Five Years On, Japan Eyes Recovery from Crisis

Japanese Prime Minister Shinzo Abe has put Japan back on the minds of global investors, as his policy mix of drastic monetary easing and fiscal stimulus has raised expectations that the economy may finally be exiting 15 years of deflation.

But the move also marks a belated departure from traditional policy measures that had failed to get the world’s third-largest economy out of the ditch it fell into five years ago following a global financial crisis.

The bankruptcy of Lehman Brothers in September 2008 shook Japan’s economy by its core. While losses suffered by Japanese financial institutions were marginal compared to their U.S. and European peers, the fall in international trade deprived the country of its main growth driver: exports.

The Japanese economy shrank 12.4% in the October-December period of 2008 in annualized terms, and then posted a record 15.0% drop in the following three months—far worse than the U.S., the epicenter of the crisis. Japanese exports fell an average 37% a month between November 2008 and October 2009. Exports took an extra hit from the yen’s sharp rise, as investors unwound years worth of so-called yen carry trade of borrowing and selling the yen for investments in higher-yielding instruments in other currencies.

The downturn quickened the fall of Japan’s standing in the international arena. China overtook Japan as the world’s second-largest economy in 2010, just as the center of global economic-policy making was shifting from the Group of Seven nations–where Japan is the only Asian member–to the G-20, where Japan is overshadowed by emerging nations including China.

And the financial crisis exacerbated the weaknesses of the economy that had for years failed to overcome growth-stunting price falls and build itself on strong domestic demand. The traces of the damage are still seen today.

While the country’s real GDP finally returned to its pre-crisis level in the April-June quarter of this year on the back of strong consumption induced by Mr. Abe’s policy, industrial production and business investment still stand below where they had were before the crisis.

Japan’s policy response to the 2008 crisis received little kudos.

Taro Aso, the prime minister at the time and now finance minister, compiled a record stimulus package worth over Y15 trillion, but its emphasis on infrastructure projects led to calls for eliminating wasteful public spending.

The Bank of Japan also came under fire for what critics said was a too-timid response. While the signs of a global crisis began to surface in the summer of 2007, the BOJ waited until the end of October 2008 to cut its policy rate. And when the bank finally moved, it only opted for a smaller-than-usual 0.2 percentage point cut–at a time when other central banks were taking more bold action, such as cuts of one full percentage point.

Some key elements of Abenomics, notably structural reform measures, are still being worked out. But by appointing a new BOJ governor who drastically stepped up monetary easy through a doubling of bond purchases, and seeking to accelerate business activity through corporate tax cut rather than pork-barrel spending, Mr. Abe has managed to raise optimism that Japan’s economy may finally recover fully from the impact of the financial crisis.

The Bank of Japan’s aggressive easing policy has pushed up asset prices, with the benchmark Nikkei stock average standing above 14,400 recently, against around 12,200 in September 2008. By pouring more money into the economy, the yen has also fallen from record highs marked after the crisis. While still stronger from its value of around Y107 to a dollar before the crisis, at just above Y99, the Japanese currency is well off the record high of Y75.32 marked in October 2011.

For Japanese financial institutions, which had kept a relatively low profile after its own banking crisis in the late 1990s, the 2008 financial crisis provided an opportunity to shine.

In the wake of the Lehman failure, Mitsubishi UFJ Financial Group Inc. Japan’s biggest bank, decided to spend $9 billion to buy a 20% stake in Morgan Stanley, which was desperately in need of cash at that time.

While the deal was viewed with skepticism given the differences in their corporate cultures and wage structures, it seems to have worked out for MUFG.

One of the three ventures they have set up since–a loan-marketing business in New York–has helped MUFG take advantage of Morgan Stanley’s network and win financing opportunities. The alliance helped push MUFG’s rankings up in the project finance and syndicated loans league table globally.

Nomura Holdings Inc., Japan’s biggest brokerage, made an even bolder move and took over Lehman’s operations in Asia and Europe, with an ambition to join the group of top global investment banks.

But Nomura’s move has produced mixed results. When it signed the deal, it hired more than 8,000 ex-Lehman staff, some with hefty pay packages. This would later hit Nomura’s profitability, forcing it to ramp up cost-cutting. Although there are now only a few senior former Lehman bankers left at Nomura globally, the brokerage continues to struggle to generate profits overseas.

Koji Nagai, who took the helm of Nomura in August last year, said the deal can’t be viewed as a success, but the purchase of Lehman operations boosted Nomura’s brand, making it easier for the firm to attract talented bankers.