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The Tokyo stock market rang in the new fiscal year on a positive note Monday, ignoring worries about the underlying economic reality.

An increasing number of market participants are turning bullish, reacting positively to the recent government package of measures to fight deflation.

Indeed, with worries about a March financial crisis out of the way, investors are counting on high-priced activity in the offing. But it is too optimistic to expect the market to keep rising.

Further volatility appears inevitable without additional government measures to keep the economy from sliding into a deflationary spiral.

Because the Financial Services Agency will announce in mid-April the results of its “special inspection” into the quality of bank loans to heavily indebted major companies, an additional injection of public funds into banks’ capital bases appears unlikely.

Banks will be unable to regain public trust merely through the strict assessment of assets and disposal of problem loans.

They will continue their current plight as their assets deteriorate further due to deflation.

To prevent trust in banks from falling further, banks will require a bold injection of public funds coupled with the continued reconfiguration of the banking industry.

Domestic economic activity appears to be bottoming out on the back of an increase in exports and advances in inventory adjustments in manufacturing industries at home.

But the recent developments are primarily attributable to a temporary inventory buildup in the United States as a result of excessive liquidations.

Inventory adjustments in Japan, as viewed from the inventory cycle, will take six more months.

Investors therefore should not be surprised if the Japanese economy enters a downward trend again, though temporarily.

Unless the government comes up with additional anti-deflation measures later this year, when the inventory cycle is expected to lead the economy toward recovery, the Tokyo stock market will most likely continue downward.

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