The Coming Week in Asia: Debate Rages over Japan's Economic Prospects

TOKYO -- The jury is still out on Japan Inc.'s prospects for growth, with foreign and domestic investors seemingly split over the economy's prospects.

The release of second-quarter gross domestic product data this Monday will add further fuel to the ongoing debate.

Bulls say that if the GDP comes in at the expected 0.8% rate, it will represent a further surge in economic activity and indicate two consecutive quarters of growth. Bears, however, are scoffing at what they call a paltry growth rate, although the government has spent 117 trillion on nine economic packages over the past eight years.

The diverging views were highlighted last Friday, when Moody's Investors Service weighed in with its opinion: It cut Japan's sovereign debt rating to Aa2, its third-highest rating, from Aa1, its second highest. In a statement, Moody's said government spending was excessive, adding that it was also worried about who would pay for national pension and health care systems that will add trillions in additional costs in coming years.

Despite this bleak warning, Japan's markets shrugged off the downgrade. The key Nikkei 225 index, which had dropped for the previous seven sessions, rose 1.2% on Friday. The reason, market watchers say, is that Japanese investors don't react to such downgrades, even though they usually spook foreign investors.

"The markets rarely react to Moody's warnings since most of the trading is controlled by Japanese traders and investors," says Yasunori Ueno, chief market economist at Fuji Securities. "But as foreigners increase their presence, that will change."

Instead of ratings downgrades, Japanese investors focus on earnings prospects and summer economic data. For example, investors have noticed that summer bonuses jumped higher for the first time since fiscal 1996, which is taken as a sign that large corporations have a brighter outlook about overall earnings. Also, the Ministry of International Trade and Industry predicts August and September industrial production figures will show that companies are churning out goods at a rate that will equal levels seen during the growth period of 1991 to 1997.

Still, the government spending issue is not one that can be easily ignored. This week will also mark the start of government discussions on how to spend the next -- or the 10th -- stimulus package. Finance Minister Kiichi Miyazawa has indicated that he wants a relatively small spending package of around 3 trillion to 4 trillion. However, key leaders in the ruling Liberal Democratic Party are already talking about a 10 trillion package. If such a large spending plan were approved, Japan's debt would surge to about 136% of GDP by March 2001. This would be the highest rate among industrialized nations.

In the face of the growth debate, investors have stuck with tried-and-true shares such as Sony (SNE Quote), Pioneer (PIO Quote) and TDK (TDK Quote) with expectations of robust fiscal first-half profits, which will be released starting in October.

Overall, profits for listed Japanese companies are expected to have increased by 14% in the first half, according to local press reports.

So amid the barrage of positive and negative news, what should investors do? Why, sit back and go neutral, says Noboru Kawai, strategist at Morgan Stanley Dean Witter.

"The economy's downside risks are getting smaller, but it's in exchange for the elimination of any additional [perks] to the pace of economic recovery," he says.