Japan running out of choices - OECD

Reform-minded prime minister Junichiro Koizumi will have to pull all the right policy levers

In this story: Meagre growth of 1 percent in 2001 Clear sense of policy direction required Government must sack bank managers, report says RELATED SITES

TOKYO, Japan -- Japan may have no choice but to bail out some of the country's ailing banks to ensure the stability of the financial system, the OECD said on Thursday.

In its semi-annual Economic Outlook, the Organisation for Economic Co-operation and Development called for urgent action to tackle squarely the balance sheet problems of banks, insurance companies and the corporate sector.

Their problems are the legacy of the bursting of Japan's bubble economy a decade ago.

Managing the loan clean-up will be a huge task for the authorities, in particular as flagging confidence may dictate that it will have to be carried out in a short period of time," the Paris-based forum of 30 industrial nations said.

Meagre growth of 1 percent in 2001

The OECD, which forecasts meagre GDP growth for Japan of one percent this calendar year and 1.1 percent in 2002, acknowledged that purging bad loans could lead to rising bankruptcies and unemployment in an economy that is already badly underperforming.

Many Japanese corporates still have to clean up their balance sheets

"The Japanese economy is faltering and at risk of entering a downward spiral," the report said.

As a result, monetary policy, which the Bank of Japan relaxed in March to drive short-term interest rates to zero, must be geared to providing "maximum support" to activity in the foreseeable future.

Moreover, new reform-minded Prime Minister Junichiro Koizumi needs to pull all the structural policy levers to facilitate the wrenching adjustments that the debt clean up will entail.

Clear sense of policy direction required

"The most pressing requirement for policy is to give a clear sense of direction. This requires an acceleration of structural reforms with priority on those that would open up new business opportunities and facilitate reallocation of resources," it said.

Koizumi has endorsed a plan put forward by the previous government to write off bad bank loans within two to three years.

But details remain vague, and the OECD said inadequate disclosure of loan quality means the scale of the problem is probably greater than the authorities have recognised.

Tougher external audits are needed to get an accurate picture of the state of loan books. Banks must then be required to write down their assets to realistic values, which could reduce their capital below the internationally mandated level of eight percent of risk-weighted capital.

Government must sack bank managers, report says

If a second bail-out is organised, on the heels of widespread public fund injections in 1998/99, the government must sack the managers of the banks involved and ensure that existing shareholders are not bailed out, the report said.

A bail-out would add to a government debt burden that is already the largest in the OECD area. Gross debt is projected to reach 138 percent of GDP next year and 158 percent by 2006.

Given the current weakness of the economy, the OECD said Japan cannot afford to start tightening its belt this year.

"However, the start of the consolidation cannot be delayed much further," the report warned.

Repeating earlier projections, it said fiscal policy might have to be tightened by a whopping 10 percent of GDP or more simply to stabilise the ratio of debt to GDP by 2010. This would require cuts in public works spending and tax rises.

The OECD assumes that the government will start to put its fiscal house in order in 2002 when, by the latter half of the year, growth should have started to firm again.

In the immediate future, however, the outlook is poor, with falling export demand exacerbating weakness stemming from the inadequate pace of corporate restructuring and concerns about financial stability -- identified as the greatest downside risk.

Reuters contributed to this report.

OECD

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