The Coming Week in Asia: Larger Japanese Companies Feel Better About Business

TOKYO -- The question that will be on traders' minds this week is whether business conditions are finally improving for Japanese corporations. But the answer will depend on what part of the Bank of Japan's quarterly tankan report, due out this week, they dig into.

In the report, investors will be examining the diffusion index, or DI, which is seen as a gauge of Japanese business conditions. The DI subtracts the percentage of firms reporting unfavorable conditions from favorable responses. A positive number, therefore, means there are more optimists than pessimists.

Most market watchers expect that the September DI for large manufacturers will improve to plus seven, up from plus three in the last survey. This would mean managers at large firms thought business conditions were improving for the seventh consecutive quarter. The survey is also expected to show a forecast that the December DI will improve even further, to plus 10.

That said, the DI for large nonmanufacturing companies paints a different picture. Many of these companies have been squeezed out of the capital markets, been the subject of bank action on outstanding loans or are possible takeover targets. The DI for these companies is expected to slip to minus eight. In addition, the DI for small to midsized firms is expected to be even worse, at minus 17. As a result, small companies aren't expected to increase spending anytime soon. Rather, they are seen cutting capital expenditures by 2% compared with the previous year.

"As I have been arguing for a long time, this sort of positive picture among Japanese manufacturers is still a product of conspicuous achievement by a relatively small number of companies," writes Noboru Kawai, analyst with Morgan Stanley Dean Witter, in a recent report. "And behind the overall improvement lies an increasing divide among players."

But if overall business sentiment is getting better, do investors have to worry about the smaller companies and the economic weaklings? They wouldn't if these teetering companies were forced to declare bankruptcy or were carved up by acquirers. Neither of these is happening, though.

The construction sector is a recent example, after news of debt forgiveness for major companies. Hazama said this week that its four main creditor banks agreed to waive nearly 105 billion yen ($981 million) in debt repayment as part of a five-year restructuring plan. Hazama owes most of its debts, or about half the total, to Dai-Ichi Kangyo Bank. DKB just re-emerged on the financial scene as Mizuho Bank, after concluding its first merger step with the Industrial Bank of Japan and Fuji Bank.

By now, Japanese investors may be used to hearing about large banks forgiving debt. Everyone wants, and according to DKB, deserves, a clean slate, right? But by waiving Hazama's debt, DKB isn't just propping up the large construction concern. It's also throwing a life preserver to small ailing concerns that are tied to Hazama. As a result, historical customs and business connections seem to be triumphing over hard-nosed, sink-or-swim business principles.

That means hard-hitting restructuring plans like that undertaken by Nissan Motor (NSANY Quote) are the exception, not the rule. So even if the tankan report shows that some businesses are feeling good about conditions, investors might want to ask if their optimism is actually a negative for the market in the long term.