Japan suffered a slide into deflation in the 1990s and 2000s as a result of a sequence of negative and mutually reinforcing factors — the collapse of asset bubbles, a banking crisis, excessively cautious monetary policy, excess capacity and debt de-leveraging by the private sector.
The Ritesh Anand Column
The situation in the Zimbabwe is not yet as severe as in Japan, but some of the same deflationary symptoms do exist — and if the policy response remains sluggish and half-hearted, this increases significantly the risk of the Zimbabwe following the Japanese route into a deflationary spiral.
Story of deflation in Japan
Japan’s slide in deflation in the 1990s and 2000s was the result of a series of negative and mutually reinforcing factors that operated over a lengthy period.
The initial cause was the bursting of the asset price bubble at the end of the 1980s. The second half of that decade had seen both stock and property prices soaring to extremely high levels, but the Bank of Japan (BoJ) monetary tightening in 1989 and 1990 induced a massive reversal in asset prices — by the third quarter of 1992 real property prices were down 30% from their peaks, and real stock prices were down a staggering 60%.
The collapse in asset prices also led to severe bad loan problems at Japanese banks, which in turn created a credit crunch and severely impaired the monetary transmission mechanism. Aggressive expansionary monetary policy might have been able to counteract the impact of the fall in asset prices and the credit crunch, but the BoJ instead followed a rather cautious approach.
Broad money supply growth was allowed to decline below the level needed to support steady economic growth and positive inflation and deflation set in from the late 1990s onwards. This in turn sparked a further negative development: the corporate sector, which had accumulated excessive debt in the 1980s, now saw the real value of this debt rising due to price deflation and began to act to reduce debt levels. This meant lower investment and economic growth, deepening the economic downturn and perpetuating the problem of excess capacity created in the bubble years of the 1980s.
How it compares?
So how does the situation in Zimbabwe today compare with that in Japan in the 1990s and 2000s?
Asset prices: Like Japan in the early 1990s, Zimbabwe has suffered a downward shock to asset prices since August 2013. Real stock prices are down 36% from their 2013 peaks and real property prices by more than 20%.
The key difference between the two experiences is that the decline in property prices in Zimbabwe so far is much smaller than that seen in Japan as mortgage lending is not as developed as in Japan. This should mean a lesser impact on bank balance sheets in the form of bad loans.
Secondly, Zimbabwe’s stock market never really reached “bubble” territory. Stock valuations were reasonable given the growth forecasts. However, as economic activity stalled so did the market. Companies such as Econet, which was trading at US$0,90 in 2013 or 9x earnings, have fallen to 40 US cents (now less than 5x earnings) in recent weeks making it one of the cheapest telco stocks in the world. Delta shares tell a similar story although the decline in share price is not as significant.
Japan experienced a number of “false dawns” in the 1990s and 2000s where equity prices recovered strongly, only to drop back sharply again in the face of further shocks and disappointing economic performance. The decline in Japanese real stock prices far outlived the initial slump seen in the early 1990s, with prices continuing to trend down until 2008.
Non-performing bank loans: as noted above, the collapse in asset prices in Japan had a devastating impact on bank balance sheets and contributed to a serious credit crunch.
Non-performing loans (NPLs) in Japanese banks peaked at an estimated 20% of all loans in 2001. In Zimbabwe, NPLs peaked at 20% in November 2014 before declining to 15% in March 2015, due primarily to the collapse of a few banks. In the case of Zimbabwe, the significant increase in NPLs was not due to collapse in asset prices, but rather a slowdown in economic activity and poor lending practices.
Monetary policy: the shrinkage of bank lending in Zimbabwe is a drag on money supply growth and the weakness of broad money growth is one of the most worrying echoes of the Japanese experience. Given the inability to print new money, Zimbabwe relies on investment and growth in deposits. Since 2013, deposit growth has declined significantly.
In March this year, bank deposits grew by just 2% on the year, which is well below the levels likely to be consistent with reasonable economic growth and inflation around 4% (broadly Zimbabwe’s target). Zimbabwe deposit growth has been depressed for the last 18 months now and is currently consistent with either very low growth, very low inflation, or both.
Reviewing all the indicators above, it is reasonable to conclude that while Zimbabwe is exhibiting some of the same deflationary symptoms seen in Japan in the 1990s and 2000s the situation at present is less severe than it was in Japan.
However, a key thread running through the 1990s and 2000s in Japan was the weakness of the policy response. The authorities missed a number of key opportunities to alleviate the deflationary forces operating in Japan — interest rates fell too slowly in the early 1990s; there was a failure to act quickly to tackle the banking crisis; fiscal policy was tightened prematurely in 1997; the first QE experiment in the early 2000s was botched; the authorities allowed a steep appreciation of the yen in 1990-1995 and then again in 1999-2001 and 2007-2012.
Unfortunately, the Zimbabwe authorities have shown a similar tendency towards sluggish or even perverse policy responses: interest rates have remained high, money supply growth has remained low and well below target. Given the dollarised environment, the only way to expand deposits is through attracting foreign investment. Zimbabwe has failed to attract meaningful foreign investment due to policy inconsistencies and political instability.
Zimbabwe needs to develop an attractive investment policy if it is to avoid falling into a deflationary spiral. Authorities need to accept that this is no longer disinflation, but rather deflation.
Corporates are starting to cut wages, prices continue to decline putting pressure on margins, while costs remain sticky. Zimbabwe, therefore, risks falling into a deflationary trap unless government acts decisively to stimulate growth and economic activity.