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In late 2002, Sovereign made a significant investment in the Japanese banking sector as the economy started to enter a period of sustainable recovery following the asset bubble collapse and deflation of the 1990s.
A Deflationary Spiral
Japan's economic significance is immense. The country, with a population of 127 million, is the world's second largest economy (third on a purchasing power parity basis) with a GDP of 4.7 trillion US dollars. It is the third largest trading nation and the largest creditor state, with net external assets of approximately USD 1.1 trillion.
In the aftermath of the 1980's asset bubble, the Japanese financial sector was left with bad loans totalling 43 trillion yen, or 8% of GDP; the manufacturing sector had huge over-capacity; land prices stagnated; and the stock market was depressed. This tipped Japan into prolonged recession as the country suffered a severe deflationary cycle. The 1990s were marked by many false dawns and uneven structural reform.
From Deflation to Inflation
The arrival of a new political leadership in 2001, in the guise of Prime Minister Junichiro Koizumi, sent a clear signal that Japan was ready to break with the capital destructive policies of the past. Koizumi adopted a reformist approach to monetary policy, appointing Toshihiko Fukui, a known monetary conservative, to the governorship of the Bank of Japan in 2003.
The combination of Fukui's monetary stimulation and Minister of Economy Takenaka's work to clean up non performing loans in the banking system has put the Japanese economy on a sounder footing. Capital allocation practices have improved and cross-shareholdings between financial and industrial enterprises have been significantly reduced.
These developments have provided the catalyst Japan needed for recovery - the commencement of a journey from deflation to inflation. The stock market has responded to the turnaround with the Nikkei Index rising to over 17,000 in 2006 from a low of just under 8,000 in 2003.
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Background
The world’s second largest economy and a major regional financial and cultural power, Japan is a stable and technologically advanced democracy. The Japanese population is highly educated, and enjoys remarkably low crime rates and personal income levels far higher than in most Asian countries. Market liberalisation continues, most notably with the recent privatisation of Japan Post. However, the economy still suffers from low growth and high levels of public debt. Anxiety over Japan’s ageing population and low birth rate has prompted debate over whether to deal with predicted labour shortages by increasing immigration.
For more information, please visit the Legatum Prosperity Index country profile of Japan: 
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