Future of Japanese Economy in Balance

PERHAPS by force of will, or maybe hope, Japan's economy seems to have remained largely unscathed by Prime Minister Morihiro Hosokawa's sudden decision to leave office last week.

Many analysts here seem ready to believe that Japan has hit bottom after a three-year recession and that its economy is now in the delicate process of turning around. After all this waiting, no one wants to see the recovery of the world's second-largest economy squashed. But economists realize that the nation faces a lengthy stretch of political turmoil.

The stock market took a tumble Friday, when Mr. Hosokawa announced his intention to step down, but investors rallied; the Nikkei Stock Average gained 44.01 points, or 0.2 percent of its value, to close at 19,934.99. Monday it dropped 36.91 points, or 0.19 percent of its value.

Signs of a recovery have been picking up lately. Last week the governor of the Bank of Japan, Yasushi Mieno, declared that prospects for a turnaround were brightening. Some key indicators released in the past two weeks suggest that ``the good news is getting better, and so is the bad news,'' says Robert Alan Feldman, a Tokyo-based economist with Salomon Brothers, the investment house.

Recently released numbers on the economy's performance in the fourth quarter of last year showed gains in three key areas: public investment, consumer spending, and housing starts. While overall gross domestic product barely grew last year, Mr. Feldman and other economists say the prospects for a broader expansion of GDP this year are good.

Hosokawa's departure will not adversely effect the turnaround trend ``because the agenda of the new government will be exactly the same as the old one,'' Feldman says. But he adds a disclaimer: ``The worry in my mind is some sort of political paralysis.''

That worry loomed larger Monday evening amid growing indications that the coalition Hosokawa headed will split. Students of Japanese politics say Japan is in the midst of creating an entirely new political system to replace the 38-year rule of the conservative, pro-business Liberal Democratic Party. Hosokawa's coalition displaced the LDP in August, but the current turmoil demonstrates that the transition is by no means over.

The business community's most immediate interest is passage of the national budget for the 1994 fiscal year, which includes a tax cut and increased infrastructure spending designed to spur growth. That process has been blocked for a month by the LDP, now in the opposition, which had been demanding information about Hosokawa's personal finances.

The prime minister said he was quitting because he had discovered evidence of improper financial activities sanctioned by his office and because he wanted to undo the parliamentary deadlock.

Yuichi Matsushita, market strategist for Nikko Securities in Tokyo, says he is a ``little bit optimistic'' about the future of the economy in spite of the resignation. He sounds hopeful about prospects for an imminent announcement of a successor to Hosokawa and a quick passage of the budget. Although institutional investors in Japan are showing more than their usual caution, he says foreign buyers have been active. ``The market is already foreseeing that the new prime minister will pursue the existing government's policies and reforms.''

Mr. Matsushita adds that he is ``very much sorry'' to see Hosokawa fall, since he was ``the consensus choice of all the people.''

Of course, not every economist is certain that what is on the horizon - never mind Hosokawa's resignation - is an economic recovery. ``I do admit that consumer sentiment improved for a while, but I'm a pessimist,'' says Mineko Sasaki-Smith, an economist for Morgan Stanley Japan. ``Cyclically there's been an upturn, but structurally there's lots of drag.''

Ms. Sasaki-Smith argues that fiscal measures like tax cuts, low interest rates, and government stimuli have been responsible for the release of some pent-up consumer demand. She says some real problems have not gone away: vast quantities of nonperforming loans left over from Japan's spend-happy ``bubble economy'' of the 1980s, as well as excess capacity in the manufacturing sector.

Companies are therefore downsizing, which Sasaki-Smith worries will increase unemployment and dampen consumer spending. The high yen also is encouraging consumers here to buy imported goods, a trend that will force further contraction among Japanese manufacturers and further downsizing. ``People will continue saving more than they are spending,'' she says. Furthermore, the potential for a lengthy period of political turmoil ``is another uncertainty, and that is not to be underestimated,'' Sasaki-Smith says.