Down But Not Yet Out; Koizumi was bruised by the opposition party's strong showing at the recent polls. But he is seeking to regain support by touting Japan's revival--and there's plenty to talk about.

Byline: George Wehrfritz (With Hideko Takayama in Tokyo)

For the gray-suited men who control Japan Inc., UFJ Holdings was a disaster waiting to happen. The weakest of the country's four megabanks carries billions in bad debt on its books, boasts dangerously wobbly "zombie" clients like the crumbling retailer Daiei and habitually seeks capital injections from its best customers to stay afloat. Yet last week the looming UFJ nightmare faded unexpectedly when the bank revealed that it had sought merger talks with healthier rival Mitsubishi Tokyo Financial Group to create the world's biggest bank.

The planned marriage brought welcome relief to embattled Prime Minister Junichiro Koizumi, whose popularity has waned precipitously in recent weeks. On July 11, voters punished his ruling Liberal Democratic Party in Upper House elections by handing the most seats to opposition rivals. Meanwhile, fresh opinion polls show support for his cabinet now below 40 percent for the first time since the silver-maned political outsider took power three years ago, pledging to enact "no pain, no gain" reforms. News of the proposed megamerger was a well-timed bright spot in an otherwise dark week. As his supporters quickly pointed out, this tidying of the banking sector is taking place only because of the tougher accounting rules Koizumi's economic team implemented to avert a financial meltdown in 2002; it bolsters his claim that he's fixing what's wrong with the world's second-largest economy.

That's always been key to Koizumi's appeal, and if he wants to follow through on his agenda in the remainder of his term, he'll have to spotlight other achievements--fast. Fortunately, there's plenty to talk up: lower unemployment, rising consumer spending, GDP growth estimated at 5 percent for the first half of 2004. In a new economic assessment released last week, the Cabinet Office said the recovery was advancing at a "solid pace," with exports and industrial production rising and growth "extending into the household sector." Indeed, Koizumi appears to be presiding over Japan's most optimistic outlook since its bubble economy deflated in the early 1990s.

Still, the prime minister won't easily recapture his rock-star edge. For starters, he's already served longer than any Japanese leader since Yasuhiro Nakasone reigned in the 1980s; familiarity inevitably breeds contempt in a system accustomed to a revolving door at the top. In a recent combination of missteps and calculated-but-unpopular moves, Koizumi has slashed his own popularity by half, measured from its peak in April 2001. His plan to revitalize Japan's sinking national pension system by cutting benefits and raising premiums, for example, proved a bitter pill to the public following revelations that many senior politicians--including Koizumi himself--at times had failed to pay into the system. And even though most Japanese question their leader's steadfast participation in the U.S.-led occupation of Iraq, a mission that tests a constitutional ban on overseas military action, Koizumi has stayed the course. The deployment is central to his broader agenda of ...