Protracted fallout

Naoto Kan’s government struggles to beat a bad press about nuclear power - despite the sector’s importance to Japan’s energy - and rebuilding delays the ruling party’s reform agenda, which perpetuates economic stagnation, writes Tomas Hirst.


Instead the point that ought to be made is that this extremely serious, but also exceedingly rare natural disaster was prevented from causing more widespread social and economic disruption. At least a part of this reflects the success of safeguards in the nuclear industry that managed to prevent a nightmare situation.

As an example, the nuclear plant in Onagawa, 75 miles from Fukushima and closer to the earthquake’s epicentre, was successfully shut down on March 11. Indeed local residents forced out of their homes by the strength of the quake made their way to the plant seeking shelter, and two weeks later more than 200 people remained there in a makeshift camp.

Simon Somerville, joint head of the Far Eastern equity team at Jupiter Asset Management and manager of the Jupiter Japan Income fund and Jupiter Japan Select Sicav, says there is also evidence the public support for nuclear power has remained resilient.

“In April, only a month after the earthquake, there were regional elections and a number of anti-nuclear campaigners stood for office. They failed to make any ground, much to the surprise of a lot of people, and more broadly there appears to be a recognition that nuclear will have to be a part of the solution to Japan’s energy needs,” he says.

Nuclear power already accounts for about 30% of Japan’s energy supply and last month Naoto Kan, the country’s prime minister, called it a “major pillar” of Japanese society. While he also announced a full revision of energy plans his words highlight the undeniable fact that to date nuclear power has offered an important solution for a resource poor country.

Moreover while the anti-nuclear lobby may complain of the inherent risks of using nuclear fuel, in the short term any reduction in energy supply from nuclear plants will likely have to be replaced with greater use of fossil fuels. This, of course, would meet equally fierce resistance and would increase Japan’s reliance on imported fuels.

At its most basic the problems at Fukushima were the result of outdated technology which meant that the structure of the plant itself was vulnerable and the safety mechanisms inadequate to cope when the quake and tsunami hit. Where viable alternatives are lacking it is problems of this nature that should be concerning policymakers around the world rather than trying to gain political capital by bringing the entire nuclear power industry into question.

This was echoed in the preliminary findings of the International Atomic Energy Agency on the Japanese earthquake released on June 1. Its report stated that the “tsunami hazard for several sites was underestimated” and recommended a tightening of nuclear regulation to ensure “regulatory independence and clarity of roles are preserved in all circumstances”.

While the tone is stern it hardly constitutes a damning assessment and includes a deal of praise for the speed and effectiveness of the response to the unfolding crisis. John-Paul Temperley, a co-manager of the Martin Currie Japan Alpha fund, says many of its recommendations already seem to be a core part of the Japanese response:

“There is some evidence that the authorities have become stricter in terms of plant maintenance. However, I think it’s unrealistic in the short term for Japan to stop using nuclear power.”

As the summer approaches the threat of increased demands on already stretched energy supplies is causing a headache for Japanese industry.

Last month the Japanese government called for businesses and households in Tokyo and northeast Japan to cut their electricity use by 15% over the peak season. This comes after the earlier announcement from Chubu Electric Power that it would close its Hamaoka nuclear plant, which supplies 15% of Tokyo’s electricity, over concerns that it would be vulnerable to a major earthquake.

The news was hardly welcomed by Japanese businesses, including automakers such as Honda and Toyota that have both been forced to operate at about half their intended levels since March because of a lack of components.

While prospects for imminent balance sheet recoveries in the first two quarters of the year look slim Temperley says the timing of the earthquake probably saved corporate Japan from a far more serious outcome.

“Of all the times for this disaster to happen it was fortuitous that it occurred after the collapse of Lehman Brothers,” he says. “Japanese companies have spent the last few years improving the quality of their balance sheets. If anything this situation should increase the resolve of these companies to move more of their business overseas and in crease their competitiveness.”

One business, however, did not survive the earthquake unscathed. Before the crisis Tepco’s market capitalisation was about ¥3.4 trillion (£25.5 billion) but in the two weeks after the quake hit it dropped by over ¥2.5 trillion to its lowest point since April 28, 1964.

Masataka Shimizu, the company’s president, quit his post last month following the announcement of a $15 billion (£9 billion) loss suffered as a consequence of the Fukushima incident. This marked another undesirable record of the worst financial losses of a nonfinancial company in Japanese history.

With the Japanese government still failing to clarify its plans for Tepco both shareholders and bondholders have been left with a great deal of uncertainty. The core debate centres on whether the business will be nationalised or whether bondholders will be forced to accept haircuts on their holdings.

“From a shareholder perspective Tepco was already a zombie company before the earthquake,” says Somerville. “It was making decisions based on what was best for Japan rather than what was best for shareholders. However, given the uncertainty surrounding the cost of the clean-up at Fukushima and the country’s national debt problems I don’t think Japan can afford to nationalise it.”

If the decision not to nationalise the struggling energy company is taken this does not preclude the possibility that the government will take an active role in protecting it. Kan’s government has already approved the creation of a fund that Tepco can draw money from to pay compensation to victims of Fukushima, expected to amount to billions of dollars.


Temperley, however, disagrees with Somerville’s analysis saying that the Japanese government can illafford to place the pain of a bail-out on bondholders.

“The costs involved to run these facilities properly rather than profitably are considerably different and personally I would never want to own utility company shares. In the end [Tepco] has to be nationalised as if the government forces bondholders to take a haircut then no-one will invest in the company again.”

The prospect of taking the company’s balance sheet liabilities onto the government’s books will not be an appealing one so it is likely Kan will prevaricate for a while longer. Since the crisis Tepco has been supported by emergency loans from banks but how long these firms will be willing to extend credit without explicit government support is open for debate.

Jonathan Schiessl, the manager of the Ashburton Japan Equity fund, says the near-impossibility of breaking up Tepco coupled with the complexity and scale of the problems facing the company might mean “we’ll see decades of these issues rumbling on”.

Given that the company supplies 29% of Japan’s energy to more than 2m businesses and 24m households the company’s present difficulties have a pronounced impact on the broader economic health of the country. As such the necessity to find a permanent solution to its woes must be a pressing concern for all the relevant parties.

In terms of finding a lasting solution not just to short-term energy supply requirements for the next few months but also for Japan’s long term energy needs clarity will be required. Sadly like the electricity itself this appears to be in short supply.

In many ways Kan’s Democratic Party of Japan (DPJ) can justifiably rue the timing of the earthquake as it has helped sink any hopes of reviving its stalled reform agenda. If it does prove to be the final nail in the proposals, however, it will be widely seen as a coffin of their own making.

It was not for want of a mandate. In the run-up to the 2009 elections the Liberal Democratic Party (LDP) had been in power for all but 11 months since 1955 but were under huge pressure from the DPJ having suffered a significant defeat in the earlier prefectural elections in Tokyo.

As predicted, the DPJ stormed to victory, taking 42.4% of the national vote against the LDP’s 26.7% share.

Given the mandate the party had – and its reformist agenda – many people in the West dared to hope that Japan could finally break with two decades of disappointing returns for equity investors just as it had with its voting patterns. Many within the country, however, remained more cautious in their enthusiasm.

Schiessl was among those who expressed his optimism that 2009 marked a turning point saying after the elections:

“As far as we are concerned this result has changed something. It’s changed the idea that Japan is unwilling and unable to change. The electorate has delivered the mandate and it’s up to the DPJ to deliver the result. This will undoubtedly take time and face considerable hurdles on the way. The sceptics would argue the DPJ has neither the policies nor political nous to deliver against huge expectations. While it is too early to fully refute this position, we expect that the widespread under-estimation of the DPJ will continue for at least the rest of 2009.”

Yet by June 2010, after only eight months in office, the dream was already being tarnished as Yukio Hatoyama, the first DPJ prime minister, resigned in the wake of a humiliating dispute with America. The spat was over his failure to accomplish his election pledge to relocate an unpopular American military base on Okinawa.

In the aftermath Kan was forced into a difficult leadership contest with Ichiro Ozawa, commonly seen as one of Japan’s most Machiavellian politicians and a representative of the old money politics. Although he won a comfortable majority from broader party members, within the ranks of the 411 DPJ members of parliament he scraped a tight victory of 206 votes against Ozawa’s 200 indicating a deep rift within the party.

Kan’s support for a rise in consumption tax was seen as a central sticking point and has been described as “political suicide” for any Japanese politician who attempts it. Despite this, outside the country such a policy is seen as essential in the long term for Japan to get itself back onto a solid fiscal footing.

The cost of the rebuilding effort following the earthquake has made the prospect of even modest reform highly unlikely. In March the new prime minister abandoned plans to raise child subsidy from ¥13,000 to ¥20,000 to free up funds for the disaster effort and in April he agreed to LDP and New Komeito party, another opposition group, suggestions to review child subsidies further and look again at highway tolls scrapped by the DPJ. This succession of climb-downs make it all the more unlikely that the DPJ will be able to maintain sufficient momentum or support for its agenda. Kan survived a vote of no confidence against him last week filed by opposition parties but faced with a rebellion within the DPJ he has offered to step down once the crisis has abated.

Were he to do so Japan would have to elect its sixth prime minister since 2006.

“The reality was that the DPJ was voted in on a protest vote against the LDP and the optimism wasn’t really there to begin with in Japan,” says
Temperley. “There’s no faith at all in Mr Kan and the DPJ. The earthquake has tied their hands at the moment and their job now is simply to stabilise the situation.”

An alternative solution to the situation being considered is the possibility of a “grand coalition” between the DPJ and LDP. What this would achieve policy- wise is unclear, especially if political stability is bought at the cost of democratic opposition.

With the full cost of the disaster relief and rebuilding projects estimated to reach about $200 billion Japan’s political quagmire looks set to swallow the DPJ. It may well be up to other, less established opposition parties to take up the baton of reform.

Not everyone is convinced, however. “Politically things couldn’t be worse than they are today,” says Paul Chesson, head of Japanese equities at Invesco Perpetual. “I don’t think anything is going to meaningfully change in Japanese politics in the rest of my career.”

Surprisingly there appears to be a fair amount of positive news beginning to creep into the public domain.

Masaaki Shirakawa, the governor of the Bank of Japan, announced at the start of the month that supply chain bottlenecks were easing much faster than initially expected. Factory output rose 1% in April after a record March decline as successful rebuilding work and better-than expected energy supplies allowed companies to beat earlier forecasts. Some automakers expect to return to normal production levels by August.

“The energy supply side has become better, including Tepco’s, and companies are being savvy moving their employees’ weekends to Thursday and Friday to ease demand pressures,” says James Salter, the manager of Polar Capital Japan. “The supply chains for the automakers have become decisively better.”

A recovery in factory output could help ease some of the concern surrounding Japan’s near-term economic prospects, made manifest in Moody’s decision to put the country’s sovereign rating under review for a potential downgrade.

It could also raise hopes that optimism earlier in the year about Japan’s recovery was not misplaced. The Bank of America Merrill Lynch Fund Manager survey in January showed the country moved from a net 13% underweight to a 5% overweight.

“This good news is significant for the equity market as it should mean profits are better than expected,” Chesson says. “Double-dip risk is very, very low and Japan was already enjoying a domestic recovery before the earthquake.”

For the longer term, Japan’s recent history has given some people grounds for more optimism.

“The positive is that after 50 years of one party in power there has been change,” says Temperley. “It’s going to take years for Japan to grasp the nettle of coming to terms with the national finances. Ultimately Japan needs to grow itself out of its current debt problem.”

Undoubtedly, despite the earthquake, corporate Japan has managed to put itself in a much stronger position than its sovereign host. Unfortunately without an alignment of interests in getting the country’s economy back onto a sustainable path – which will likely mean targeting the domestic market’s apparently insatiable desire for government bonds – the long-term outlook continues to be challenging.