Will the Nikkei continue its rise?

Tomohiko Taniguchi (Editor at Large, Nikkei Business Publications)

Will the Nikkei stock index soar above 15,000 this year? The answer is almost certainly an assured yes, especially as the economy is now proven to be on a growth track. In the fourth quarter of 2003 the nation's GDP grew by an annualized rate of 7.0 %, a stunning rate and an all time high over the last 14 years.

Three underlying factors are at work: what I call the "KGB connection", diminishing non-performing loans (NPLs), and the lure of the Chinese economy. And yet starting with Toyota the nation's leading companies are determined to carry on massive restructuring, indicative of their values continuing to go upward, not downward.

Bush spends, Greenspan checks that interest rates are low, and liquidity is provided by Junichiro Koizumi, Japan's Premier. Hence came the KGB - or rather BGK connection to put it in a logical order. This triad connection keeps US stock indexes at rock bottom, and recycles the wealth this creates to Tokyo to boost the Nikkei. So long as it spins, the Nikkei will be on the rise. The question of course is whether this circular connection is sustainable. But again the answer is an assured yes for this is not a normal year - it is an election year.

The US is now like a huge loss-making company with negative cash flow amounting to 1.5 billion USD each and every day. Still its risk premium never rises; indeed it is kept at historical low. Is this because George W. Bush the CEO has gained so much confidence from his financier, Alan Greenspan? Whatever the case, Greenspan can tap into Japan's enormous savings pool.

Japan has been a dirty floater for more than a year. The year 2003 alone witnessed Japan purchasing US Treasury bills and other short term notes to the value of more than 20 trillion yen, which on a daily basis amounts to 530 million USD, covering more than one third of the negative cash flow of Bush & Co.

Beijing also plays a role in supporting Washington, but only a minor one compared to Koizumi's. Throughout the year 2003, China increased the amount of its holding of US Treasury securities by 28.5 billion USD. Japan did the same by six times that, 160.2 billion USD, or 107 days worth of cash the US needs.

Japan in return has only partially been rewarded, as the yen-denominated amount of its dollar reserves has kept decreasing. But the partial reward was not insignificant. Last year, non-residents (the majority of whom are US investors) bought as much as 93 billion USD of Japanese stocks, the net amount second only to the 1999 record. Uncle Sam arguably returned 60 % of the money the Rising Sun gave him.

Without this connection, Greenspan would have been forced to raise interest rates long ago. The positive feedback connecting Washington and Tokyo must have turned negative, with the USD declining and the yen appreciating yet further. Bush could not have continued his spending spree, making it hard to sustain the war efforts in Iraq as well as in homeland.

Enough on the KGB front. David A. Coulter, the number two man of JP Morgan Chase, told the Nikkei newspaper on February 19 that there has been "progress obviously" on the NPL issue "as evinced by the declining ratio of non performing assets within the banking sector". Heizo Takenaka, Minister in charge of the Financial Services Agency, announced in late October, 2002, that by the end of March 2005, the NPL ratio would have to be halved. He maintains that banks are on the right track and the goal seems increasingly achievable.

We should nonetheless believe not in words but deeds. And the deeds tell amongst others that: the Sumitomo Mitsui Financial Group cut the NPL ratio from 8.4 % to 6.4 %, during the six months from March to September 2003, reducing the NPL amount by 13 billion USD; Shigemitsu Miki, CEO of the Mitsubishi Tokyo Financial Group, declared on February 4 that they had "overcome the NPL issue", and that by the end of March 2007, they should "enter the top ten financial institutions globally by market cap". True, rumors are circulating that the UFJ (the merged bank of Sanwa and Tokai) may be nationalized, with some other regional banks possibly following suit. With that the debt laden retail chain Daiei may also be acquired by the government-run Industry Revitalization Corporation. But none of the above is likely to provoke a risk of a systemic kind. Indeed investors are queuing up to make bulk purchases of the assets that banks such as Mizuho, Resona and others are unloading daily. In short, it is a time to buy, not to sell.

The last important growth-sustainer came from an unlikely direction: China. Unlikely, as it customarily came from US consumers when Japan was under recession. This time, however, the Japanese economy is making a strategic shift from one dependent upon the US market to one dependant upon China. For the first time in postwar history, Greater China, which combines the Mainland, Taiwan and Hong Kong, emerged as the single largest export destination for Japanese goods and services. The amount they imported from Japan from January to November last year totaled some 118 billion USD, while the US bought 117 billion USD worth from Japan in the same period.

Echoing this, the image of China in the eyes of the Japanese has also taken a turn for the better. Conventional wisdom now holds that "up until 2008 when Beijing will host the Olympic games", the Chinese market will continue to expand, absorbing more and more Japanese products. Executives at Toyota for instance are even talking of their production amounting to 10 million units world-wide over the coming years, counting heavily on the growth capacity of the Chinese market. It is even more necessary for Koizumi and his economic team to push Beijing to appreciate Renminbi, not so much to enhance Japan's industrial competitiveness as to empower Chinese consumers. The truth is Japan's economy will be the tail, no longer the dog in Asia. That will be China, for sure.