The Coming Week in Asia: Sogo Bankruptcy Muddies Policy Waters

TOKYO -- When

Sogo

, one of Japan's largest department store operators, filed Wednesday for bankruptcy under court protection with $18 billion in liabilities, the first question traders asked was how the collapse would affect monetary policy.

Sogo's failure has thrown a big question mark out there. When they meet on Monday, will

Bank of Japan

policymakers raise the overnight call loan rate, akin to the

fed funds rate, by 25 basis points to around 0.27%? Or will the bank keep its extraordinary zero-interest rate policy until the fall to avoid any controversy in the wake of the nation's second-largest corporate collapse?

"Should bank shares come under selling pressure due to (Sogo's) failure, the BOJ may have to concede that the very condition that spurred zero rates in the first place has not been adequately resolved," said Tim Kerans, strategist at

Barclays Capital

. Before Sogo's failure, it was widely believed that the BOJ would do nothing.

The

Tokyo Stock Exchange's

bank subindex dropped 2.1% the day after Sogo filed for bankruptcy but rebounded smartly Friday, taking back 1.5%. This indicates a confidence that creditor banks can survive even if more dud loans emerge with a rise in bankruptcies. So perhaps, some traders say, raising rates can be justified. On the other hand, perhaps the banks rebounded on the perception that the bank

can't

raise rates in the wake of the Sogo blowup.

At this point, nobody seems to have a clear-cut answer on what the BOJ will do. If the bank does, in fact, hike rates, the stock market may see yet another dip because investors reckon higher rates will lead to more bankruptcies.

According to

Teikoku Databank

, a private research firm, bankruptcies jumped 32.2% in the first half of 2000 from the same period last year to 9,304 cases. If there are plenty of firms out there that can't pay back loans when interest rates are nearly zero, how could they pay back lenders with rates higher? Traders suggest the

Nikkei 225

could easily drop to a key psychological

support level of 16,800 from Friday's close of 17,142.9 before any bargain-hunting fund managers came in.

In the long term, however, what happened to Sogo, is actually good for the stock market. When the government backtracked on its promise to prop up the ailing firm with taxpayer money, it set an important precedent. If it was willing to let Sogo, a firm with a rich 170-year history, collapse, then maybe it won't use public funds to bail out other teetering firms, as it often has in the past. Japan's public debt will reach 136% of gross domestic product this year; nobody wants to see it go any higher.

"In the long-term, the retraction of Sogo's debt forgiveness package should contribute to more transparent restructuring processes and a stronger credit culture," says Takamasa Yamaoka, analyst at

Standard & Poor's

.

That's exactly what the stock market is looking for corporate Japan to embrace. In the end, investors are going to love the fact that Japanese firms are cleaning up their books and adopting corporate governance procedures. The positive reaction in the stock market, however, probably won't emerge until later this year, when investors are more comfortable with a rate hike and therefore an increase in bankruptcies.

Prime Minister

Yoshiro Mori

may have a lot of explaining to do about interest rates and Sogo when he meets his

Group of Eight

counterparts at the Okinawa summit next weekend. But instead of profusely apologizing as Japanese leaders often do, Mori should stress that Sogo's failure was a sign of change in the right direction in corporate and municipal Japan, and not a bungling of policy.