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Saturday, 23 January 2021

Lessons from the Japanese Great Depression

I have been fascinated by the “Great Depression” and the lost decades of Japan for a long time now. I have a personal fascination for Japan because it was the first foreign country I ever visited. It is intriguing because here is one example of one of the foremost economies in the world, with world-leading companies and yet they ended up in nearly 20+ years of economic depression. Bank of Japan had tried “pump-priming” which is a convoluted way of saying they tried to money-print their way out of the problem. Despite having near zero or very low interest rates for decades there has been no effective pick up of the economy.

I always thought it was a result of the socio-politico-economic structure of Japan that led it such a prolonged slump. A few days back I tweeted about this and asked twitterati about any good suggestions to read on this topic. @Relax_Cap suggested I read The Holy Grail of Macroeconomics: Lessons from Japan's Great Recession by Richard Koo. The book and a few interviews of Richard Koo has been a wonderful revelation to me and I very thankful to @relax_cap for the great suggestion.

Balance Sheet Recession

Richard Koo’s main premise is as follows. Asset prices got inflated during the bubble years and corporates took on large debts to either acquire assets or fuel growth. Once the bubble burst, corporates were straddled with the debt and much less valued corresponding asset value as the market prices of the assets they owned had crashed. The initial tendency of the corporates was to save from their cashflow to repair their balance sheet. Central bank step in to bolster growth and starts by reducing rates. But there is no demand for debt as the corporates (and households) are trying to reduce their existing debt burden and are in no mood to add on to debt even at ridiculously low rates. This results in economic growth to falter and slacken and it continues in this manner till the corporate balance sheets are repaired. Richard Koo termed this as a “balance sheet recession”.

He has gone on to explain this in a lot of detail and has lots of examples related to US and Eurozone.

Indian Situation

I think we are seeing a part of this being played out in India as well post the 2008 Great Financial Crisis (GFC). We have seen a large reduction in corporate debt. Most of bank debt growth has come from the retail segment led by consumer spending. That explains the dream run of consumer-facing NBFC like Bajaj Finance. In India, IBC is another policy is likely to increase this balance sheet recession further. With erstwhile big businesses and “connected” promoters now losing their companies due to the new bankruptcy code. Add this to a post-Covid situation where both corporates and households suddenly realize the value of cash, it is possible that people increase their savings to shore up their cash balances. The only saving grace for India, unlike US or Europe, is that India is much less debt-ridden and so we are unlikely to get into a prolonged recession.

The implications could be:

  • Inflation will unlikely to pick up even though most “experts” think so
  • Financial savings and investment products like mutual funds or insurance companies to do well
  • Banks will have better CASA and deposits

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