Japan’s stock market is rising. Are “zombie” companies a threat?

These are businesses that are unprofitable and struggle to survive. They may be able to pay operating costs such as wages and rent, or pay interest on debt, but they have no surplus to invest and grow the business or repay the principal. I don’t have capital.

Japan’s “zombie” problem has been around for a long time, said William Pesek, author of “Japanification: What the World Can Learn from Japan’s Lost Decades.”

The issue is coming to the fore as the Bank of Japan is widely expected to raise interest rates this year for the first time since 2007.

Higher borrowing costs put these zombie companies at risk of bankruptcy or bailout, and any job losses could have far-reaching effects on the economy.

In the Japanese context, the term was first used after the 1990s asset bubble and subsequent crash, when banks continued to support companies that would have gone bankrupt.

According to Pesek, as of the end of 2023, there will be approximately 250,000 companies in Japan that can technically be called zombie companies.

“Over the past 11 years, the number of zombies has increased by about 30%,” Pesek told Martin Soong of CNBC’s “Squawk Box Asia” in a Jan. 29 interview.

The coronavirus pandemic has accelerated the problem of “zombieization”, with the number of zombie companies in Japan jumping by nearly a third between 2021 and 2022, Pesek said in Asia on January 25.・As stated in a Times column.

His views are backed up by market research firm Teikoku Databank, which said in a November report that zombie companies have been on the rise since the coronavirus outbreak, according to Google Translate.

According to the report, the number of “zombie companies” has increased by 30 times the number of corporate bankruptcies recorded in Japan in 2023, mainly due to “zero-zero” loans that are virtually interest-free and unsecured.

According to Teikoku’s research, as of the end of September 2022, approximately 2.45 million loans totaling approximately 43 trillion yen have been provided to support small and medium-sized enterprises.

The Japan Times reported in May that a national program that provided “virtually interest-free, unsecured loans” to small businesses during the pandemic had helped them survive and supported local economies.

“However, this aid program has increased the number of ‘zombie’ businesses that would not have been able to continue operating if it were not for the aid program,” the report added.

But Pesek said many businesses were “barely breathing” even before the pandemic hit.

In a column for Asia Times, he quoted Warren Buffett’s famous observation that “only when the tide goes out do we find out who was swimming naked.”

The coronavirus has exposed “the unhealthy thinness of Japan’s corporate leaders,” Pesek wrote.

Nevertheless, thanks to the Bank of Japan’s “grand liquidity program” since 2013, the so-called tide has not receded.

This allows companies to continue to ride the “wave of free cash flowing from the Bank of Japan” without having to restructure, innovate or take risks, Pesek said.

In an interview with CNBC, Pesek said that in order to maintain full employment in the country, the Bank of Japan has basically been helping companies avoid bankruptcy.

He acknowledged the need to improve corporate governance, but noted that the Bank of Japan was “injecting more and more money into the system.”

“It’s not that things are changing all that much in terms of the structure. The structure is changing because there’s a lot of money in the system. If you take that money away, it’s a trend in the Warren Buffett sense. will disappear.”

Under the leadership of Bank of Japan Governor Kazuo Ueda, the Bank of Japan has already changed its stance on yield curve control policy.

Most analysts expect the Bank of Japan to end its negative interest rate policy sometime in 2024, with market consensus pointing to an end in April.

Pesek told CNBC that many foreign strategists view Japan “through the traditional lens of economics and financial science,” but that Japan has had zero or negative interest rates for more than 20 years. It pointed out.

As a result, he questioned whether Japan’s financial system could wean itself off quantitative easing and withstand interest rate hikes.

Raising interest rates would mean that the interest-free loans that zombie companies have come to rely on would face higher borrowing costs, potentially pushing them to the brink of bankruptcy.

Japan’s stock market is also testing new highs since 2023, and rising interest rates could halt the rally. “If you were Governor Ueda… you would be paying attention to the current rise in the Nikkei Stock Average, but does the Bank of Japan really want to be the spoiler that stops the Nikkei Stock Average from its first bull run in 30 years?” Pesek said. .

As such, the Bank of Japan will face difficult decisions at its monetary policy meetings in March and April, he added.

Some expect the Bank of Japan to exit its negative interest rate policy as early as March, but Pesek is less optimistic.

There are fears that zombie companies could have far-reaching implications for the world’s third-largest economy, but analysts at Julius Baer take a different view.

Bhaskar Lakshminarayan, CIO and head of Asia investment management at Julius Baer, ​​believes that many of the zombie companies are small.

He said large-cap companies have large amounts of cash on their balance sheets, and it is these large companies that attract investors to the Japanese market.

It was not immediately clear what Julius Baer’s large-cap benchmark was, although large-cap companies are widely considered to have market capitalizations of more than $10 billion.

Having a large amount of cash ostensibly means that a company can repay interest payments on its debt, even if interest rates rise.

In his outlook for 2024, Julius Baer highlighted that the cash to market capitalization ratio of Japanese companies is 21%. That compares with 7% for U.S. companies, according to the Swiss private bank.

The cash-to-market ratio is a measure of a company’s liquidity, and companies with a higher ratio are considered more financially stable.

With more cash available, these large companies could have more room to increase their return on equity.

Julius Baer pointed out that Japanese companies’ share buybacks account for 0.7% to 1.4% of their market capitalization, while US acquisitions account for 2% to 3.5%.

This means that cash on Japanese companies’ balance sheets could also be put into initiating share buybacks, which could act as a catalyst for stock prices to rise.