Abstract
This Selected Issues paper focuses on Japan’s public debt and the challenges facing small- and medium-size enterprises in Japan. Historically, Japan’s public debt has been financed in a fairly smooth manner. The large pool of household savings and the stable domestic institutional investor base appear to have contributed to this successful experience. However, Japan is already undergoing rapid population aging, which will likely limit the market’s future absorptive capacity of public debt. In addition, structural shifts in institutional investors could also serve to reduce market demand.
III. Current Challenges Facing SMEs in Japan1
A. Introduction and Background
1. The global recession has had a much greater impact on Japan’s manufacturing sector than on services. In the six-month period ending in March, sales in manufacturing fell by 24 percent (y/y), and operating profits by nearly 125 percent (y/y)—nearly two times and four times greater than the respective declines in services. Within manufacturing, the shock affected automakers mostly, followed by semiconductors and electronics.
MOF Corporate Survey
(Oct-Mar yoy change)
MOF Corporate Survey
(Oct-Mar yoy change)
| of which | ||||||
|---|---|---|---|---|---|---|
| Item | Total | Non-man. | Manuf. | Auto | Elec. | Prec. |
| Sales | -16.0 | -12.3 | -23.8 | -41.3 | -26.2 | -28.2 |
| Operating profits | -69.2 | -28.6 | -123.8 | -210.7 | -178.5 | -107.2 |
| Current profits | -66.5 | -28.1 | -114.9 | -161.4 | -135.5 | -104.9 |
MOF Corporate Survey
(Oct-Mar yoy change)
| of which | ||||||
|---|---|---|---|---|---|---|
| Item | Total | Non-man. | Manuf. | Auto | Elec. | Prec. |
| Sales | -16.0 | -12.3 | -23.8 | -41.3 | -26.2 | -28.2 |
| Operating profits | -69.2 | -28.6 | -123.8 | -210.7 | -178.5 | -107.2 |
| Current profits | -66.5 | -28.1 | -114.9 | -161.4 | -135.5 | -104.9 |
2. Manufacturing small and medium-size enterprises (SMEs)2 in particular were hit hard as the shock rippled down the entire supply chain. Large manufacturers responded quickly by slashing production and cutting costs, including from their SME suppliers. Shrinking cashflows and tighter financial conditions have put a strain on SMEs, forcing many to consolidate or exit. In some cases, large corporations have helped by lengthening the terms of receivables with key supplier, or by providing short-term financing, while the government has stepped in with exceptional financial support.3 Despite these efforts, bank credit to SMEs continues to decline, while bankruptcies concentrated in manufacturing remain on the rise.
Japanese Bank Lending: Large Firms vs. SMEs
(y-o-y, percent change)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: CEIC.Japanese Bank Lending: Large Firms vs. SMEs
(y-o-y, percent change)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: CEIC.Japanese Bank Lending: Large Firms vs. SMEs
(y-o-y, percent change)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: CEIC.3. Against this background, this chapter examines the financial position of the corporate sector prior to the crisis. The analysis uses the MoF corporate survey to assess the vulnerabilities of the sector to the financial shock. The chapter also discusses how corporate restructuring can be advanced to facilitate the adjustment process, particularly among smaller firms which were in a much weaker position compared to larger firms prior to the crisis.
B. Financial Position of the Corporate Sector
4. The corporate sector overall has made significant progress in deleveraging. The debt-to-equity ratio has been on a trend decline since the 1970s, with the pace of deleveraging accelerating in recent years. The large drop in the debt-to-equity ratio in the non-manufacturing sector between 1997 and 2008 mainly reflects a clean-up of the real estate sector (from over 2,000 in 2000 to under 200 in 2008). Over the same period, the debt-to-equity ratio for manufacturing has almost halved. Since 1999, the nominal stock of corporate debt has fallen nearly 20 percent.
Debt to Equity Ratio
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.Debt to Equity Ratio
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.Debt to Equity Ratio
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.5. Prior to the crisis, the corporate sector also appeared reasonably liquid, led by improvements in non-manufacturing. The quick ratio for non-manufacturing firms rose from around 83 in 2003 to 100 in 2008.4 For manufacturing firms, the picture is more mixed, as a decline in liquidity for large firms offset improvements by SMEs. The difference could be attributed to financing conditions, as SMEs raised precautionary savings in response to tighter credit conditions, while larger firms may have drawn down their cash reserves with improved access to capital markets.
Quick Ratio
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.Quick Ratio
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.Quick Ratio
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.
Quick Ratio, Manufacturing Sector
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.Quick Ratio, Manufacturing Sector
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.Quick Ratio, Manufacturing Sector
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.6. Profit margins in the manufacturing sector recovered somewhat as excess capacity declined. Up to 2008, the improvement in manufacturing profitability, measured by return on assets, was greater than for non-manufacturing, rising from around 3 percent in the mid-1990s to just over 5 percent prior to the current crisis. Separating the calculation of ROA into two components reveals that the improvement reflects both an improvement in asset turnover (operating revenue / total assets)—a measure of asset utilization—and profit margins (net income / operating revenue). Capacity utilization was over 100 percent just prior to start of the current downturn.
Return on Assets
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.Return on Assets
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.Return on Assets
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.
Factors Driving Profitability: Manufacturing Sector
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.Factors Driving Profitability: Manufacturing Sector
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.Factors Driving Profitability: Manufacturing Sector
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.7. Improving profitability and lower borrowing rates have strengthened the capacity of the corporate sector to remain current on its debt obligations. Interest coverage ratios (ICR = operating profits divided by interest expense) have risen steadily, from 1.5 in the mid-1990s to 6.7 in 2007. The rise is even more dramatic for the manufacturing sector, which reached 13 in 2006. This reflected both improved cash flow and the sharp fall in average borrowing rates, which have declined to just under 2 percent along with the concurrent decline in government yields since 1991.
Interest Coverage Ratio
(Times)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.Interest Coverage Ratio
(Times)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.Interest Coverage Ratio
(Times)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.
Interest Rate on Corporate Debt
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.Interest Rate on Corporate Debt
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.Interest Rate on Corporate Debt
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.8. The improvements in the aggregate figures, however, mask structural weaknesses among SMEs. A breakdown by firm size shows that in 2008, SMEs suffered from significantly higher leverage and lower profitability than larger firms. Compared to large firms, debt-equity ratios for SMEs were nearly three times as high and profitability, as measured by ICR, four times lower. The difference in part reflects the more aggressive deleveraging by larger corporations after the late 1990 banking crisis. By sector, profitability in the electronics sector has lagged behind improvements in other export-industries.
Manufacturing Firms
(MOF Corporate Survey, Sep 2008)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Manufacturing Firms
(MOF Corporate Survey, Sep 2008)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Manufacturing Firms
(MOF Corporate Survey, Sep 2008)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Return on Assets
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.Return on Assets
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.Return on Assets
(In percent)
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Ministry of Finance.9. To summarize, smaller firms entered the crisis with much weaker balance sheets and lower profitability than larger firms. Although overall debt levels in 2008 were lower, profits margins greater, and liquidity ratios higher relative to the 1990s banking crisis, this improvement was concentrated mainly among larger firms. Smaller firms with higher leverage ratios and lower profitability were left more vulnerable to the slowdown, highlighting the greater need for restructuring for this sector.
C. Promoting Restructuring of the Corporate Sector
10. Spurred by the previous banking crisis, Japan has made considerable progress in improving its framework for bankruptcy (Box III.1). Important advances include:
Simplification of bankruptcy court procedures, a reduction in administrative costs, and the revision of the Bankruptcy Law in 2004. Consequently, the percent of court-administered bankruptcies in the total number of bankruptcies rose from under 10 percent in 1994 to close to 67 percent in 2008.
Passage of the Civil Rehabilitation Law (CRL) in 1999. The CRL simplified the court-led restructuring processes—similar to the U.S.’s chapter 11. The law was originally aimed at medium-sized firms and SMEs but gained popularity amongst larger firms as well because it allowed management to remain in place. Since its passage, over 6,000 firms have been successfully restructured.
Share of Bankruptcies: Private-led vs. Court-led
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Tokyo Shoko Research.Share of Bankruptcies: Private-led vs. Court-led
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Tokyo Shoko Research.Share of Bankruptcies: Private-led vs. Court-led
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Tokyo Shoko Research.
Number of Court-Led Restucturing Cases
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Tokyo Shoko Research.Number of Court-Led Restucturing Cases
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Tokyo Shoko Research.Number of Court-Led Restucturing Cases
Citation: IMF Staff Country Reports 2009, 211; 10.5089/9781451820744.002.A003
Source: Tokyo Shoko Research.11. At the same time, efforts have been made to increase out-of-court workouts. In 2001, guidelines were introduced for large corporations, which helped improve the transparency of the process. Through 2005, at least 30–40 firms had successfully used the process. For SMEs, METI has introduced SME support centers in each regional government (47 total). Since their inception, the centers have held discussions with over 17,000 SMEs, of which it has helped formulate 2,100 restructuring plans. The restructuring plans have mainly resulted in debt rescheduling (63 percent) or debt forgiveness (23 percent), with the number of firms receiving debt-for-equity or debt-for-debt swaps relatively low at around 10 percent. To provide needed financing, METI has also encouraged the establishment of 17 SME restructuring funds, but these funds have been underutilized. Of the ¥51.5 billion raised, only ¥25.7 billion has been disbursed to 131 companies.
12. Promoting the restructuring of SMEs could provide significant benefits to the economy. SMEs are an important part of the Japanese economy. They account for over 50 percent of manufacturing shipments and 25 percent of exports and investment. They span many industries and historically have served as key suppliers to large manufacturing firms. SMEs account for 70 percent of employment and in recent years have been a major source of jobs for the economy. The SME sector can play a vital role in fostering new employment opportunities and raising overall productivity, but have been held back by long-standing structural weaknesses.
13. Both price incentives and institutional settings help explain the lack of progress within the SME sector, with some of the major barriers including:
SMEs have been cushioned by easy financing. Since the early 2000s, a weak yen, low interest rates, and a government guarantee on financing have shielded SMEs from making difficult tradeoffs. Of the total loans outstanding to SMEs, roughly 10–15 percent are covered by a government guarantee.
Creditors have few incentives to restructure. From the creditors standpoint, SMEs—relative to larger corporations—have increasingly sourced loans from multiple banks making it more difficult for a main bank to induce reform. Furthermore, the size of the loans are usually not large enough for a bank to invest the time needed to restructure smaller firms or help them merge with other firms in the region.
Debtors are unable to make a new start. For debtors, the stigma associated with a bankruptcy and the inability of management to make a fresh start following procedures has strongly discouraged firms from asking for assistance early on in the process. Some deterrents for bankruptcy filing include a historically low home exemption (which was recently raised from around $3,000 to $9,000) in personal bankruptcies and the widespread use of guarantees, thus making default an unattractive option.
14. How then can restructuring be facilitated? Some ideas include:
Improving consultative services. The SME support centers are a step in the right direction, but the number of qualified personnel is still insufficient.
Making the out-of-court process more transparent and less costly. Introducing guidelines for out-of-court workouts for SMEs—as was done for large corporations in 2001—could help improve transparency. At the same time, introduction of more out-of-court alternatives could help lower the costs to restructuring. One alternative that has been tried recently is the adoption of Alternative Dispute Resolution (ADRs) courts. In addition, under the revision of the Industrial Revitalization Law, tax breaks and subsidized financing will be offered to SMEs that successfully spin-off the viable components of their business as a new company.
Providing new financing for restructuring. A public asset company similar to the ICRJ, could be restarted to assist banks in working out viable but distressed firms by providing new financing and helping resolve creditor disputes. A bill, Kigyo Saisei Shien Kiko Ho, providing such a framework for medium-sized firms is currently being discussed in the Diet. Expanding the availability of other financing, such as DIP financing, or making better use of existing SME funds could also provide the needed incentives.
Facilitating start-ups. Recent efforts by the government to establish a public-private partnership, Sangyo Kakushin Kiko, targeted at funding advanced and innovative-technology industries could provide some needed incentives. (The government plans to provide ¥82 billion in initial funding.)
D. Conclusions
15. An analysis of the corporate sector highlights that SMEs with their weaker balance sheets and lower profitability were more vulnerable to the global slowdown than larger firms. Restructuring through either out-of-court workouts or the bankruptcy system could help Japanese SMEs to strengthen their balance sheets, improve core profitability, and reorient themselves to the new global environment, much in the way that the large corporates sector did after the 1990s banking crisis. A vibrant SME sector could assist in the adjustment process by absorbing labor and capital from manufacturing.
Court-Led Options for Financially Distressed Firms
Japan has made considerable progress in improving its framework for restructuring. An overhaul of the system began in 1996, with successive reforms starting in 1999.
1999: Enacted the Civil Rehabilitation Law introducing a new chapter 11-style procedure for smaller firms.
2002: Revised Corporate Reorganization Law streamlining processes and easing criteria for application. Allowed Tokyo and Osaka courts to administer cases throughout Japan.
2004: Revised the Bankruptcy Law helping streamline processes.
2005: Enacted a new Corporate Law, which helped clarify procedures for liquidation.
Within the court system, firms have broadly three choices.
Civil Rehabilitation Law (Chapter 11 for medium and small size firms). The law facilitates restructuring under bankruptcy procedures. (It replaces an older Composition Law.) In 2008, more than 763 firms filed for CRL protection, relative to only 300 hundred firms at the peak of the old Composition Law in 1998. While it is intended for small to medium size firms, large firms have been known to use its procedures. The application and approval process is relatively quick, usually taking 5 months, with the full process expected to be completed within 10 years. A key differentiating factor is that management is usually allowed to stay in place, often referred to as Debtor-In-Possession (DIP). Secured creditors usually fall outside of its jurisdiction, unless there are extenuating circumstances. Unsecured creditors approve the rehabilitation plan.
Corporate Reorganization Law (Chapter 11 for large firms). The procedures are more comprehensive and are geared toward large corporate bankruptcies. Only 30 firms filed under this procedure in 2008. Management is usually replaced by a court-appointed receiver, but this is not required. DIP procedures were codified in the 2002 revisions, resulting in a few DIP cases recently in Tokyo courts. The process is somewhat longer than CRL, with the application and approval process taking up to one-year, and with the full process expected to be completed within 15 years. The court may order a stay if necessary to protect the firm from creditor harassment. Secured creditors, unsecured creditors, and shareholders approve the reorganization plan.
Bankruptcy Law (Chapter 7). Established for insolvent firms to ensure an orderly exit. This is the most common form of bankruptcy, with 9,351 cases in 2008. A court-appointed receiver administers the process. Secured creditors can access their rights under the procedures.
Prepared by Chad Steinberg and Sumiko Ogawa.
SMEs in manufacturing are defined as enterprises with less than ¥300 million in capital or fewer than 300 workers. The criteria are lower for SMEs in wholesale, services, and retail.
See Appendix I of the staff report for a summary of recent financial and corporate sector support measures.
Quick ratios measure the ability of a company to use its near cash or quick assets to immediately extinguish or retire its current liabilities; a quick ratio above 100 percent is a good benchmark.
