---- by Tony Barrett ----
TOKYO (AFX-ASIA) - The equity market is likely to stall ahead of the Upper House elections due July 29 and after sharp gains made on optimism over proposed changes by new Prime Minister Junichiro Koizumi, analysts said.
While reiterating the reformist rhetoric that brought him to power, Koizumi has disappointed some by what they see at best as a failure to add meat to the bones of his restructuring plans and at worst a pandering to old-guard interests.
Investors have become increasingly wary in recent days over the reformist credentials of the new prime minister, given the lack of momentum as well as the failed attempts at reform seen during Japan's so-called "lost decade".
However, analysts noted Koizumi will inevitably be constrained by the local political scene until given a stronger mandate in the upcoming polls, adding that his ascendancy itself marks a decisive shift in democratic accountability.
The premier is popular with both the public and investors interested in seeing a long-term revival of the country, but the key area of controversy remains their reaction to the inevitable hardships that reform will bring.
"The man is real; he's the closest thing we have had to a reformer for 30 years," HSBC Securities Japan strategist Garry Evans said. "The hurdles are not insurmountable. He's the only thing stopping the LDP from falling into oblivion; if I was a member of the old guard, I'd be keeping my head down."
Other analysts were equally hopeful.
"It is very difficult not to be very positive about Koizumi," Morgan Stanley Dean Witter strategist Noboru Kawai said. "Japanese voters who heard his Diet speech on Monday could not fail, in my opinion, to be impressed."
However, many also noted a reticence, since Koizumi's election as president of the ruling Liberal Democratic Party, to shift from offering general policy directions to providing a road map for reform. "Koizumi has voiced a strong rhetorical commitment to structural reform but has provided few details," Nikko Salomon Smith Barney economist Jeffrey Young said in a note issued yesterday.
"Koizumi's various statements on fiscal policy imply a commitment to medium-term fiscal consolidation," he said. "Yet, Mr Koizumi has also said that fiscal consolidation will be implemented 'flexibly', with due consideration to economic conditions."
Controversially, plans to dispose of the bulk of banks' bad loans within two to three years are likely to require injections of public funds, which have previously proved to be deeply unpopular among the public.
"Thus far, Mr Koizumi has skirted this issue," Young said, noting: "Many of these reforms are anathema to the conservative members in the LDP."
HSBC's Evans also described as a "retrograde step" the appointment of Hideyuki Aizawa as LDP tax panel chief.
Aizawa was viewed unfavourably by the markets when placed in charge of financial restructuring under a previous administration.
"Tax reform is one of the key planks of what Koizumi has to do," Evans stressed, though adding that the premier may avoid making such faction-based appointments in future because of his direct appeal to the voting public.
Merrill Lynch chief economist Jesper Koll sees in this appeal a dramatic shift in the nature of public accountability in Japan. "The risk of a so-called backlash (by the LDP old guard) -- where the PM is just a puppet -- is slowly going to be a thing of the past," he told investors in a conference call this week.
Koll believes the world is witnessing a "fundamental change in the way political power is actually allocated in Japan (with) power based on popularity rather than sharing power within LDP factionalism." Nikko Salomon's Young places the seeds of this revolution in the creation of the single-member district voting system used during June 2000 elections.
"The new electoral system is gradually, but profoundly, changing how politicians are elected and which policies they espouse," he said. "Under the old system, politicians won Diet seats with only a narrow slice of the vote ... by appealing to equally narrow special interest groups.
"It is impossible to attract support (that is necessarily) broad on the basis of the policies -- such as regulations and public works -- that guaranteed election under the old system," Young said. Koll added: "Koizumi is leading a political rather than an economic revolution," with the emphasis on assuring success in the Upper House election.
"The key focus is going to be to prove to the elders of the LDP that he can keep the LDP in power. Over six to eight weeks, you will get very little detail on economic policy," he said.
"After the initial enthusiasm ... over the next four to six weeks the consolidation is setting in."
Yet Koll remains optimistic that, assuming Koizumi wins the July elections, the premier will push ahead with his restructuring programme and "reignite enthusiasm for Japanese shares."
At this point, the opinions of analysts diverge.
HSBC's Evans has looked at the experiences of other markets that have undergone political upheaval, including the U.S. under president Ronald Reagan and the UK under Margaret Thatcher, as well as nations such as Italy and Sweden.
"In other countries, when you had a major political turning point ... the pattern of the stockmarket is very similar," he said, with a "three month share rise of 20-30 pct" as the reality of change sinks in.
However, it is over the following "18 months to two years where the market has moved sideways to down," before the positive effects of reform feed through to equity prices, he said.
"I look for the Topix to get to 1,500 then see a bit of a fall back," Evans said, noting then the possibility that "the market is not going to see a significant rise over the next year and a half." This long gestation and the hardship that results from restructuring will prove an economic and political test.
"The initial effect of any reforms would be to lift unemployment, perhaps massively," Nikko Salomon's Young said. "Restoring confidence will be the key to the success of the emerging policy approach ... offsetting some of the negative short-run impact of reform on demand." Morgan Stanley's Kawai said the Japanese public is ready to pay the necessary price, noting unprecedented levels of popular support for Koizumi in recent polls.
"His 80 pct (popularity) rating is an ultimate confirmation that higher-risk economic strategies are politically acceptable in the eyes of Japanese voters today after the long period of deprivation," he said.
However, HSBC's Evans, while agreeing that the public would be happy to see an end to pork-barrel politics, noted that the risks should not be ignored, citing again foreign experience. "Thatcher would have lost the elections if not for the Falklands," he said, refering to the military conflict with Argentina that raised strong nationalist sentiment in the UK and revived the fortunes of the deeply unpopular premier.
"In the early 80s, the economy was in a terrible state. It's not impossible that you would see the same thing here."
At 10:17 am, the Topix index was up 7.21 points at 1,388.46, while the Nikkei 225 index was up 160.53 points at 14,178.32.