b>JAPANS CONTINUING DEFLATION

Japans core consumer price index fell for the 35th consecutive month in August, down 0.9 per cent year-on-year. Unemployment in August was just below post-war highs at 5.4 per cent. The number of jobless increased by 250,000 year-on-year to 3.6m. To cap this extremely depressing batch of economic data household spending fell 2 per cent in August month-on-month. This seems to indicate that Japan is as much in the grip of deflation as ever and should give the G7 leaders assembled for the Washington summit plenty to muse over. Meanwhile, in an attempt to deflect criticism, Japan's leaders are suggesting that they may be prepared to act more agressively on the bad loans problem that plagues the banking system:

Japan will tell fellow members of the Group of Seven industrialised nations in Washington this weekend that it is prepared to use public money to bail out its debt laden banks, Masajuro Shiokawa, finance minister, said yesterday.

But the veteran politician offered no details of how the potential injections would take place and insisted the bailout would only proceed "if necessary", offering policymakers a range of options to avoid having to abide by this strategically timed pledge. Members of the G7 have been calling for a meaningful resolution of Japan's bad debt problem for many years and Mr Shiokawa's statement is likely to mollify them. But it could backfire if not backed by action. "At the meeting I will stress the importance of banks' liquidation of corporate borrowers in serious trouble. As a result we may inject public funds into banks, if necessary," Mr Shiokawa said yesterday.

Despite the rumours of his demise, Mr Yanagisawa - Japan's Financial Services Minister -was in unrepentant form yesterday, insisting an injection of funds is not needed but making his first public commitment to a scheme that would help the banks by expanding the role of the Resolution and Collection Corporation (RCC).Mr Yanagisawa said yesterday he would accept the use of public funds only if they were used to cover losses incurred by the RCC when it offloaded the loans it had purchased from the banks.The minister's comments neatly capture the core of the debate over how to deal with the bad loan problem. One view - the true bailout scenario - involves public funds being injected directly into the banks, wholesale management changes, a short-term rise in bankruptcies, rising unemployment and potential political and social unrest.The other view - the quasi bailout scenario - involves the bad loans being transferred to the RCC, which will offer a better price for them than previously. This will restore the banks to health but leaves borrowers just as bankrupt as before, but able to struggle on.
Source: Financial Times
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JAPAN BOND AUCTION FIASCO

Perhaps the best introduction to this latest faux pas in the unwinding Japan saga is the comment from Merrill Lynch bond strategist Masuhihsa Kobayashi who is quoted as saying: "It seems that fiction is becoming a reality." The backdrop to this rather painfully reality recognition (actually life has always been stranger than fiction) is todays withdrawal the Y1,800bn on auction offer since the bid volume was only Y1,185bn. This latest embarassment - following the BOJ sally into the terrain of share buying earlier this week - only serves to underline the instability of the whole situation. This is the first time ever a bond offer has been withdrawn (of course the bonds themselves have been fully subscribed by the contracted underwriters) and gives the awful impression that there are few buyers for Japan government debt. Of course the reality might just be an internal factional shooting war, hitting back at the BOJ, and attempting to undermine its authority, in the wake at the share buying initiative, which could, in its turn have been only a way of turning up the pressure. Who outside of the Byzantine world of Japanese institutional finance knows? The only painfully obvious truth is that this cannot continue indefinately.

Investor confidence in Japan suffered another blow on Friday after a Y1,800bn auction of 10-year Japanese government bonds was undersubscribed for the first time in its history. Traders were unnerved by the unprecedented lack of demand, but chalked it up to a case of incredibly bad timing. Earlier this week, the Bank of Japan said it would buy shares directly from commercial banks in an effort to reduce their massive exposure to stock markets, a move which sent shock waves through the markets.

Masaru Hayami, governor of the BoJ, was unconcerned. "I am not that worried. I believe investors' appetite for JGBs is unchanged," said Mr Hayami. He added that 10-year JGBs were in a correction phase and that some market instability was inevitable.But investors thought otherwise, and the auction's failure sent the JGB market reeling. The yield on the benchmark 10-year JGB rose 12.5 basis points to near two-month highs and the key 10-year JGB futures contract fell more than a point to 139.04 in intraday trade.
Source: Financial Times
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JAPAN FAILS TO CONVINCE

The latest news and economic data from Tokyo continue to cause concern. Yesterday the Nikkei average dropped 1.67 percent or 159.10 points to 9,362.53 after touching in one moment an 18 year low at 9,269.10. On November 10, 1983, it closed at 9,244.24.In part this downward movement is provoked by uncertainty concerning the immediate outlook in the US (and now in Europe judging by the latest survey data on August manufacturing). In part the fall is a reaction to talk of plans for large scale tax cuts, when it is absolutely clear that reducing government debt has to be high among Japan's priorities. And in part the move is a reaction to the continuing doubts about the real health of the Japan business sector as evidence accumulates that all is not what it seems.

It is hard to identify precise tipping points for Japan's agony, but in the past I have pointed to one indicator - a Nikkei below 10,000, for its feedback effects on the value of bank assets - as a possible candidate. Every day the Nikkei stays below that level marks one more day in which Tokyo moves a little bit nearer to the brink. Another possible candidate is obviously government debt, which continues to increase rather than decrease. My view is that no-one really has a firm, agreed figure for the value of Japan government debt as a percentage of GDP. In part this depends in what you count as debt. However for a long time now a widely quoted figure has been stuck at 130%. Well in this piece from the Reuters on Yahoo News they suggest the value is now 140% (remember with deflation the real value of debt automatically rises), so perhaps the stakes just went up.

It was only a matter of time until we fell this low," said Masanori Hoshina, head of global portfolio marketing at BNP Paribas. "Part of our weakness lies in concerns about the cloudy economic outlook in the U.S. But the key problem is that there are still no signs of a sustainable economic recovery in Japan," he added. Data on Friday showed the Japanese economy grew at a faster-than-expected 0.5 percent in the April-June quarter, but industrial production fell unexpectedly for the second straight month in July and other data showed deflation worsening. Declines in prices make it harder for Japanese companies to service their mountains of debt, adding to pressure on banks. High government debt levels are also a worry. "With a public debt of around 140 percent of GDP, the Japanese government doesn't have many cards left up its sleeve," said Hiroshi Nishiyama, senior portfolio manager at SG Yamaichi.

Against such a backdrop banks were pummelled. Mizuho Holdings Inc, the world's largest bank by assets, plunged 7.23 percent to 231,000 yen and was the highest traded issue by value on the first section of the Tokyo Stock Exchange. Rival UFJ Holdings Inc slipped 4.18 percent to 252,000. Japan's megabanks have large holdings of stocks on their books and falls in the stock market eat into their capital base, increasing fears of financial instability.

Another notable loser was Tokyo Electric Power Co Inc (TEPCO) , which extended its losing skid to six straight sessi ons and was down 1.46 percent on the day at 2,360. Shares in Japan's biggest power utility have come under heavy pressure since it said last week that it may have failed to accurately report cracks in its reactors. Traders say that a string of recent scandals in corporate Japan has helped undermine market sentiment and depress trading volume in recent weeks.
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CHINESE EXPORTS TO JAPAN JUST KEEP GOING UP

China is on the way to replacing the United States as the top exporter to Japan and could do it as early as this year, according to information provided by the Japanese government last Tuesday. China is still Japan's No. 2 trading partner behind the United States. But the figures indicate that China is rapidly passing the United States as the top exporter to Japan.

Roughly 17.8 percent of all good imported to Japan came from China during the first half of 2002, according to the Japan External Trade Organization. That's just behind the United States, which accounted for 18.2 percent of Japan's imports over the period.

But whereas imports from China increased over the period, imports from the United States decreased � narrowing the gap. "It is possible that, in terms of imports, China will surpass the United States in the very near future, perhaps as early as the second half of this year," said Masaki Yabuuchi, director of JETRO's China division.

Yabuuchi said imports from China were on the rise because Japanese manufacturers increasingly relocate their factories in China to take advantage of lower labor and materials costs. They then use China as a base for exporting back to Japan.

In terms of exports and imports, China accounted for 12.8 percent of Japan's total trade in the first half of the year, while the United States accounted for 24.3 percent.

The largest category of imports from China was machinery and equipment, comprising 33.9 percent, or $9.44 billion, of total imports. Japanese imports of communications equipment, including mobile phones, nearly doubled, $370 million, the report said.

Growth in Japanese exports was led by the automobile, steel and metalworking industries. The value of cars shipped to China in the period totaled $640 million � an increase of 60.5 percent.
Source: Yahoo News
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