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The chief economic development over the Lunar New Year period has been the renewed weakness of the yen. The decision by the Japanese authorities to make it abundantly clear that they don't favor yen strength is positive, as is the growing focus on monetary policy in Japan.

This is not to say that we have resolved how Japan should "monetize." The fact is that the

Bank of Japan

has been accommodative in recent years in the sense that its balance sheet has expanded. It is therefore overly simplistic to say that Japan should just "print money." It is also understandable that the Bank of Japan is not prepared to underwrite new Japanese government bond issues by buying them directly from the government. This would clearly be an abdication of central bank responsibility.

The main reason that there has not been more expansionary monetary consequences of the Bank of Japan's liquidity-enhancing actions lies in the continuing failure of the banking system to create credit, which in return relates to its burden of nonperforming loans. The key financial point therefore remains what it has always been, namely for the banks to write off their bad debts. In this respect the new banking regulator in Tokyo is clearly making progress in focusing individual banks on their respective realities as regulatory deadlines near. Do not be surprised at some of the prestigious names that fail to pass the solvency test.

Yen Weakness: Good and Bad News for Asia

A weaker yen may be good news for Japan given the deflationary momentum of a stronger currency. But the rest of Asia will not view it as such. Greed & Fear will now act on the premise that the yen will continue to weaken, which is the logical consequence of the current trend of both Japanese fiscal and monetary policy and in line with the long-term yen forecast here of 150 yen to the dollar. The weak yen will initially look worse for Korea.

Still, Greed & Fear will remain overweight this stock market because the positive stance there is based on perceived restructuring, not on a strong yen play. Indeed, the yen weakness will provide an opportunity to add to weightings in Korea at lower price levels. The kick provided by the weaker Japanese currency will also give a renewed prod to the Chaebol to push ahead with restructuring.

The other big losers from renewed yen weakness will be in the greater China block. Hong Kong remains the predominant hiding place of the closet-index crowd running Asia ex-Japan money. The turn in the Japanese currency has added to the risk of that stance. Longer term, however, a declining yen must be good news for Asia, since it will hasten the day of a long-awaited Japanese recovery. That will not bail out Hong Kong from a renewed downturn in asset prices.

Thailand vs. Indonesia

Systemic nonperforming loans in Thailand are now probably running at more than 50%. This poses the question, What is the difference between Thailand and Indonesia? The answer is now only one, namely racial riots. Still, the stock market has more than discounted that contrast. The

Jakarta Composite Index

is down 7.9% in U.S. dollar terms this year, as is the

MSCI Far East Free ex-Japan Index

. Greed & Fear is raising the Indonesian weighting to a neutral 3% due to an improvement in the political situation.

The recent amendments to the electoral laws have created an environment in which it is possible to imagine the elections in June being conducted in a "reasonably" fair manner, in the sense that the process will be legitimate enough not to provoke mass bloodshed. The best that can be hoped for is that the majority of the ruling


party be reduced to such an extent by some form of coalition arrangement that it satiates the thirst for change, fanned by a now free and lively press, which permeates all sections of society, be it taxi drivers, students or stockbrokers.

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This raises the issue of who will head Golkar in the election. There is growing talk in Jakarta that Gen.


, head of the armed forces, may now emerge as the Golkar candidate. If so, this would prove to be the party's best chance of maintaining a semblance of popular legitimacy given President


proximity to


. Golkar may be widely detested but its key advantage in any election remains its grassroots organization, which means the ability to buy votes from reasonably empty stomachs.

It is also a fact that Golkar is less unpopular outside Java than within it, since the economic crisis has most devastated Java for precisely the reason that it was the region which profited the most from the boom. Wiranto running for president would also give the army incentive to make sure the election process looked reasonably fair, as this would be needed to ensure continued



World Bank

funding. It is, after all, the continuation of such funding that is the only thing giving the present government legitimacy. The passage of the electoral laws in January reducing armed forces representation in the lower house to 38 unelected seats out of 500 from 75 has also shown a willingness to compromise. That may not meet the student demands for a total removal of the army from the legislature. But such a radical move could easily have backfired in the sense that it would have given the military every incentive to go extraparliamentary.

The history of emerging markets has shown that it usually makes sense to buy before a critical election, since the worst tends to be discounted before the actual polling. Remember Russia in early 1996, when

Boris Yeltsin

had only 5% approval in opinion polls and there were widespread fears of a

Communist Party

resurgence? If the market begins to sense that some form of coalition government can emerge with the necessary legitimacy, a pre-election rally can occur. Certainly the two key opposition figures,

Megawati Sukarnoputri


Amien Rais

, are both politicians that stock market investors can live with, in the sense that they are not espousing extremist or sectarian positions. Any such rally would have more fundamental underpinning if the forthcoming plan to close 40-odd banks by the end of this month is implemented better than the disastrous efforts of the past. In this respect it is hardly possible to believe it could be handled worse.

The lack of banking sector recapitalization remains a key problem in Indonesia. But this will not stop a rally since the sort of stocks foreign investors will buy -- namely



Gudang Garam





-- are not banks. In this respect, Indonesia is also different from Thailand.

Bangkok Bank's

market capitalization is $1.8 billion, compared with $2 billion for the entire Indonesian banking sector.

Suharto's Legacy

One last word on Indonesian politics. The country's fundamental problem remains a power vacuum, a natural consequence of Suharto's New Order, which prevented any opposition for 32 years. Everyone in the current power structure, be they politician, bureaucrat or in the military, owes their place to Suharto, including Wiranto. Indeed Wiranto was Suharto's former aide-de-camp. If the commander really wants to act presidential, he is going to have to make a break with the past. This may involve having to reconcile what many would perceive to be the irreconcilable -- namely honoring his oath to protect Suharto and his family while at the same time heeding popular agitation for investigation of the former first family.

Wiranto is also going to have to show his mettle by dealing more resolutely with growing outbreaks of disorder across the country. A policy of shoot to kill will not please armchair liberals abroad, but it will satisfy a popular yearning for law and order, for if the military cannot keep the peace, what is its

raison d'etre

? The answer is not business.

Christopher Wood is the global emerging market strategist for ABN Amro. He is the author of The End of Japan Inc. (Simon & Schuster, 1994). Under no circumstances is this to be used or considered as an offer to sell, or a solicitation or recommendation of any offer to buy. While he cannot provide investment advice or recommendations, he welcomes your feedback.