City on alert over Japan crisis

Fears that gloomiest Japanese reports yet may spark panic selling in world markets

REGULATORS are looking at the position of Japanese banks in the City of London, according to a well-placed government official. The fear is that a corporate bankruptcy in Japan could spook Western bankers into refusing to make short-term loans to Japanese banks exposed to such a failure, and that this disruption to London's inter-bank market could spark panic selling on international stock markets.

The move by financial regulators to identify Japanese banks that might be targeted if a large Japanese corporation were to founder is precautionary, and indeed is being publicised to demonstrate that officials are ahead of the game. But it underlines how seriously Western officials are taking the spate of bad news emerging from Tokyo over the past four days.

Both the London and New York stock markets are expected to open up tomorrow, according to City analysts. But they say that unless something is done to stop Japan's deteriorating economic position soon, investors may conclude the bull market is unsustainable. "It only took two months of instability in Asia to lead to talk about global deflation," said Joanne Collins, a market analyst at Nomura. "That's why Western leaders are making sure the situation in Japan remains under control."

In the wake of a dismal report on Thursday, showing that Japan's business leaders are less confident now than at any point in the past three years, Moody's Investor Services warned on Friday that its Triple A credit rating for Japan could be cut. Moody's warning pushed the yen to a six-year low against the dollar, and drove the Nikkei stock average down 1.2 per cent to 15,517 - only 10 per cent above the 14,000 level at which analysts say Japanese banks would begin struggling to meet international minimum capital standards.

Moody's warning came a day after Sony chairman Norio Ohga warned that "the Japanese economy is facing its most difficult time ever. I am concerned that if Japan falls into a deflationary spiral it would affect the Asian economies. In that case, not even the US economy would be able to maintain its healthy state."

Speaking at the London summit of Asian and European heads of state over the weekend, Japanese prime minister Ryutaro Hashimoto argued that his government was on top of the situation. "Japan will take the necessary economic measures, and at the same time provide assistance to the countries of Asia as well," he said.

This week, however, the markets will be focused on Hashimoto's stimulus package for the 1998 fiscal year under scrutiny in Japan's Upper House. "We expect the bill to be passed by 10 April," said Mr Collins. "When it is, the politicians will be able to speak more freely about its contents. The issue is whether there will be more tax cuts than the 2 trillion yen [pounds 9bn] in last year's package."

In London and New York, the quality of investors' fears has changed since last October, when the New York Stock Exchange closed after going into a free fall. The fear then was that collapses in a string of second-tier Asian stock markets would knock on to Tokyo and then to London and New York. This fear proved unfounded as US private investors, the rock on which Wall Street is founded, sat on their hands. Indeed, the weight of money speeding out of Asia buoyed Western stock and bond markets.

Now the fear is that the gap between Western and Asian economies and stock markets has grown so large that Asia faces a vicious deflationary spiral, which will suck the West into it. "If you look at what Hoover was saying at the start of the Great Depression and what Mr Hashimoto is saying at the moment, they are very similar," Sony's Ohga said.

So far, Western stock markets have shrugged off pessimistic talk of a slow-motion version of the dramatic collapse investors feared last autumn. Last Wednesday, the FT-SE 100 Index closed above 6,000 for the first time. On Friday, it closed at 6,064. The Dow Jones Industrial Average broke through 9,000 on Friday, before closing at 8,983.

But US corporate profits fell 2.8 per cent in the fourth quarter of 1997. Forecasters expect the rate of growth in both the US and UK economies to slow this year. The unresolved question is whether this slowdown will be a healthy pause, or the beginning of a downturn beyond the control of government officials and worse than the recession that wrong-footed politicians and forecasters in 1990.

City analysts say they will be watching the Bank of England's monetary policy committee when it meets on Wednesday and Thursday. A fortnight ago, after the Chancellor's Budget did little to restrain the British economy, it seemed all but certain the monetary policy committee would lift the 7.25 per cent base rate. Now, fears that the outlook for the world economy has darkened in the last four days may keep British interest rates right where they are.