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Sat, Aug 25, 2001 - Page 19 News List

Five percent interest rate lift would solve Japan's banking woes

Cheap money has enabled Japan's economy to avoid a crisis but raising interest rates dramatically would weed out weak and struggling companies

By William Pesek Jr  /  BLOOMBERG , TOKYO

For years now, the Bank of Japan has averted a crisis in the world's second-biggest economy with cheap money. So cheap, in fact, that many banks and companies couldn't have survived without it.

How can Japan wean its economy off ultra-low interest rates once and for all? Raise them dramatically, of course.

It's what Goldman Sachs (Japan) Ltd Managing Director David Atkinson calls the "5 percent solution" to what ails Japan. Raising rates to 5 percent or 6 percent for a year would force hopeless companies into bankruptcy rather than wait for a bailout.

"With rates so low, companies can be in the red for a very long time without going bust," Atkinson says. Because the average company is paying just over 2 percent interest on loans, businesses that don't have a prayer of paying back the principal are still considered sound.

That's the beauty of this tough-love solution: It forces change.

It's highly doubtful the BoJ would even consider it now. After all, central bank Governor Masaru Hayami was vilified as the global village idiot for daring to raise rates from close to zero to 0.25 percent a little over a year ago. Hayami's bold move was meant to spook Japan's public and private sectors into implementing structural reforms. It didn't work -- he returned rates to zero in March.

Maybe the BoJ should rethink the strategy. The bank's mistake wasn't raising rates, but boosting them too little and giving up too quickly. Hayami admits the BoJ's ``super-easy" stance is allowing companies to delay needed restructuring and undermining the role of markets in setting risk premiums. Japan's debt is a third larger than the economy and bond yields are an impossibly low 1.40 percent.

Ultra-low interest rates help Japan hide the true magnitude of its bad-loan problem. Atkinson estimates non-performing loans to be about 50 percent more than the Yn151 trillion (US$1.26 trillion) the government's Financial Services Agency says. Atkinson's examination of debt and operating profit of 2,823 publicly traded companies puts bad loans at an eye-popping Yn237 trillion.

The main reason asset quality in Japan isn't properly reflected is because nominal interest rates are so low. Companies can pretend to be sound because borrowing costs are negligible enough for them to make interest payments out of cash flows. Companies can be underwater but survive for years, so long as they can report an operating profit, or at least hold operating losses to a minimum.

All this leaves executives with little urgency to restructure.

Since they're propped-up by low rate loans, companies only have to cut costs enough to minimize losses, or preferably report just enough operating profit to cover the interest expense. "The low level of interest rates and the postponing of pain that it has allowed help to create a self-regulating, low-growth environment," Atkinson says.

A large number of Japanese companies are close to the edge. If borrowing costs rise or Japan's credit rating is downgraded, many companies couldn't afford the extra interest expense. Many would go bust.

It's at that point that things really get bad. Headlines about massive job losses at companies like Fujitsu Ltd, which is shedding 5,000 workers in Japan, may undermine consumer spending and send the economy even lower. Standard & Poor's this week had to deny reports it was lowering Japan's "AA+" credit rating amid fears mounting bad debts would destabilize the economy. The mere fact investors took the reports seriously speaks volumes about the economy's situation.

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