Annual Report on Japan' s

Economy and Public Finance


- No Gains Without Reforms -

December 2001

Cabinet Office

Government of Japan

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   Points of Chapter 2
   [Section 1 Swelling non-performing loans]
 With cases of loans becoming fresh non-performing loans continuing, the balance of non-performing loans keeps increasing. (Estimate: About ¥10 trillion of bad loans disposed of a year and about ¥10 trillion of loans becoming fresh non-performing loans right arrow Balance of non-performing loans remains high at slightly more than ¥30 trillion)
 With the amount of disposal of non-performing loans exceeding the profits from the core banking business, it can be said that, in terms of profitability, banks are virtually in the red. The non-performing loans will continue to erode banks' profitability for some time to come.
 The actual amount of non-performing loans disposal expenses far exceeded earlier estimates.
 54% of the non-performing loans are concentrated in three industries: real estate, construction, and wholesale and retail. Recently, non-performing loans to manufacturers have been expanding.
 Factors that gave rise to fresh non-performing loans: Against the background of the prolonged economic recession, the following three points are important: (a) Since the three industries hold huge tracts of land, they were affected by a decline in land prices, (b) In addition to the sluggish economy, business performance with other industries is spreading in the wave of industrial structural adjustment pressures, (c) Stricter assessments by financial institutions.
 Estimate of excessive debts of corporations: About ¥70 trillion (Total outstanding debts: about ¥400 trillion)

   [Section 2 Non-performing loans and excessive debts a burden on the Japanese economy]
 The problem of non-performing loans drags on the economy in the following ways:
   (a) Disintermediation of bank-system lending caused by the erosion of banks' profitability (Coupled with sluggish demand for lending, banks' lending decreased by an annual rate of 2%. DI reading for bank willingness to lend stays at a low level despite low interest rates (the DI reading of small and medium-sized enterprises still remains negative). Banks, busy with the disposal of non-performing loans, are unable to engage in forward-looking tasks.)
   (b) Economic resources, such as labor and capital, are stagnating in low productive fields. (In the 1990s, lending to the real estate industry that had been suffering from sluggish profitability increased drastically: more than double (in 1990) compared with 1985 right arrow increased nearly three-fold (in 1998))
   (c) Corporations and consumers have become cautious due to a decline in confidence in the financial system. (At present, the proportion of people who are worried about their deposits due to potential collapses of financial institutions = exceeds 50%, and those who are cutting back on consumption = 20%)
 The problem of excessive debts reduced business investment. (It dragged the level of capital investment down 8% in the second half of the 1990s)
 Necessary measures: (a) Drastic disposal of non-performing loans and establishment of bank revenue sources, (b) Economic revitalization through structural reforms will curb the incidence of non-performing loans and support the above.

   [Section 3 Structural reform raises growth rate]
 As a result of low growth in the last 10 years, Japan' s potential growth rate has declined drastically. Japan' s potential growth rate over the next two to three years is about 1%. The decline of productivity of the non-manufacturing industries is conspicuous.
 If structural reforms are completed, Japan' s potential growth rate is likely to rise to about 2% or above in the medium- and long terms.
 The present GDP gap is about 3~4%. (It was 4% during the 1998 recession.)
   It is necessary to open future prospects (raise the expected growth rate) for corporations through structural reforms. Rise in expected growth rate right arrow Expansion of business investment and personal consumption right arrow Rise in growth rate (Estimate: A 1% rise in expected growth rate right arrowAbout 0.5% rise in the actual rate of growth)

Chapter 2

Problem of Non-Performing Loans and Strength of the Japanese Economy
   The government at a cabinet meeting in June 2001 adopted "Structural Reform of the Japanese Economy: Basic Policies for Macroeconomic Management" (or "The Basic Policies" ), outlining the type of economy and society that Japan should aim to build in the 21st century and the basic policies for achieving this aim. "The Basic Policies" sets forth solving the problem of non-performing loans as the first step toward economic revitalization in response to the contents of the Emergency Economic Package (adopted in April 2001) that calls on banks to clear their non-performing loans off their balance sheets in two to three years. Later, the government worked out the "Reform Schedule" outlining the sequence of structural reform initiatives and then the "Front-Loaded Reform Program" that contains certain initiatives which must be formulated and implemented in advance of the general body of reform, including specific measures to promote the disposal of non-performing loans, such as expansion of the function of the Resolution and Collection Corporation (RCC).
   In this chapter, the present state of the problem of non-performing loans will be analyzed in Section 1 and the importance of the final disposal of non-performing loans and corporate restructuring as called for in "The Basic Policies" for the Japanese economy to extricate itself from 10 years of stagnation will be explained in Section 2 by exploring the mechanism by which the problem of non-performing loans constitutes a burden on the Japanese economy. And Section 3 will show that the potential growth of the present Japanese economy has declined considerably and study to what extent the economy could increase its potential growth if the problem of non-performing loans was drastically disposed of and if the strength of the Japanese economy was drawn out by structural reforms.

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