Bull Market in Bankruptcies Darkens BOJ's Year: William Pesek

Commentary by William Pesek

Aug. 18 (Bloomberg) -- Bank of Japan officials can be excused for feeling a bit disoriented.

When Masaaki Shirakawa became BOJ governor in April, Japan was holding its ground amid a worsening global credit crisis. He and his fellow policy makers were predisposed toward raising Japan's 0.5 percent overnight lending rate.

As the BOJ tomorrow begins a two-day policy meeting, it is looking at a very different scenario. Asia's biggest economy -- which contracted an annualized 2.4 percent last quarter -- is on the verge of a recession. It also may be in the midst of its worst year of bankruptcies since a banking crisis that ended early this decade.

That kind of economic whiplash would be bad enough if not for the return of inflation. After a decade of falling prices, higher energy and commodity costs are eroding households' purchasing power and companies' profits. Consumer prices, excluding fresh food, climbed 1.9 percent in June, the fastest pace in a decade.

All this puts the BOJ in quite a bind. It can forget its strategy to get short-term rates further away from zero. The ultra-low level of borrowing costs also means there's little ammunition for monetary stimulus.

The odds of a rate cut are growing, and last week's bankruptcy filing by property developer Urban Corp. demonstrates why. With $2.35 billion in debt, Urban marks Japan's biggest corporate failure this year. It joined builders Zephyr Co. and Kyoei Sangyo Co. that went bankrupt last month and raises the stakes for the BOJ.

Confidence Booster

A quarter or even half a percentage point move wouldn't revitalize Japan's economy. Cutting rates would be more of a confidence-boosting exercise to soothe four constituencies: business executives, households, politicians and investors. Expect the BOJ to come under more pressure to act as U.S. growth wanes and chips away at Asia's prospects.

Japan, which has the world's largest public debt, has little room to come up with a generous stimulus package. Yet elected officials and regulators would be negligent if they ignored worrisome signs from the real-estate and construction industries.

Nationwide corporate bankruptcies rose to 1,372 cases in July, the highest since July 2003, Tokyo Shoko Research Ltd. said in an Aug. 8 report. To analysts such as Nobuo Tomoda of Tokyo Shoko, ``bankruptcies are very clearly on a rising trend'' with real-estate and construction companies at the forefront of a recent wave of failures.

Worse, the trend is set to accelerate. Expect additional collapses of mid- and small-size companies as banks cut off funds to businesses with poor management.

Corporate Failures

The biggest question is how the increased appearance of the word ``bankruptcy'' in headlines affects the economy. That's especially so as the global credit squeeze intensifies, Japanese land prices fall further, and companies suffer greater losses.

The dynamic is a work in progress. Failures among property enterprises are having a ripple effect on construction firms and banks with large loans outstanding. The industry is struggling as banks cut lending and the economy slows. On Aug. 6, the government said there is a ``high possibility'' the economy has entered a recession after six years of growth.

``Due to the series of bankruptcies over a short period of time and because Urban Corp. is relatively large, we think banks will become even more conservative with regard to loan policy to the real estate sector,'' says Koichi Iwama, a credit-research analyst at UBS Securities Japan Ltd.

Property Values

Much has been made in recent years of rising real-estate values in major cities. Condominiums for sale in the Tokyo region in July dropped 45 percent to mark the 11th month of declines, the longest stretch since a 15-month drop through December 1991, according to Japan's Real Estate Economic Research Institute.

Such trends would be less of a concern if other forces seemed likely to drive growth. Japan has been pledging to balance the budget by 2011, and so fiscal options are limited. So are monetary options. Slowing global growth also means Japan can't rely on exports.

BOJ's policies appear to be benefiting folks overseas more than those in Japan. The lowest government-bond yields in three years are prompting investors in Japan to buy higher-coupon debt. That has corporate borrowers turning to Japan for cash they are hard-pressed to get anywhere else.

From Zurich-based bank UBS AG to Bentonville, Arkansas-based Wal-Mart Stores Inc., debt sales in Japan by overseas issuers are up 37 percent this year from the same period of 2007, data compiled by Bloomberg show. Merrill Lynch & Co. says sales of so- called samurai bonds this year may be the highest since 1996.

If only Japan's monetary largess were benefiting its own economy more. The problem is scant confidence among executives and consumers about the future, and rising bankruptcies won't help. If BOJ officials were expecting an uneventful end to 2008, they aren't likely to get it.

(William Pesek is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: William Pesek in Tokyo at wpesek@bloomberg.net