The Japanese stock market tore up the government's carefully crafted script by plunging to a 16-year low Monday, intensifying pressure on the ruling party days before it faces a key national election.
Led by sharp declines in bank and technology stocks, the fall in the benchmark Nikkei index threatens to undermine the government's strategy: Attract voters with vague calls for reform, coast to victory in Sunday's upper house election and only then begin tackling Japan's many economic problems.
But the market signaled Monday it wasn't happy with Prime Minister Junichiro Koizumi's political timetable, as it sent the closely watched share index down 298.76 points, or 2.51%, to 11,609.63. By late morning today, the Nikkei had eked out a 50-point gain with traders bargain-hunting among badly battered banking stocks.
"Koizumi isn't dealing with reality. He's just coasting on his popularity," said Tsuyoshi Shiba, economist with Sumitomo Marine Asset Management. "He's like someone sitting on top of a hill watching the ball roll away. The market knows the crisis is now."
The wake-up call seemed to get the politicians' attention, at least temporarily. Economic Minister Heizo Takenaka quickly pledged new measures to boost the sagging stock market. Finance Minister Masajuro Shiokawa immediately chided brokers for undervaluing Japanese stocks. And Financial Services Minister Hakuo Yanagisawa vowed to spur Japanese securities tax reform by the end of August.
Notably lacking in Monday's response, however, were specifics or convincing evidence the Japanese government will go beyond the symptoms to address such root economic causes as ballooning company debt, massive banking losses and the cycle of denial and weak disclosure that has allowed problems to fester.
"They're saying the same old thing, and within the government there's no consensus on economic policy," said Takeshi Hyuga, analyst with Nissei Research Institute. "The market knows this."
Traders also seemed disappointed that the Group of 8 meeting over the weekend failed to include concrete recommendations for the Japanese or global economies.
On the face of it, a 2.5% stock drop is not that serious in a world of increasingly volatile financial markets. What's different here, however, is the absolute level. The Nikkei is below the 12,000-point level, with grave implications for Japan's already troubled banking system.
Accounting changes recently introduced here mean that companies and banks must disclose the market value of their stock holdings, not just the book value at which they purchased the shares. Once the market sinks below 12,000, most of these portfolios are underwater, forcing banks to find more capital to cover the losses.
In a worst-case scenario, declining stock prices could lead to a chain reaction, as hundreds of banks and related companies are thrown into bankruptcy.
"The result was that bank shares were sold quite a lot today," said Hirokazu Yuihama, analyst with Daiwa Research Institute, affiliated with Daiwa Securities.
Tackling Japan's huge economic and fiscal problems, however, requires a strong dose of political will. And widespread unemployment and bankruptcies--leading to social dislocation, angst and family breakups--are tough pills to swallow in any country.
"While reform might help the big companies, writing off bad loans will devastate small and medium-size companies," said Katsushi Miwa, 42, a cleaning company employee. "Suicide rates are increasing and would probably get worse. Ordinary people can't take any more pain."
If Koizumi does move ahead aggressively with structural reform, as he's pledged, it would hurt short-term profits as many less efficient companies collapse.
"It's sometimes hard to tell what the Japanese stock market wants--is it structural reform or a short-term economic recovery," said Yoshito Sakakibara, economist with Merrill Lynch. "It could be both."
What would it take to regain a bit of market confidence? One step, economists say, would be for Koizumi to clarify the details of his tax reform plan, making it easier for institutions and, ultimately, individuals to invest in shares. So far, there's been a lot of infighting within the administration over what form it should take.
Economists also say Japan needs to flush out how it plans to resolve the debt that hangs over the banking industry. There's been great ambiguity over what constitutes a bad loan. And plans to place much of the debt in a third-party corporation, a sort of holding tank, for several years only puts off the problem.
Another issue that concerns some experts is Koizumi's pledge to cap new government bond issuance at $240 billion. Though the Japanese government is the most debt-laden of any industrialized country, moving too quickly to repair its fiscal picture could throw the economy into an even worse tailspin. Like it or not, the government is still a key part of the economic engine and suddenly shutting it off doesn't help, economists say.
Ultimately, Monday's sharp stock market decline may be a blessing in disguise, if the warning is heeded. "From another angle, it may not be such a bad thing," said Masaki Kanno, chief economist with J.P. Morgan Securities Asia. "If the government responds to the pressure correctly, things could turn out all right."
Hisako Ueno in The Times' Tokyo Bureau contributed to this report.
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Plunging bank stocks Monday pushed the Nikkei to its lowest level in 16 years.
Nikkei index, yearly closes and latest
Source: Bloomberg News