
Banking Act empowers FSA inspectors to perform on-site bank inspections to insure the bank is
carrying out the correct operations under the regulatory laws. The Guidelines for Supervision are
guidelines in which supervision and operational procedure of the bank should be conducted. The
main objective for the FSA is “better regulation”; their goal is to do things differently than what
the Ministry of Finance did in the past. “Better regulations” entails a “better” relationship
between the regulators and the banks. The FSA wishes the banking sector become more
transparent and less discretionary (Japanese Bankers Association).

Internationalization of Banking Sector

Banks participate in the international market. They conduct operations in the area of
international finance, such as buying and selling foreign-denominated investment stocks and
bonds. For example, Japanese banks are involved in the foreign exchange market to make
foreign exchange transactions by buying and selling foreign currencies and foreign-currency-
denominated assets. Major banks, such as Mitsubishi, are also the parent company of banks in
foreign countries. For instance, Mitsubishi UFJ Financial Group owns Union Bank in the United
States. The Bank of Japan also aids other foreign monetary authorities and international
organizations in investing and financing yen. BOJ has joined several financial groups with other
foreign governments’ central banks, such as the Group of Twenty, the Bank of International
Settlements, and the Executives’ Meeting of East Asia-Pacific Central Banks (EMEAP), in order
to stay abreast on the current position of the global financial markets.
Japan’s Sovereign Credit Rating

On May 22, 2012 Fitch Ratings reduced Japan’s long-term foreign currency rating by two
levels, from AA to A-plus. A represents high credit quality and expectations of low default risk.
At this position Japan is vulnerable to any harmful or detrimental business or economic
conditions that may occur. The local currency rating was also cut down one level from AA-minus
to A-plus. These downgrades were a result of their high debt to GDP ratio of -9.7. Fitch warns
Japan’s government that there could be further credit rating downgrades if Japan’s sovereign
credit profiles show signs of growing risk (Fitch Ratings). Last year on August 24, Moody’s

3
Credit Rating rated Japan’s sovereign credit at AA3, one level above Fitch Ratings, blaming the
political sector for their instability and inability to conceal a plan to control the debt.
Current Changes in Central Bank’s Policy

The central bank of Japan has recently implemented innovative monetary policies to deal
with the current sluggish state of the Japanese economy. It has become obvious that the Japanese
economy has recently undergone stagnation and a multitude of internal and external limitations.
Much like the United States, monetary policies in Japan have been altered to reflect the current
situation. Similar to the Federal Reserve, the central bank of Japan has introduced a “fresh
economic stimulus” to spur growth and to surmount deflation. This stimulus includes, among
others, asset-buying. Through asset-buying, the central bank of Japan will be able to increase its
reserves and hopefully lower the cost of lending; thus increasing the flow of money in the
economy (Tabuchi, Bank of Japan).
As deflation has persisted for more or less than a decade, prices, wages, and profit have
been severely impacted. Economic progression in Japan has been deterred further by a shrinking
population, soaring public debt, and a listless global economy. Industrial output in Japan has
diminished almost 8% in the past year due to decreasing exports, a territorial disagreement with
neighboring China, and a general economic malaise in the developed world. The events and
conditions within overseas economies dictate many of the policies that the central bank enacts.
The asset-buying plan is one of a few measures that the central bank has put into effect. The
central bank also recently established a new loan program to supply banks with “cheap long-term
funds”. The bank kept its usual interest rate between the ranges of 0-0.1% (Tabuchi, Japan
Central Bank Acts to Aid Fragile Recovery). The most recent development was the approval of a
¥423 billion emergency stimulus package less than one week ago. Many may perceive this to be
similar to an act of Quantitative Easing by the US Federal Reserve - where money is ultimately
“injected” into the economy. Many analysts predict that this stimulus will be too diminutive to
create any significant economic upswing. The Japanese Government (Cabinet) and the central
bank will continue to evaluate methods to fight deflation. The central bank set a 1% inflation
target in February; a goal that will not be reached by year’s end. Recently, on November 28 the
Liberal Democratic Leader Shinzo Abe announced the BOJ and government officials should
work together to reach an inflation rate of 2% by implementing unlimited monetary easing
(Rttnews). There are also been changes in the Basel III, which a global bank regulation that

4
requires banks to hold a standard amount of capital of 4.5% of common equity and 6% of Tier 1
capital of risk-weighted assets. The Basel III is expected to deleverage and add strict banking
regulatory requirements. Specialist estimate the Asian bond issuance could triple over the next
five years.
Impact of the Policy Changes

The Bank of Japan abstained more stimulus from government bonds; after increasing its
asset-purchase program to ¥80 trillion ($1.01 trillion) from ¥70 trillion, and extended its deadline
by six months to the end of 2013 with an interest rate of nearly zero. In addition, Japan’s export
has been weak. However, the Bond-buying program is intended to encourage lending and
spending and help make Japan’s exports more competitive
The Bank of Japan announced that the monetary base in Japan climbed 10.8 percent on
year in October, coming in at 128.134 trillion yen. That beat forecasts for an increase of 9.2
percent following the 9.0 percent gain in September. This year banknotes that were in the market
circulation have increased by 2.6% compared to the previous month of 2.3%. Also, the coins in
circulation have remained constant at .4% (BOJ Minutes).
Foreign Exchange Market
The foreign exchange market, also known as the Forex market, is the market in which
currencies are traded. The foreign exchange market is the largest financial market in the world
(Tang). The three most important financial capitals of the world, in succession, are London, New
York, and Tokyo. The Forex market offers “the perfect competition market” with no product
differentiation. This market is a 24 hour operation that facilitates international trade by allowing
businesses to perform transactions outside of their local currency. In essence, it is a forum for
currency conversion. This is especially significant for a country like Japan; a country that is
centered on exporting and international trade. Overall, it is estimated as much as $3.98 trillion
worth of transactions occur within the market daily (ibfx.com). These transactions evolve from
central banks, speculators, investors, governments, and other organizations. Over time, the
Japanese government has intervened in this under-regulated market to prevent domestic
economic ramifications. To juxtapose its high public debt, the Japanese government has
increased its foreign currency reserves. As of March 2012, Japan held $1.3 trillion in official
exchange reserves. While these reserves can be liquidated, the Japanese government has
illustrated no intention in converting these assets into yen (Kumakura). This would inevitably

5
over-value the very delicate currency and further hinder exporting opportunities. Overall, the
Central Bank of Japan is very involved within the foreign exchange market.
Possibility of a Crisis
There is marginal evidence pointing to a possible financial crisis in Japan within the
coming years. Our evidence indicates that the economic progress in Japan has stagnated and a
possible crisis could be on the horizon. Japan has faced a multitude of recent financial and
economic hardships. A primary concern for Japan is their enormous amount of public debt; the
country owns a 225.8% debt/GDP ratio. The public debt is essentially money or credit owed by
the government, both central and local (Tang). Much of this debt in Japan is held by domestic
investors; a significant difference between Japan and other fluttering economies. According to
the Wall Street Journal, the incredible debt will place the country in “unchartered territory” and
drive unforeseen policy reform. These reforms will evolve within immigration and the tax code.
Recently, a bill was proposed that would increase the sales tax in Japan from 5% to 10%
(Emsden). This would allow the public debt to flatten over the long-term. However, this still
relies on the assumption that the Japanese economy can spurt from recent mediocrity. Tensions
with China have also been a cause for concern. Japan and China represent two of the top tier
economies in the world. The conflict with China has erupted over territorial rights to islands in
the East China Sea. This has led to violent demonstrations in China and a boycott of Japanese
goods (Reuters). As a result of this feud, there has been a subsequent slide in Japan’s ability to
export. The Japanese economy has already been negatively affected with the resurgence of the
American auto industry and a reduction in their car exports to the U.S. In recent history,
exporting in Japan has been the number one source of economic prosperity. The figure below
represents the trend of Japanese exporting capabilities over the past decade.

6
 Overall, sluggish exports have compounded with a lesser demand to produce massive
economic pessimism. From July-September of this year, overall exports in Japan contracted by
5%. Japanese electronics, a keystone of their economy, have faced tremendous competition from
abroad. Samsung and Apple, from South Korea and the U.S. respectively, have undermined
respectable companies such as Panasonic and Sony. Both of these significant companies plan to
reduce capital spending by as much as 30% by March 2013 (Reuters). In regards to currency, a
strong yen has had a debilitating effect on industry and exports. As of September, the yen/dollar
exchange rate was about 78.18. The Japanese government favors a weak yen and has intervened
in the currency market to prevent appreciation (Chua). According to a global credit strategist: “if
we see a move (in dollar/yen) below 78 being sustained, the risk of intervention gets higher”
(Ranasinghe). However, some analysts have predicted that the yen could potentially reduce to 74
yen/$1 by the end of 2012. The Central Bank of Japan will need to continue to monitor and
amend monetary policy depending on statistics and forecasts. Various policies have already been
enacted that would facilitate growth, curb deflation, increase the money supply, and expand
exports. However, Japan is predictably headed for a recession. The amount of goods and services
produced came to an annualized 3.5% contraction. Reconstruction from the 2011 tsunami and
earthquake has decelerated and private consumption has dwindled (Tabuchi). While the Japanese
unemployment rate remains very low (about 4%), the economy is hindered by a variety of other
blockades. Resolving the territorial spat with China may be the first goal; this would alleviate
massive tensions and facilitate more Japanese exports. More exports would resolve recent
shortcomings within the current account.
Another major goal, and primary concern of government, is to halt deflation. While the

7
inflation target for this year will not be reached, the Central Bank of Japan has installed various
measures to stimulate prices and rejuvenate the downward trend. The Central Bank has a
tremendous understanding of the crisis that has become prevalent in the country. Several analysts
predict that this recession will be “short-lived”. Demand is expected to increase and there are
signs of “positive growth” for the New Year (Tabuchi). It is with hope that Japan can avoid a
full-blown financial crisis. Japan must maintain an edge over other rising Asian economies.
Exports and industry must return to previous levels, deflation must continue to be contested,
monetary policy must be in concordance with economic conditions, and the public debt must be
handled with diligence. Japan has the institutions and ideas to encourage a widespread
revitalization. As with several European countries, we will soon see if Japan can avoid
catastrophe. For now, the consensus is that the country will avert a crisis of epic proportions.
Potential Risks

One of Japan’s main weaknesses that are affecting their economy is their decreasing
population and growing “old age” population which is leading to a rise in social security costs.
Also, their large government deficit has put a strain on the economy’s growth. Japan has
implemented a new tax plan to deal with these rising costs. As previously noted before, there was
a bill that was passed to double the sales tax from 5% to 10%. Japanese investors are traveling
abroad to take advantage of higher yields they cannot get in Japan. 2-year to 5-year yields still
remains under zero percent at .10% and .18%, respectively. Also, their LIBOR rates are also just
under zero percent.
Standard and Poor’s rating of Japan’s economic risk last year with a score of 2; ranking
system is from 1 to 10, with 10 being the riskiest. Their economic resilience has a “low risk”,
economic imbalances have a “very low risk”, and credit risk in the economy also has a “low
risk”. Japan’s economic resilience is based on the stability of their economy in the event of any
adverse occurrences, such as earthquakes. An economic imbalance is based on credit-fueled
asset-price bubbles and unbalances in the current account. The credit risk in the economy is
based household and companies’ exposure to credit risk and the private-sector and government’s
debt and leverage (Standard and Poor's Financial Services, LLC).

8
(Standard and Poor's Financial Services, LLC)

Charts & Diagrams

9
http://www.huffingtonpost.com/2012/05/22/fitch-japan-credit-rating_n_1535275.html

http://www.stat.go.jp/data/nenkan/pdf/z20-1.pdf

10
http://www.tradingeconomics.com/japan/balance-of-trade

http://www.tradingeconomics.com/japan/government-budget

11
Works Cited
BOJ Minutes: To Maintain Powerful Monetary Easing. 1 November 2012.
http://www.rttnews.com/1996456/boj-minutes-to-maintain-powerful-monetary-
easing.aspx.
Fitch Ratings. Definitions of Ratings and Other Forms of Opinion. New York City: Fitch Rating,
2012.
http://www.fitchratings.com/web_content/ratings/fitch_ratings_definitions_and_scales.pd
f.
Fujikawa, Megumi and Tatsuo Ito. Japan Eases Monetary Policy in Surprise Move. 19
September 2012.
http://online.wsj.com/article/SB10000872396390443816804578005260696436022.html.
November 2012.
Japanese Bankers Association. Banking Regulation. n.d.
http://www.zenginkyo.or.jp/en/banks/banking_regulation/. November 2012.
Kondo, Masaki, Monami Yui and Hiroko Komiya. Abe Spurs Tripling of Overseas Debt Buying
on Yen: Japan Credit. 27 November 2012. http://www.businessweek.com/news/2012-11-
27/abe-spurs-tripling-of-overseas-debt-buying-on-yen-japan-credit#p1. 28 November
2012.
Standard and Poor's Financial Services, LLC. Banking Industry and Country Risk Assessment:
Japan. 19 December 2011.
http://www.standardandpoors.com/ratings/articles/en/us/?articleType=HTML&assetID=1
245327784035. 1 December 2012.
Tabuchi, Hiroko. Bank of Japan Announces Fresh Economic Stimulus. 30 October 2012.
http://www.nytimes.com/2012/10/31/business/global/bank-of-japan-announces-fresh-
economic-stimulus.html.
—. Japan Central Bank Acts to Aid Fragile Recovery. 19 September 2012.
http://www.nytimes.com/2012/09/20/business/global/japanese-central-bank-expands-
asset-buying-to-bolster-economy.html?_r=0. November 2012.
Yen Falls As IDP Leader Abe Calls Unlimited Easing Unitl Inflation At 2%. 28 November 2012.
http://www.rttnews.com/2013948/yen-falls-as-ldp-leader-abe-calls-unlimited-easing-
until-inflation-at-2.aspx?type=cm&utm_source=google&utm_campaign=sitemap. 28
November 2012.

12