Global economic recovery – Does Japan’s handling of ‘Lost decade’ offer any clue?
Although there are semblances of global economic recovery and talks of green shoots gaining momentum, the recent IMF working paper – “Lost Decade” in transition: What Japan’s Crisis could Portend about recovery from great Recession- draws parallel from earlier Japanese crisis and the subsequent Japanese recovery and suggests that if Japanese history is any guide, then, the global recovery could still be in the initial stages.
The paper highlights the similarities on the genesis of the crises and the policy challenges they posed. Both crises were triggered by bursting asset bubbles, lax financial regulations against the backdrop of escalating private debt. But the problems that generated the current crisis continue to linger in advanced economies. Delinquencies on mortgage loans are still rising, household debts still stagger, the financial system is yet to get rid of toxic and distressed assets and remains encumbered by doubts about firms’ capital positions.
Even in emerging Asia, a vigorous and sustained turnaround cannot be taken for granted and the significant fragility of external demand outside the region may slow momentum of exports dampening what has historically been a key channel for Asia’s recoveries.
Sound macroeconomic management in the lead-up to the crisis has also allowed more aggressive policy responses in many parts of the Asian region. But private domestic demand still looks vulnerable in export-oriented Asian economies with business confidence and private consumption still not in full recovery mode.
Morgan Stanley economist, Joachim Feels and associates project 4.0 percent global growth for 2010 but just two percent in the advanced economies of the G10. Feels said the economies will see “credit less recoveries “where banks are reluctant to lend and predicted a “jobless G10 recovery” with unemployment still high in the United States, Europe and Japan.
In the light of the above global scenario the IMF paper asks – Is the recovery from the global crisis now secured? The paper observed that the striking similarities between the current crisis and the crisis that stalled Japan’s growth could provide some clues. The paper presented by Mustafa Side, Kenneth Kang and Keechi Tokuoka explores the implications for the current global outlook and policies. According to the paper, Japan’s experience suggests four broad lessons.
1. Green shoots do not guarantee recovery.
2. Financial fragilities can leave an economy vulnerable to adverse shocks and should be resolved for durable recovery.
3. Well calibrated macroeconomic stimulus can facilitate this adjustment but carries increasing costs.
4. Timing of exit from policy support is difficult but clear medium-term plans may help.
No doubt the latest economic numbers across the globe provide grounds for cautious optimism fuelling hopes of an end to the “GREAT RECESSION”. But the paper feels that though the panic has receded, stresses remain. The paper posits that the all important boost to the economic activity has been provided by aggressive macro economic stimulus, unprecedented financial sector interventions and restocking associated with global inventory cycles .The paper then suggests that any reversal of policy support is to be based on whether private demand is sufficiently well placed to replace government support.
Having considered the glaring similarities between the current financial crisis and the Japanese banking crisis of the 1990s, sometimes dubbed the “lost decade”, the paper further analyzed the Japanese scenario to draw valuable conclusions. Japan’s lost decade was not an uninterrupted period of economic decline, but involved three distinct phases.
Phase I: 1990-97: The crisis was sparked by bubbles in its stock and real estate markets in the early 1990s. Thanks to policy stimulus green shoots were sprouting in 1994. Signs of recovery allowed policy stimulus to be withdrawn.
Phase II: 1997-2000. The fall of ASIAN tigers in 1997 pushed the Japanese economy close to a meltdown. The economy started to mend with further infusion of capital into the banking system but without tackling toxic asset/problem loans and policy stimulus was reintroduced in the form of larger fiscal packages and a shift to ZERO rate interest policy.
Phase III: 2001-2003. The global information technology collapse from March, 2000.
A more comprehensive approach addressing the underlying problems in the financial and corporate sectors was finally put in place. According to the paper a more aggressive approach to dealing with problem loans and capital shortages in the banking system was adopted to restore confidence in the banking system. These measures coupled with positive growth stimulus from China enabled a more durable expansion of the economy.
Twice, green shoots of recovery emerged allowing stimulus to be withdrawn. However, on both occasions, the external environment subsequently deteriorated dramatically-first during the Asian financial crisis in 1997 and then the IT bubble burst in 2000 – and the shock to the economy amplified by a still, fragile financial system. A more severe downturn followed, necessitating even more aggressive stimulus to support real activity and magnifying the longer term challenges associated with unwinding policy support. An enduring recovery was ultimately possible only when financial and corporate sector problems at the heart of the crisis were addressed, allowing a resumption of policy stimulus and a favorable external environment to reinvigorate private demand.
The brief history of the Japanese episode indicates that more care needed to be exercised in policy stimulus exit strategies and in ensuring a healthy and enduring financial and corporate sector. The paper adds that the appropriate stance of policies in today’s scenario would be:
I. Resolving financial sector and debtor imbalances.
In Japan it was only when corporate debt had returned to pre bubble levels and only when banks disposed off their distressed loans and had been adequately recapitalized, that the benefits from policy stimulus and favorable external environment could spill over and reinvigorate private domestic demand. This would follow that in advanced countries that are at the centre of the GREAT RECESSION, private-led recovery is not possible or may not take hold until household debt levels fall back toward more normal levels and banks are sufficiently strengthened.
The IMF paper inter-alia suggests the following measures to strengthen financial system.
1. Global banks face potential write downs of around US$2.8 trillion (IMF2009). Around half of these are still to be written down, roughly where Japan stood in the middle of its crisis. Hence, it is imperative that bank losses are recognized early so that the capital shortage could be identified, quantified and refurbished.
Any delay would exacerbate the financial crisis and postpone a sustained recovery.
2. Banks must be forced to clean up their balance sheets and dispose off bad assets.
Japan had earlier set up asset management companies to deal with toxic debts.
3. The IMF paper calls for rigorous inspection of bank asset quality. It may even be a prerequisite. In the present situation, this would call for continued close monitoring and regular stress- testing to evaluate vulnerabilities on an on-going basis, particularly as a prolonged downturn could place further strains on bank capital.
4. The paper suggests a centralized asset management approach by establishing institutions with clear mandate to buy distressed assets from banks and recover value.
5. Rehabilitating distressed borrowers would support bank restructuring.
II. Maintain policy stimulus while restructuring is underway and recovery becomes more established
1. The paper suggests that successful policy support hinges on identifying “spending with high multipliers.” On public investment, multipliers higher than unity may be needed with priority on projects that are more likely to stimulate private demand, while transfers could be targeted at lower, income households that have higher marginal propensity to consume.
2. Restoring credit function of the banking sector. This needs a sound financial system with an equally sound capital buffers in the banking system
3. Co-ordination of monetary and fiscal policies.
4. Restoring fiscal position through tax increases and expenditure reforms.
III. Clear exit policy
The IMF working paper suggests that outlining a concrete medium-term fiscal consolidation strategy could help manage the difficult balancing act between supporting the economy and maintain confidence in longer term sustainability.
The most desirable exit scenario would be for investors’ appetite to recover and credit markets to normalize smoothly as happened in Japan.
Finally it may be observed that while talks of green shoots are encouraging, the Japanese experience suggests that it may be too early to declare victory and that further policy support could be needed for some more time. But prolongation of policy support may endanger fiscal deficits.
by S.Srinath
Email: [email protected]
The author is a Chartered Accountant and Financial Contoller of Noble Industries in Accra.