EUROWEEK: Do you believe that the Abe stimulus programme, the rally in the Japanese equity market and the downward pressure on the yen are all sustainable, or is this just another false dawn for Japan?
Kubo: You’re absolutely right to base your question on the fact that, for the last 20 years or so, Japan suffered from deflation and a stagnant economy. There were quite a few reasons for this. One was that we had an unstable political environment in recent years.
Mr Abe seems to have learned a lot from these periods of instability and has prepared well for his second term in office in order to pull Japan out of the very long-term doldrums we have experienced. He also has a talented team of political and economic advisors. He is healthy, gifted, and determined to take a strong leadership role as we expect. And his economic policy — the so-called “Abenomics” — has been very timely.
He has already fired the first arrow, which is a bold monetary policy, by appointing Mr Kuroda as Governor of the Bank of Japan. Kuroda-san has been aggressive in proceeding with the monetary policy.
The second arrow is the flexible fiscal policy. Specifically, the supplemental budget for FY2013 should boost Japan’s GDP by 2% or so. Two arrows have been fired and up to now these policies have been working very well.
As to the third arrow, which I believe is most important, Mr Abe is to launch a growth strategy. The third arrow should be effectively fired versus plenty of opposition expected since this growth strategy will call for massive deregulation and the fixing of various long-term structural weaknesses.
Having said that, we should admit that people’s mind-set has been changing gradually. Although not completely yet, consumers’ confidence is clearly improving, as seen in department store sales etc. Additionally, some of Japan’s leading entrepreneurs and CEOs are also changing their attitudes towards investment.
Abenomics has started to gain some ground in the battle against deflation. The general sentiment is on the mend compared with six or 12 months ago when the sentiment in this country was quite negative.
EUROWEEK: Internationally, the media and the investment community seem to be giving Japan the benefit of the doubt, but there also appear to be some serious issues ahead. How confident are you that Japan can meet these challenges, especially those that arise from slow growth and unfavourable demographics?
Kubo: I think the BoJ’s action, together with Prime Minister Abe’s fiscal policies, are very bold. They are perhaps even unprecedented, which is why markets have responded positively so far.
Having said that, the sentiment of many investors who had become accustomed to deflation is still fixed income oriented. I don’t think the majority of them have started to rotate their portfolios out of bonds. At the same time, many overseas investors are still adopting a wait and see attitude.
These investors want to make sure that the third arrow is fired properly. So the real test will come after the Upper House election scheduled in July. But I am confident that under the leadership of Mr Abe, the government will execute various growth strategies.
This administration has more chances of implementing this challenging growth strategy. Politicians are fully aware of the economic difficulties which Japan would face if these policies aren’t implemented. We face serious demographic challenges, and the birth rate is declining. Therefore, in order for the government to revitalise Japan, drastic measures have to be taken. I personally have a feeling that this administration is committed to doing whatever is necessary in this regard, in spite of the expected opposition of various parties.
EUROWEEK: Won’t the real challenge in terms of growth come next year, when the consumption tax is increased? What needs to be done in the very narrow window between July and the first quarter of 2014 to ensure confidence is strong enough to withstand the increase in the consumption tax?
Kubo: In the past, economic policies have tended to be relatively short-sighted, which is why former Prime Ministers struggled to address the main issues. They were not necessarily successful in maintaining consistent policies.
The most important challenge today is to fix our social security system. Because of the long life expectancy in Japan, social security payments are increasing, which is why a rise in the consumption tax is so urgently needed. Pension reform is also needed. And as Japan’s population has started to decline, we have to encourage more women to enter the labour force.
If the government follows clear policies it will give corporate executives in the private sector more confidence they need to make long-term investment plans to support future growth. Until clarity is shown in the levels of the government and industries, few people are likely to invest actively. So the most important thing from the government’s standpoint is to introduce growth strategies, labour and tax reform.
Reducing public debt is also significant. The government is trying to reduce the financial deficit of its primary balance by 50% during fiscal year 2015. This is ambitious and challenging, because the government is looking to accelerate growth at the same time as reducing the deficit.
As we don’t have a very positive immigration policy, it is hard to see how our population will increase, as it will in the US and the UK. So the size of the labour force will continue to decline unless more women and the elderly are encouraged to work.
The government is expected to take measures very wisely to address all these issues at the same time, which we all know is a great challenge.
EUROWEEK: Presumably encouraging more immigration is a very sensitive issue from a political perspective, because of the social, cultural and linguistic challenges that would arise?
Kubo: Yes. It is sensitive. I’m not so optimistic about the prospects for more immigration. The government seems to be prepared to open more doors to medical care workers from neighbouring countries, as we don’t have enough such professionals to look after senior citizens.
EUROWEEK: Let’s move away from politics and on to the financial markets. What business opportunities do Abenomics and the new policy at the BoJ mean for Japanese banking and capital markets?
Kubo: In the very short term, the securities industry is enjoying a boom time as turnover on the Tokyo Stock Exchange has increased by more than 200% compared with last year, and sales of mutual funds are at record levels on a monthly basis. Fixed income issuance is also at a high level because of the very low interest rates.
So the retail business is booming and the wholesale business is also picking up, all of which is encouraging news for the whole securities industry. It is also positive for the commercial banking sector where lending volumes appear to have bottomed out for the first time in many years. So, Japanese financial institutions are feeling that the good times may be coming back.
It is, of course, rather too early to forecast that this trend will continue for some time.
As far as SMBC Nikko is concerned, currently our business performance is decent, but whether or not this trend will continue really depends on the performance of the Japanese economy. Regardless of what happens to the local economy, we will strengthen our capabilities on both the retail and the wholesale businesses, as in the long term, we are committed to making SMBC Nikko one of the most powerful and trusted securities companies.
We’d also like to become the number one securities house in the future, although we recognise that, at the moment, we are still a challenger rather than a frontrunner. We rebuilt the wholesale business three and a half years ago. Since then, we have strengthened our capabilities steadily and we have established a very good base.
EUROWEEK: Will you be prioritising the domestic or the international business?
Kubo: Regardless of Abenomics, we have been making every effort to make our international business as strong as possible to support Japanese companies expanding their businesses globally. The volume of cross-border M&A deals will increase, and in order for us to capture business opportunities in that market, our business should be global. Also, we are eager to offer international products such as Samurai bonds to Japanese investors.
EUROWEEK: Does this mean that you plan to expand internationally to enhance your origination capability by investing in the US, Australia and Hong Kong as well as the UK? Where do you see the most exciting opportunities in terms of bringing international borrowers to the Japanese capital market?
Kubo: Traditionally, European, Australian and Korean borrowers have been the most active in the Samurai bond market. Americans have not been so active.
Recently, SMBC Nikko Capital Markets in London was appointed as a lead manager for a Daimler euro-denominated bond, so the European market is another area where we would like to focus.
EUROWEEK: So once you’ve established a relationship with a borrower like a European auto giant, is the strategy to offer a comprehensive range of capital markets products including Eurobonds, Samurais, Uridashis and so on?
Kubo: Yes. That’s the model we would like to establish. SMBC has a good banking relationship with those issuers, so at SMBC Nikko, we would like to leverage off these relationships.
But we differ from some of the US investment banks in the sense that we don’t do proprietary trading. Our business is all customer flow-oriented, focusing particularly on Japan or on the yen market. Global big players need to make substantial investments in managing their massive global operations. We don’t have global ambitions to that extent.
Once we have established a very strong track record, then we can start to look at areas beyond our natural niche.
First of all, we are a Japanese house, and the Japanese economy is the third largest in the world. If the Japanese economy is revitalised, it means there will be a lot of business opportunities for Japanese houses.
We have something like ¥1,500tr of individual financial assets in Japan, or about $15tr, which means there will also be plenty of business opportunities here.
SMBC Nikko has very strong placement power in Japan. So it is probably worthwhile for us to invest in that field rather than in the euro or global markets. This is why I have publicly said that we don’t see ourselves as competing with bulge bracket firms.
EUROWEEK: Is the Japanese investor changing? Some large pension funds have announced that they intend to reduce their holdings in JGBs and buy riskier assets.
Kubo: Domestic pension funds are very big investors in JGBs. Their investment may be changing but gradually. When their existing investments reach maturity, they don’t always reinvest the entire proceeds into JGBs. To some extent they are transferring some of these investments into equities and foreign bonds.
But I would agree that this is probably a good time for investors to start shifting some of their portfolios from fixed income to equities. Many are not yet convinced, because their mind-set is still influenced by many years of deflation, which some investors expect will continue for some more time, in spite of the BoJ’s massive monetary easing.
Compared with the period of the former BoJ Governor Shirakawa, the chances of inflation have risen. It may not reach 2%. In the short term it may only reach 1% of 1.5%. But the drastic change in the BoJ’s policy has definitely increased the possibility of the era of deflation coming to an end.
If inflation does reach 1%, what are the implications for the yield on the 10 year JGB? Will it decline from 0.6% to 0.4%, or increase to 1% or 1.2%? The answer seems to be obvious enough.
EUROWEEK: One or two commentators have expressed the concern that inflation might overshoot. Is this a legitimate worry?
Kubo: That would of course lead to a severe increase in interest rates, which the BoJ will have to avoid.
But if we think of this country as a hospital patient with a high fever, the first priority is to administer the right medicine. We can worry about the possible side-effects later. I believe that is the situation Japan finds itself in now.
EUROWEEK: Are you confident that Kuroda-san has the necessary experience, commitment and communication skills to achieve his anti-deflationary goals?
Kubo: Yes. Kuroda-san’s communications skills, as evidenced by recent G20 meetings, are excellent. He is a very experienced, internationally-minded banker. So I am confident about his credentials and those of his staff.
However, bear in mind that his policies amount to an experiment. No other country has taken such bold actions. So delivering on the targets will be a challenge, but he will have a lot of support from a number of well-respected academics.
EUROWEEK: You were involved in the alliance with Moelis & Company of the US. Do you expect to see further growth by acquisition, or is your aim to achieve organic growth?
Kubo: I do not comment on our specific plans in that regard. We already have a good international presence and some very strong partners throughout the world, so for the time being, the real issue for us is to utilise our existing human resources as efficiently as we can. We will look for all the possibilities to pursue our growth.
EUROWEEK: Is the culture of SMBC Nikko changing?
Kubo: SMBC Nikko is a capable company with a very strong client base, both in the retail and wholesale markets, which will be celebrating its centenary in five years. But in recent years, until three and a half years ago, SMBC Nikko had only focused on domestic retail business. Therefore, investment banking and the international business are relatively new to some of our employees.
So, while we will maintain the strength in the domestic retail franchise, we also want to strengthen the international and investment banking capabilities. That will certainly involve some cultural change.
EUROWEEK: More generally, are you confident that the Japanese banks won’t repeat the mistakes of the 1980s when they expanded overseas too far and too fast?
Kubo: That’s a very interesting question. At that time, the Japanese banks tended to overrate their strengths, and as a result they overstretched themselves. They believed that their triple-A ratings would last indefinitely, so they used their huge balance sheets to sell loans.
Looking back, it is clear that the Japanese banks did not enjoy as much of their edge at that time as they thought they did. Their strong edge was their balance sheets and huge hidden reserves in the form of unrealised gains on stocks.
This time around, Japanese banks need to be more modest, and confine their investments to areas they know well. The lesson we learned in the securities industry as well is not to invest with high leverage.
As our earnings grow, we may come under pressure to expand more and to try to emulate the major US investment banking firms. But we need to think about our history and our strengths, and recognise that areas like the dollar business might be difficult for Japanese houses.
EUROWEEK: Some European banks are still looking extraordinarily cheap. Is it out of the question that a Japanese bank could make a big acquisition in Europe?
Kubo: I wouldn’t say it is out of the question indefinitely, because policies will change with time. But at this moment, Japanese megabanks will continue to be cautious — their growth will be slow but steady.
Of course, for the last three or four years, the Japanese financial system has been very stable, and in relative terms, Japanese banks are now stronger than European banks and, to some extent, American banks as well. However, American banks are already recovering and I’m sure the same will be true with the powerful European houses. So the competitive battle among the world’s leading G-SIFIs will be fierce.
EUROWEEK: Finally, are you confident that the worst of the global crisis is now over?
Kubo: My short answer is yes. The worst seems to be over, because very strong international co-operation has been quickly established in response to the crisis. As a result, tail risk in Europe has diminished substantially. Monetary union is obviously a big challenge, and it will take a long time to fix it completely. So the eurozone crisis is not over, but I don’t see a worst case scenario unfolding. The US economy is clearly recovering and emerging markets such as China, Brazil and India all have their own issues to resolve, but are also doing well.
And of course Japan is back. So, all in all, the global investment environment seems to be on the mend.