JAPAN: REQUEST INFORMATION IN PREPARATION FOR G-20

C O N F I D E N T I A L SECTION 01 OF 07 TOKYO 000493

SIPDIS

STATE FOR EEB/IFD SAKAUE, WHITTINGTON, HUFF AND BROWN
NSC FOR HENNESSEY
TREASURY FOR MONROE, MURDEN AND BEASLEY, IA FOSTER, WINSHIP
AND DOHNER
USTR FOR AUSTR CUTLER AND BEEMAN

E.O. 12958: DECL: 03/04/2019
TAGS: ECON EFIN ETRD JA
SUBJECT: JAPAN: REQUEST INFORMATION IN PREPARATION FOR G-20
MEETING

REF: STATE 17502

Classified By: CDA James P. Zumwalt, Reason 1.4 (b) and (d)


1. (C) Summary. Domestic political gridlock continues to
stymie Japan's ability to implement the economic and
financial policies needed to help lead the country out of its
worst recession in over half a century. The government's
economic stimulus measures have large headline figures, but
the Cabinet Office estimates that the measures will only
boost GDP by less than 1 percent. Prime Minister Aso
promised bold action to correct plunging business activity,
to ease fears of rising unemployment, and to address record
drops in business confidence, but his policy proposals have
neither slowed the speed of the drop in Japan's economic
activity nor stemmed the erosion of his, his cabinets', or
the ruling coalition parties' public support. Japan analysts
are revising 2009 economic growth prospects downwards with
most expecting a drop of at least 10 percent in the
January-March 2009 quarter and forecasting that negative
growth until at least the second half of 2009.


2. (SBU) Recent Mission reporting on the economic crisis and
Japan's policy measures aimed at assisting the economy and
workers is contained in the following cables, all of which
have been e-mailed as well to State, Treasury, and NSC.

TOKYO 472
TOKYO 420
TOKYO 410
TOKYO 345
TOKYO 295
TOKYO 307
TOKYO 286
TOKYO 345
TOKYO 228
TOKYO 219
TOKYO 189
TOKYO 174
TOKYO 99
TOKYO 37
TOKYO 25
NAGOYA 1
08 TOKYO 3315
08 TOKYO 3430
08 TOKYO 3417
08 TOKYO 3408
08 TOKYO 3401
08 TOKYO 3326
08 TOKYO 3311
08 TOKYO 3302
08 TOKYO 3102
08 TOKYO 3079

MISSION JAPAN RESPONSES TO ECONOMIC CRISIS QUESTIONS
-------------- --------------


I. (SBU) Objectives for the London Summit


A. In the run up to the London Summit, what are the issues of
greatest importance to the host government?

-- The GOJ is fixated on domestic political difficulties,
with the ruling Liberal Democratic Party (LDP) primarily
focused on the timing and outcome of Lower House elections
that must take place by mid October 2009. Polls widely
predict the LDP will lose to the opposition Democratic Party

TOKYO 00000493 002 OF 007


of Japan (DPJ),which now controls the Upper House. Aso has
sought to leverage participation in international diplomacy,
including in the G-20 Summit process, into an improved image
at home to boost his and the LDP's election prospects.


B. Based on public comments made by host government
officials, what are the country's likely objectives for the
summit?

-- In his October 30 press conference before the first G-20
Summit in Washington, PM Aso named three priorities: (1) more
effective international coordination on the supervision and
regulation of financial institutions; (2) appropriate
regulation of credit rating agencies; and (3) reform of
international accounting standards, including easing
requirements to mark-to-market.

-- The GOJ supports a rapid and significant capital increase
for the Asian Development Bank. The GOJ also supports a
generalized quota increase in the IMF and has offered to lend
$100 billion of its own reserves to the IMF. The IMF and MOF
are working out the modalities of the loan.


C. Are there desired outcomes that officials have identified
publicly?

-- Not beyond those listed above.


D. Based on public information, what recommendations or
reforms might the host government suggest? For example, is
the host government proposing changes to international
financial architecture, reform of international financial
institutions, or advocating the creation of new international
bodies? Is the host government proposing additional
regulation of financial products or institutions, making
changes to existing regulatory standards, or advocating new
best practices?

-- The only further specificity based on publicly available
information came in October and November 2008, when the
Accounting Standards Board of Japan: (1) issued a
re-interpretation of the calculation of fair value for
illiquid assets; and (2) allowed for the reclassification of
some securities from the trading book. Both moves were
intended to be consistent with recent changes in U.S.
Generally Accepted Accounting Principles (GAAP) and
International Financial Reporting Standards (IFRS).

II. (SBU) Impacts of the Global Financial Crisis


E. What are the host government's greatest financial market
concerns (providing more liquidity to financial institutions,
dealing with bad assets, injecting fresh capital, improving
housing markets, guaranteeing deposits, making trade finance
available, etc.)?

-- The GOJ's main financial market concerns have been:
(1) The effect of the fall in equity prices on bank capital,
since Japanese banks still held JPY10.6 trillion in corporate
equities at end-September book closings;
(2) The health of smaller regional banks, which were never
cleaned up like the major banks in 1997-2004, and the
consequent effect on lending to small and medium-sized
enterprises (SME);
(3) The liquidity of the commercial paper (CP) market; and
(4) The ability of Japanese banks to access dollar funding.


TOKYO 00000493 003 OF 007



F. What are the most important impacts on the host country's
financial sector (what specific financial institutions have
failed, which ones have had liquidity/solvency problems, has
domestic lending to the corporate sector been affected, etc.)?

-- No major specific financial institutions have failed,
though the three largest banks (Mitsubishi-UFJ Financial
Group, Mizuho Financial Group, and Sumitomo Mitsui Financial
Group) have moved to raise additional capital. One small
life insurance firm, Yamato Life, failed in October 2008
after it made excessively risky investments, including in
foreign structured securities, in an attempt to compensate
for its relatively high distribution costs. Domestic lending
to the corporate sector has actually increased since the CP
market froze up, as firms moved from direct to indirect
finance.


G. What initiatives has the government taken in response to
the financial crisis (has the government rescued financial
institutions, provided capital injections or credit lines,
changed its deposit insurance guarantees, provided interbank
guarantees, established asset purchase programs, trade
finance, etc.)?

-- The GOJ has budgeted JPY20 trillion to purchase corporate
equities from the banks (although actual purchases will
likely be much less). The objective is to remove a source of
volatility from bank balance sheets without putting further
downward pressure on the markets.

-- The Diet passed new legislation allowing the GOJ to inject
up to JPY12 trillion in capital into banks. The GOJ has
already started injecting capital into smaller, regional
banks but has not announced any plans to inject capital into
larger banks.

-- The Bank of Japan initiated a program to purchase outright
up to JPY3 trillion in CP from financial institutions. The
government-affiliated Development Bank of Japan (DBJ) will
also purchase up to JPY2 trillion in CP directly from issuers.

-- The Bank of Japan also concluded a currency swap with the
Federal Reserve Bank of New York for dollar funding (without
an ex ante upper limit).

III. (SBU) The Broader Economic Crisis


H. What are the most important impacts on the host country's
real economy? What steps has the host government taken to
mitigate the effects of the crisis?

-- Japan was already in recession when the crisis worsened in
the fall of 2008. In Q4 2008, Japanese real GDP plummeted
12.7% quarter-on-quarter, seasonally adjusted. Real exports
fell at an unprecedented 45% seasonally adjusted annual rate
and net exports subtracted 11.5 percentage points from
overall growth. A drop in domestic demand also subtracted
2.5 percentage points from overall growth, mostly due to
declines in business investment (-19.5%) and private
consumption (-1.6%). Inventory build-up contributed positive
1.4 percentage points to growth, which bodes poorly for Q1

2009. Non-GDP data releases for January are now becoming
available and show continued drops exports and broader
economic activity.

-- The GOJ has implemented three separate economic stimulus
measures (one under former PM Fukuda and two under PM Aso).

TOKYO 00000493 004 OF 007


While their combined headline figure is an impressive JPY75
trillion, the Japanese Cabinet Office estimates that the
actual effect on GDP due to the creation of new demand will
be only 1%.


I. What has been the impact on trade, trade finance, and
employment in export-oriented sectors? Are there problems
financing exports and/or imports? If so, in which sectors?
How is the host government attempting to address these
problems?

-- Japan's exports (-45.7%) and imports (-31%) in January
2009 dropped dramatically according to GOJ data. Japan has
run four consecutive month-on-month trade deficits and ran
its largest current account deficit (Y968 billion) since
current statistics began in 1980. Private analysts forecast
Japan may run its first full-year trade deficit since 1980.
Export-oriented companies (e.g., Toyota, Honda, Nissan,
Panasonic, Sony, and shipping companies) are losing money,
but they also are restructuring domestically and
internationally to position themselves for when the global
economy recovers. Restructuring includes cutting part-time,
temporary, and contract workers as well as re-evaluating some
planned expansions in plant and other investments. These
companies are also applying for GOJ assistance programs,
including emergency financing and financial support for
overseas subsidies. Analysts' estimates of the number of
"non-regular" workers who will lose their jobs between
October 2008 and March 2009 run as high as 400,000. Media
reports suggest Japanese multinationals have laid off over
50,000 workers at overseas production facilities.


J. How has the crisis affected the host government's outlook
on trade and investment? Has there been a perceivable shift
in how the government and population view the benefits of
international trade? Are political pressures growing for
protectionist policies? Are measures being taken or
contemplated that would impose costs on other countries in an
attempt to meet domestic needs (e.g., tariff hikes, import
licensing or other trade restrictions on, or discrimination
against, foreign investors)? Is the host government
considering capital controls? On the other hand, is the host
government considering easing investment restrictions in an
effort to encourage foreign investment?

-- There has been no change in Japan's official policy of
promoting inward FDI or the national goal of raising Japan's
stock of FDI to 5% of GDP by FY2010. However, the need to
address immediate issues of declining industrial production
and increasing job losses means investment policy is not
receiving the high-level political attention it has in recent
years. Nonetheless, the bureaucracy continues to work on
updating and implementing the national investment strategy.
Japan is not considering capital controls. In fact, since
the crisis began, Japan has experienced a capital inflow and
a concurrent rise in the value of the yen. As part of its
new draft investment strategy, the GOJ is considering changes
to the effective corporate tax rate and targeted action plans
to promote inward FDI in selected industrial sectors, such as
health care and medical devices.

-- Japanese media opinion pieces -- and public figures --
have questioned the soundness of the U.S. economic model and
there have been articles comparing the Japanese "lost decade"
to the current U.S. economic crisis. Government officials,
however, have not expressed these sentiments and businesses
are not abandoning their strategies for U.S. markets.

TOKYO 00000493 005 OF 007


Ministry of Foreign Affairs (MOFA) and Economy, Trade and
Industry (METI) bureaucrats forcefully advocate for "no new
protectionist measures" language in all leaders'
declarations.


K. Do financial sector/industry bailouts or stimulus packages
have local preferences? Is the government acting to
influence the value of its currency (for example, to improve
export competitiveness)?

-- The measures taken by the GOJ do not appear to have local
preferences. There is foreign interest in participation in
the new BOJ and DBJ initiatives to purchase CP. The GOJ has
not intervened in the foreign exchange market since March

2004.

IV. (SBU) Near-term Outlook and Political/Foreign Policy
Ramifications


L. How has the outlook for growth, inflation, the current
account, exchange rates, and the budget deficit changed? What
are the biggest economic challenges facing the host country
in the coming months and year? How is this crisis expected
to affect employment?

-- January 28 the IMF projected Japan's economy will contract
2.6% in 2009 before returning to positive 0.6% growth in

2010. However, since then, economic data have generally
worsened. Private analysts project double digit negative
growth on a seasonally adjusted annualized basis in Q1 2009.
Private analysts also forecast a return to mild consumer
price deflation in 2009. The general government budget
deficit, already large, is projected to grow from 6.4% in
FY08 to nearly 10% of GDP in FY2009. Given a debt-to-GDP
ratio of 178%, Japan's lack of fiscal headspace inhibits the
size of stimulus measures. Unemployment jumped up in
December, although it ticked back 0.2 percentage points to
4.1% in January (seasonally adjusted),as discouraged workers
left the labor force. The crisis has prompted political
interest in providing greater protection for part-time and
dispatch workers, who have borne the brunt of layoffs, even
if those measures further restrict an already relatively
inflexible labor market.


M. What are the potential political ramifications for the
host country? How might the crisis directly impact
leadership? Is a change of government a possibility? What
are the social and security ramifications of the crisis?

-- Prime Minister Aso's public support numbers have fallen
from the mid-40s in September to the low teens. Aso and the
ruling LDP coalition's inability to undertake aggressive
economic policies contributed to the drop in support, which
could result in the first real switch between parties in
power since the 1950s. A change in government is possible in
the upcoming election, but given the present structure of the
Japanese economy, only an increase in the U.S., Chinese, or
other major foreign market demand for Japanese exports will
result in the country's return to economic health.


N. Has the host government criticized and/or become
significantly more critical of the United States for its role
in the crisis or for provisions in the U.S. economic stimulus
package (such as the "Buy American" provision)?

-- The GOJ has expressed concern on a number of occasions
about "Buy American" provisions in the U.S. stimulus package

TOKYO 00000493 006 OF 007


and urged the U.S. and other countries to avoid implementing
new protectionist in the name of combating the economic
downturn. There is Japanese criticism of the U.S. as the
cause of the crisis, but it has been muted and largely
limited to select newspaper editorials. Instead, the
government and high profile politicians have noted on many
occasions that Japan's experience in the 1990s provides
lessons for responding to the current crisis. These public
figures also call for a coordinated regulatory and monetary
responses within the G-20 and joint efforts to strengthen
international financial institutions.


O. How might the crisis affect host government foreign or
security policy and U.S. interests?

-- The global financial crisis hit Japan during a period of
stagnating economic activity and severe domestic political
turbulence, thereby heightening public dissatisfaction with
PM Aso and threatening the half-century dominance of his
ruling Liberal Democratic Party (LDP). With public support
for his administration in the low teens and the Upper House
of the Diet already in the hands of the opposition Democratic
Party of Japan (DPJ),Aso is constrained in his ability to
advance foreign policy and security goals. An electoral loss
to the DPJ could result in a new direction for Japan's
foreign policy and a period of uncertainty for U.S.-Japan
relations. In the near term, however, the focus on domestic
economic concerns should not have any real effect on the
government's willingness or ability to meet its international
commitments. If anything, Aso has worked hard to highlight
continued cooperation with the U.S. and other international
partners, as demonstrated by Japan's continued contribution
to refueling efforts in support of Operation Enduring Freedom
and the recent signing of an agreement to help finance the
relocation of U.S. forces from Japan to Guam.


P. How might the crisis affect the host government's ability
and commitment to sustain foreign assistance levels?

-- Japan's leaders have signaled an intent to meet ODA
commitments. In particular, the financial crisis has
catalyzed efforts to use ODA to pave the way for private
sector investment, particularly in Asia and Africa. At the
World Economic Forum annual meeting in January, PM Aso said
Japan is ready to provide ODA totaling JPY1.5 trillion ($17
billion) to support regional development in Asia and he
restated Japan's commitment to double assistance to Africa by

2012. Foreign Ministry officials are considering issuing a
statement during the March 2009 Tokyo International
Conference on African Development (TICAD) in Botswana calling
on G-20 leaders to resist falling behind on ODA commitments
to the region. In addition, a blue ribbon expert panel
submitted a report to MOFA in February concluding the GOJ
should restore the Japan International Cooperation Agency's
facility to direct ODA to support private sector
infrastructure projects. Japanese officials have reported no
effect from the crisis on the GOJ's ability to fund official
assistance, although the Japan Bank for International
Cooperation is reportedly considering borrowing dollars from
the GOJ's dollar reserves to offset increasing costs of
raising dollars in the bond market to fund foreign lending.


Q. How might the crisis impact government support for global
peacekeeping operations and commitments to NATO operations,
e.g., in Afghanistan?

-- Japan's tight fiscal situation has hit the Ministry of

TOKYO 00000493 007 OF 007


Defense (MOD) budget particularly hard. The 2008 defense
budget was the lowest in ten years as a percentage of GDP,
despite a general trend towards expanded missions for the
Self-Defense Forces. While government policy seeks expanded
contributions to UN peacekeeping operations, MOD has resisted
dispatching personnel to what the ministry considers
"non-critical" missions such as Nepal and Sudan, in large
part for existing budgetary reasons. The MOD has started to
invest in equipment necessary to take part in larger scale
multilateral operations, including Afghanistan. For example,
in the JFY2009 budget, MOD procured a mobile field hospital
and began the upgrade of its CH-47 heavy lift helicopter
fleet (the second largest in the world) to support
high-altitude operations.

-- Japan has made financial support for Afghanistan a
priority despite government belt-tightening. In the FY09
budget, Japan allocated over $300 million for support to the
Afghan National Police, the NATO helicopter fund, and other
stabilization projects in Afghanistan. Japan has also
expressed interest in becoming a major contributor to the
NATO Afghan National Army (ANA) expansion fund, although the
GOJ seeks to earmark its money to ensure it is spent only on
non-lethal programs. Japan has made a number of additional
commitments as the 2009 G-8 Chair to support international
peacekeeping and peacebuilding initiatives. Funding for
existing programs, such as the $15.5 million support for PKO
centers in Africa and Asia through the Japan-UNDP Partnership
Fund, is already locked in and should not be affected by the
economic crisis.
ZUMWALT