Japanese gloom deepens as shares hit 30-month low

Fears of more corporate failures and deepening pessimism about the state of the Japanese economy sent share prices in Tokyo down to a 30-month low.

Meanwhile, the credit rating agency Moody's Investors' Service announced that it had downgraded the sovereign debt of Indonesia, Malaysia, Thailand and South Korea to junk bond status. Stephen Vines in Hong Kong reviews the carnage.

Remarkably the downgrading of credit standings in four Tiger economies yesterday did little to shake South East Asian markets whereas in Tokyo the International Monetary Fund's (IMF) downgrading of Japan's economic growth outlook for the coming year was received very badly.

The IMF is now predicting that the economy will only grow by up to 1.1 per cent. Just two months ago it was forecasting growth of 2.1 per cent. Japan's Economic Planning Agency has also revised its economic estimates down but said over the weekend that it expected the economy to grow by 1.9 per cent in the coming financial year.

Neither prediction is very encouraging. Investors responded by marking down shares on the key Nikkei-225 index by 3.4 per cent, taking it to a low of 14,569 points before the market finally closed at 14,799. In the last four trading days the Japanese stock market has plunged by more than 10 per cent.

At this level the market is well below the psychologically important 15,000 barrier which many analysts had predicted would not be breached without finding buying support.

However the buying support was notably absent yesterday. Moreover the market is now in danger of plunging into a self feeding circle of decline. This is because the biggest holders of shares are Japanese banks, whose asset base is unusually dependent on equity holdings.

The government's tight fiscal policy is causing real pain Aware of investors' concerns the Japanese government has made some concessions designed to stimulate economic activity. The biggest measure, announced last Thursday, was a two trillion yen (pounds 9.2bn) tax rebate. The ruling Liberal Democratic Party is also proposing a massive bond issue to raise 10 trillion yen (pounds 46bn) for the Deposit Insurance Corp. to protect depositors and help boost capital at troubled financial firms.

These measures have failed to impress investors who are still saying that the government has acted too little, too late. The government however insists that its actions will be enough to produce economic growth of close to 2 per cent next year.

Although the sell-off of the Japanese market has probably been slightly overdone and some bargain hunting is likely to lift shares in the near term, the underlying problems of the economy and an expected squeeze on corporate profits suggest that the stock market will not be able to sustain a recovery any time soon.

Meanwhile the selling pressure on the Japanese yen mounted again yesterday with the yen falling to around Y130.5 against the United States dollar. Last week the Bank of Japan made an aggressive foray into the foreign exchange market to stop the yen losing value. This represented a backtracking of the previous policy which was to allow the yen to find its own value and sent uncertain signals to investors.

Yesterday, the Bank of Japan retreated to the sidelines and the yen slid back around one US cent. However, the government does not want the yen to fall and some market rumours suggest that it will try on Christmas Day to push up the value of the yen in the Japanese market which will remain open.

Whether this would be sufficient to shift investor sentiment towards the Japanese currency remains doubtful. However, as yesterday's events in Asian markets yet again proved, investor sentiment is hard to predict. Just a month ago Moody's savage downgrading of bonds and bank deposits in Indonesia, Malaysia, South Korea and, to a slightly less extent, in Thailand would have sent their financial markets into free fall.

However, these markets are now sufficiently battered as to be virtually shock resistant. The stock market response was quite modest by the standards of extreme volatility which now prevail in the region. The Thai market suffered most, declining by 2 per cent. Both the Malaysian and Korean market slipped just 1 per cent, while the Indonesian market actually managed to inch forward a few points. Their currencies eased a touch but more on end-year balancing of books than the Moody's downgrading.