Japan’s economy has been in a funk for nearly 25 years. The global economic slump that followed the 2008 financial crisis only added to worries, prompting Japanese companies to horde cash. As a result, many corporate treasury functions went into hibernation.
Companies have had little need to borrow, whether from banks or the capital markets. Indeed, their net liabilities – excluding shares and other equities – fell below zero last year. In addition, memories from earlier decades of huge losses from real estate and other disastrous investments have prompted them to confine investing their abundant cash to highly conservative investments offering minimal returns.
Ultra low interest rates in Japan and the declining yen (JPY) have made hedging those risks all but unnecessary, especially for exporting companies. Importers with sufficient heft to hedge currency risk have stuck to the most straightforward financial hedges.
Since Abenomics launched two years ago, those trends have mostly grown more pronounced. Treasurers’ humdrum days of late, however, might soon start to sizzle again. A key indicator suggests Japanese companies are bound to ramp up capital expenditures, mergers and acquisitions (M&As) and the accompanying capital-market activities, with increased M&A potentially resulting in some finance executives fighting for their jobs.
This Time it’s Different
The indictor in question is net domestic fund demand, the sum of corporate savings and the Japanese government’s budget deficit, which has jumped in recent years.
The corporate savings rate has been trending down since 2010, a sign companies are increasingly putting their capital to use. However according to Takuji Aida, Société Générale Securities’ chief economist in Japan, someone has to borrow to expand the macro economic balance sheet and spur economic activity. From 2001 until late 2011, fund demand hovered around zero, meaning there was little monetary expansion. That in turn meant that Japan’s economy experienced no growth, whether measured by gross domestic product (GDP) or stock or real estate prices.
Today, via Abenomics, the government is providing the necessary leverage in a big way, resulting in greater net domestic fund demand. “The definition of ‘Japanisation’ is not just falling prices, but the loss of net fund demand,” says Aida. “It’s different this time around. Net fund demand has revived, and this is because of Abenomics.”
Increasing net fund demand means more money circulating in the Japanese economy and – if it continues -climbing out of the deflationary stagnation that has plagued the country for over two decades. In fact, that has been the goal of Abenomics and its three prongs: fiscal stimulus, monetary easing and structural reform.
Government’s Leverage Opens Business Opportunities
Fiscal stimulus adds to the Japanese government’s debt, already troublesome at more than 200% of gross domestic product (GDP) and prompting a Moody’s Investors Service downgrade on December 1 over concerns about deficit reduction. Nevertheless, Japanese corporate risk receives a top A1 rating from Coface, a French provider of credit insurance and receivables-related services.
“Abenomics has helped Japanese corporates,” says Julien Marcilly, head of country risk at Coface. “The first rule of Abenomics was much more accommodative monetary policy. Consequently, the yen has depreciated a lot, and that has had very positive impact on corporate profits.”
A sign that Abenomics is starting to work is banks’ increasing willingness to lend to small and medium-size Japanese companies. They have previously been reluctant lenders, since SMEs are typically service-related and depend primarily on the domestic market for growth. “Those companies are lagging indicators, so even the lagging indicators are improving,” notes Aida.
He acknowledges that some recent economy activity has been generated by government spending unrelated to Abenomics; primarily reconstruction spending in the wake of the March 2011 earthquake and tsunami. Aida expects the impact of Abenomics’ fiscal portion, including a variety of infrastructure projects, to be felt over the next few years, further bolstering economic activity. Japanese unemployment rate has already been falling rapidly, now hovering around 3.5%. “Next year it should fall below 3.5%, and then aggregate wages should expand very strongly and consumers will finally feel the end of deflation,” he predicts.
More Corporate Treasury Action
That’s good news for Japanese companies. Combine more money in consumers’ pockets with ultra low corporate borrowing costs, whether bank loans or bonds priced over government debt (this month began with the 10-year rate at 0.47%), and it’s a recipe for a significant increase in business activity.
“If Japanese companies collectively begin to see light at the end of the tunnel, a tremendous amount of economic activity could erupt,” says John De Clue, chief investment officer (CIO) of the private client reserve at US Bank.
Abenomics has had a less positive impact on exports than expected because Japanese companies, like those in other developed countries, have shipped much of their production overseas. Jun Kigoshi, head of corporate banking in Japan for Bank of America Merrill Lynch, said companies’ more expensive and advanced products are often still produced in Japan, and the weaker yen – with over JPY120 to the US dollar at the time of writing against just over JPY100 in August – has been a boon.
“Japanese companies have regained competitiveness for the high-end products, and their sales forecasts for the coming year in terms of sales are very positive,” says Kigoshi. They further benefit from producing and selling products in overseas markets, since repatriating those earnings and converting them into the weaker home currency magnifies profits. All this means corporate balance sheets are cash rich.
“The headache for treasury executives is finding where to put all that liquidity, since Japanese banks provide virtually no interest on deposits,” says Kigoshi. He adds that banks
are still a primary destination for JPY-denominated cash, and dollars typically are invested in US Treasury bonds or other ultra safe investments. Companies don’t wish to take market risks and instead keep the money available for future big decisions, especially acquisitions abroad.
Aida notes that at just over 1% inflation is still very low but – in large part due to Abenomics – it has finally exceeded the rate of long-term government bonds. That prompted investors, whether individuals, institutions or corporates, to seek investments with returns exceeding the inflation rate. An indication of that occurring is corporates’ increasing capital expenditures. “If one looks at profit data for the third quarter that has recently been released, and also data on corporates’ capital expenditures, you see that they’re both increasing,” says Marcilly.
Another indication is last month’s announcement by Japan’s Government Pension Investment Fund (GPIF), which manages US$1.4 trillion in assets and is one of several huge Japanese public pension funds that it plans to increase its allocation domestic and foreign equities significantly.
“In Japan, institutions tend to move in unison, and GPIF is one of the largest pension funds, suggesting others will follow suit,” De Clue said. “This is one of the most tantalising stories today about Japan.”
Abenomics’ pressure on JPY clearly complicates the pursuit of foreign acquisitions. However, weighing in demographical trends that point to a shrinking Japanese market makes overseas expansion essential for Japanese multinationals seeking long-term growth.
“Japanese companies are always looking for opportunities to grow their global footprint and gain market share outside of Japan,” says Kigoshi. “That means M&As may always be an option. Treasury executives are being asked by top management to be ready to move if good opportunities arise.”
He adds that Japanese exporters essentially stopped hedging fluctuations in JPY a year ago. Simply holding a stronger foreign currency has proved to be a more profitable route, or waiting to exchange into JPY only when necessary, since that’s likely to result in a better FX rate. In general, however, companies prefer stable exchange rates, and that has especially been the case for importers, such as energy companies or those focusing on agricultural products or consumer goods.
“The yen has been very volatile, and that’s a headache for treasurers of companies on the importing side,” says Kigoshi. He added that SMEs typically have neither the negotiating power with their banks nor the expertise or staff to effectively engage in financial hedges. Larger companies, recalling losses stemming from complicated hedging strategies pursued two decades ago, are using straightforward hedges, such as forward contracts, and finding ways to reduce costs. “Since they can’t control the cost of imported materials, they’re putting more pressure on operations or administration to cut costs.”
Acquisitions, however, are a priority for Japan’s multinationals. Although the weaker currency is a hindrance, banks are flush with capital and loans are cheap. According to Kigoshi, one of the main concerns in terms of M&A for Japan’s top executives has always been how to integrate corporate cultures. Foreign acquisitions often have more advanced finance frameworks and systems to handle cash management and other functions. “Several companies that have made big acquisitions have proceeded to upgrade their treasury system infrastructure and methods, learning from the acquired company,” he notes.
In a significant change, Japanese multinationals have even hired non-Japanese executives to fill top positions. In the past 18 months, for example, Takeda Pharmaceutical has hired both a French president and chief financial officer. With regard to CFO François-Xavier Roger, the company said in the press release that, “Takeda is seeking to raise the global competitiveness of every aspect of its business,” adding, “The establishment of the CFO position to lead global financial functions, as well as IT and procurement, is one example of the strategic initiatives being implemented in this regard.”
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