Is Japan's recovery under threat?

The sun is steadily rising again over Japan's economy. But could there be clouds on the horizon in the form of new restrictions on consumer finance?

The sun is steadily rising again over Japan's economy, but more than a few doomsters claim to see clouds on the horizon. Their focus is the financial regulator's plans to toughen restrictions on consumer finance and reduce the interest-rate cap levied on borrowers from 29.2% to 15%-20%.

Some foreign investors, including large hedge funds, say that they will reduce their investments in Japan, or even withdraw completely if the proposals go ahead, according to the FT. They complain that it will reduce the number of lenders prepared to offer sub-prime loans and undermine the consumer finance sector, and say that the knock-on effects could weaken the entire economy. The FT quotes Jesper Koll, Merrill Lynch's chief economist in Tokyo, who says it could shave a whole percentage point off the country's GDP at a time when economic growth is forecast by the central bank as no more than 2.4% in the current fiscal year and 2% in the next. He says this could be as big a mistake as the consumption-tax hike in 1997 that stubbed out a previous nascent recovery.

"Nonsense", retorts Julian Jessop of Capital Economics; such fears are "grossly overdone". Japan is a low-debt economy where consumer borrowing "plays only a small part in driving spending". What's more, the cap has been reduced before in 2000, from 40% without causing major problems and as the current charges by the five largest consumer finance companies average 23%, rather than 29.2%, the new cut is less than it seems. On top of that, the new restrictions on the dominant consumer finance companies could also have positive effects by stimulating conventional bank and credit-card lending, which are relatively under-developed in Japan.

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It's to be hoped (and sounds likely) that Jessop is right, but Japanese policymakers have a long record of derailing recoveries. If they avoid doing so this time, Japanese equities are set for a storming bull run, according to a recent analysis of post-deflation stockmarkets by CLSA strategist Russell Napier. Although the Nikkei 225 has more than doubled in three years, this is normal in a deflation recovery; equities should eventually rise 700% from their lows, he says. Currently, the bull market is only in stage one: deflation has ended, reducing equity risk and boosting valuations. Stage two when bond investors move back into equities

en masse hasn't yet begun.

For more on investing in Japan, see our recent Money Morning article: Could Japan's stockmarkets rise another 300%? Find out what Japanese interest rate rises will mean for markets, and why you should invest in Japan now. And for another opinion on Japan's economy, read Jeremy Batstone on what's next for Japan's recovery.