Japan
Japanese Prime Minister Keizo Obuchi stated in a Jan. 28 speech to
the Diet, Japan's legislative assembly, that "fiscal reform is
important," but that the country "cannot commit the mistake of
undertaking it while the economy is not firm and before it is on
the path of full-fledged recovery." His remarks came within hours
of the Japanese government's announcement that it would begin
borrowing money directly from its crippled banking system in order
to meet its financial obligations to local governments.
Government policies have locked the Japanese economy in a downward
spiral. In order to promote growth, Japan creates supplemental
budgets funded by borrowed money. When the government money runs
out, the economy again slips into the doldrums, thus necessitating
new projects funded by new loans. This deepening addiction to
borrowed money has caused catastrophic damage. Japan's inefficient
economic structures promote social welfare at the cost of stymied
growth.
Japan already holds the record as the world's most indebted
government. Its newest budget deficit, at 38.4 percent, will only
compound this. At this pace, Japan's debt will top 150 percent of
its GDP within three years. Japan's budget and economic structures
are not sustainable, and by refusing to adopt direly needed
reforms, Japan's economy will only decay further.
Put simply, Japan is attempting to borrow-and-spend itself to
recovery, but without constructing an environment that encourages
private sector development. Every action the Japanese government
takes along these lines to bolster its economy only extends the
damage.
Japan's latest plan seeks to achieve three goals: give business to
Japan's banks; decrease the value of the yen; and gain additional
income for the government without issuing new bonds.
First, Japan's recession has idled many of the nation's banks; few
companies are willing to take on additional financial risks until
the economy recovers. The new plan would give the banks some badly
needed business.
Indeed, Japan's banks are awash with money, but this does not mean
they are healthy. Japan's banking sector is still struggling to rid
itself of at least $2 trillion in bad loans, acquired from two
decades of irresponsible lending practices. Furthermore, Japan has
a bad habit of instituting superficial reforms throughout its
political and economic systems. Its banking industry is no
exception. When many Japanese banks went bust after the Asian
financial crisis, several "reformed" themselves by closing foreign
offices in order to avoid adherence to international financial
norms. Moreover, Japan went so far as to refine the meaning of a
bad loan, loosening the criteria, thereby delaying or preventing
unprofitable enterprises from foreclosing. This, in turn, meant
that on paper the banks appeared to be more financially solvent
than they really were. It's easy to avoid a debt reckoning if you
rewrite the financial laws.
Japan's second goal is to increase the country's money supply. In
borrowing from these same capital-rich banks, the government will
inject additional money into its economy. Japan hopes that this
additional spending will reduce the value of the yen and increase
the international competitiveness of Japanese exporters. Yet, in
the recent past financial markets have shrugged off every attempt
by Japan to reduce the yen's value; there is no reason why a
slightly less direct attempt will be successful. In the unlikely
event that it does work, it will be a fleeting success at best. As
soon as the Japanese lending spree ends, the yen will rise again.
Japan will have spent borrowed money and achieved nothing.
Third, the plan calls for loans instead of bonds - Japan's
preferred method of borrowing money. After nearly a decade of
issuing bonds to fund massive, and irrelevant, infrastructure
projects in an attempt to jumpstart the economy, Japan has
saturated its bond market. Japan's plan allows the Japanese
government to obtain additional funds without harming the bond
market.
This actually magnifies Japan's debt problem. One of Japan's
advantages over its neighbors during the Asian financial crisis was
that Japanese debt was long-term at low interest - it in and of
itself did not trigger a crisis in the way that Korea's short-term
development debt did. Japan's new plan destroys much of that
advantage by racking up short-term high-interest loans for regular,
recurring expenses. This is tantamount to charging your rent on a
high interest credit card that you cannot pay in full. If Japanese
debt rises as Japan's Finance Minister Kiichi Miyazawa predicts, it
will top $6.15 trillion this year. When Japanese interest rates
rise, as they must eventually, the cost of servicing this mountain
of debt will be massive. Japan will have secured an additional
source of income, but condemned itself to paying interest payments
indefinitely.
Powers outside of Japan have noticed these problems. Fitch IBCA and
Moody's Investors Service - international credit rating agencies -
have both reduced Japan's credit rating and are considering
lowering it further due to excessive debt. This raises the cost of
borrowing for Japanese businesses. The G7 and the OECD have also
tried and failed to get Japan to take more appropriate action.
Japan's Asian neighbors are also aware that the region's economic
colossus has feet of clay. Japan's Miyazawa funds, designed to
stimulate the purchase of Japanese exports in Japan's neighbors,
have found few takers in recent months. Japan has also seen most of
its Pacific Rim trading partners eschew new trade links with Tokyo
in favor of lashing themselves to a seemingly unending U.S.
economic boom. This is unsurprising considering Japan's
unwillingness to dismantle its outdated protectionist policies and
its inability to stimulate consumer demand. This "Fortress Japan"
mentality atop a mangled financial infrastructure will ensure a
continued exodus of economic - and therefore political - power from
the world's second largest economy.
By publicly abandoning financial reforms, Japan is sending a
dangerous message. Japan continues to borrow in order to fund
temporary stimulus packages. These stimulus packages create an
economy dependant on continual government investment, which can
only be paid for with more borrowing. Having exhausted the bond
market, Japan has now resorted to higher-interest loans to
perpetuate this vicious circle and make the Japanese economy even
more indebted, and more out of synch with the rest of the world.
Japan's day of reckoning is not far off.
The Tokyo metropolitan government in Japan is poised to pass a new
law taxing the city's largest banks. Tokyo Gov. Shintaro Ishihara
expects the law to raise almost a billion dollars in revenue - an
attractive sum in a city with a $6 billion budget deficit and $60
billion in debt. The legislation has attracted overwhelming support
in Tokyo, from 90 percent of the city's residents and both ruling
and opposition parties. In a Kyodo News survey, more than half of
the country's other prefectures voiced at least partial support.
The legislation's popularity among local governments and the public
stems from more than just empty coffers in city halls throughout
Japan. Those behind the legislation, including Ishihara, are
unwilling to sit idly by while the central government fails to
restore Japan's economy. The legislation could further disable the
city's crippled banks, making central government officials very
anxious. But with general elections on the horizon, political
imperatives are pressuring Tokyo's ruling parties to bite their
tongues.
Gov. Ishihara proposed the tax several weeks ago, sending bank
officials and many economists into histrionics. The law will tax
gross profit instead of net gains in banks with deposits of more
than $45.7 billion. In other words, even banks with negative
balance sheets will have to pay taxes. Critics argue that such a
heavy burden - as much as 20 or 30 times the existing taxes - will
keep the banks from paying off bad loans, thereby stalling economic
recovery. The Japanese Bankers Association has even threatened a
lawsuit if the government passes the legislation.
But Ishihara and other proponents have ignored such criticism, as
well as quiet pressure from Diet members, including Finance
Minister Kiichi Miyazawa. Instead, Ishihara has painted the
legislation as a necessary reaction to a domineering and
ineffective central government.
Calls to decentralize the government have existed for years. But as
Japan's economic infirmity persists and intensifies, the calls have
grown more urgent. Currently, local prefectures in Japan have very
little control over their own finances. The Tokyo government
receives less than 30 percent of the revenues it collects. As well,
the prefectures have been forced to issue bonds to help finance the
central government's deficit spending. The new tax would give the
Tokyo government total control over a large infusion of revenue.
The central government realizes that the tax could devastate the
banking system if applied nationwide. Yet elections could come as
early as April, and the parties must handle the situation
carefully. If they crusade against the legislation, even on the
grounds of shaky economics, they will be denounced as overbearing
and unwilling to decentralize. The circumstances are especially
troublesome for the Liberal Democratic Party (LDP), which seeks to
resurrect its lost legacy as the country's number-one political
authority. It must oppose the legislation, but would like to avoid
bad publicity.
As a result, top LDP members appear divided. Key Cabinet ministers,
including the finance and home affairs ministers, have pressured
Ishihara to change details of his plan. Others, such as Labor
Minister Takamori Makino, have suggested that the decision
"deserves understanding in light of the promotion of
decentralization," reported the newspaper Asahi Shimbun.
The LDP's Research Commission on the Tax System has undertaken the
party's most significant effort to engage in political damage
control. On Feb. 16, it announced that it would consider extending
the tax nationwide to all corporations, not just banks - but only
after the economy had fully recovered, perhaps in fiscal 2001. The
announcement was clearly a stalling tactic, intended to soothe
those who support the legislation because they believe the
government will resist decentralization indefinitely.
But ultimately, the central government - LDP included - must take
forceful measures to regain control of the economy. Although the
Tokyo bill now has enough support in the city assembly to win, the
assembly won't vote until Feb. 23. That gives the central
government and the banks a few days to increase the pressure. The
bank tax initiative could easily spread to other prefectures;
already, the LDP in Osaka has petitioned the governor to impose a
similar tax. Unless the central government finds an alternative to
Ishihara's solution, the battle for control over the country's
economic policy will only intensify.
The Nikkei-225, Japan's premier stock index, dropped 6.98 percent
on Monday. This, its fifth-largest drop ever, was in response to
the Dow Jones plummeting on Friday. To counter the perceived threat
of a stock market meltdown, the three parties of Japan's coalition
government submitted a proposal that will likely be adopted. The
proposal calls on the government to intervene directly in the
Japanese stock exchange to prop up share prices. Against all odds,
Japan has found a way to make its already piddling economy even
worse.
This drop was not insignificant. The total value of Japan's stock
market is approximately the same as Japan's GDP - about $4
trillion. It is also one of the last economic institutions that has
not been hindered by direct government intervention. The stock
market is heralded as one of the few sure sources of capital for an
economy managed by a government addicted to borrowing. The
governing coalition's new plan envisions purchasing one trillion
yen ($92 billion) of stock to offset the recent loss.
Other countries, while not thrilled with their stock market
devaluations, are shrugging off the losses as the cost of being
linked to an international economy. Also hard-hit were Hong Kong,
Mexico and South Korea. Only Japan is reacting with such a large-
scale intervention. The effects of the new Japanese plan will be
numerous and dire.
First of all, Japan cannot afford such a costly bailout. After a
decade of barely perceptible growth and rising debt, the government
has little money to spare. Japan's economic stagnation is
exacerbated by its expensive cradle-to-grave social welfare policy
and an economic structure that values stability and personal
connections over ingenuity and merit. Japan needs to address these
problems. Spending billions on bailing out a stock market that is
suffering a cyclical downswing is not the way to do it.
Second, a $92 billion investment amounts to only 2.3 percent of the
market's value, not nearly enough to account for the recent loss.
If the U.S stock market plummets further, as expected, Japan's $92
billion investment will be wasted money. Stock markets are by their
nature volatile as the past few months in America plainly
demonstrate. Dumping an extra $92 billion into the market whenever
it falls beneath an arbitrary trigger - especially when the fall is
caused by factors in New York - is economically unsound.
Third, Japan is already so low on cash that it has to take out high
interest loans to fund its stimulus packages. This new plan calls
upon the government to tap into one of its few remaining sources of
funds, pension reserves - the Japanese version of Social Security.
This would be equivalent to the United States spending retirees'
savings to bail out private investors whenever the Dow drops below
10,000.
Fourth, Japan's record of intervention is less than stellar. Often
times when the government has intervened in the currency markets to
weaken the yen, it strengthened instead. With the yen continuing to
strengthen, Japan is likely to engage in another of these pointless
interventions soon. Stock markets are even more difficult to
predict. U.S. Federal Reserve Board Chairman Alan Greenspan solves
this problem by having as little to do with the stock market as
possible.
The recent proposal also calls upon the government to accelerate
the implementation of large-scale public works projects outlined in
the 2000 budget. The logic being that early spending will help
alleviate the negative short-term effects of the stock market fall.
However, accelerating the implementation of the stimulus package,
paid for with borrowed funds, will strengthen the possibility that
Japan will borrow even more from its crippled banks later in the
year.
Incurring more debt will sink Japan - already holding the world
record for most-indebted government with $6.15 trillion borrowed -
further into the red. Japan currently runs a budget deficit of
nearly 40 percent. When Japanese interest rates rise as eventually
they must - Japan cannot keep them at zero percent forever,
especially with U.S. rates at 6 percent - the cost of servicing
these debts will mushroom and crash the Japanese budget.
Despite the unfettered stupidity of this plan, Japan will likely
implement it, so powerful is the perception that it must address
the most visible aspect of its flagging economy - the stock market.
The plan already has the support of the top policy makers of all
three parties in Japan's ruling coalition. Japan's uninspiring
prime minister, Yoshiro Mori, is not the type to stand in the way
of such consensus. Furthermore, Japan has a history of adopting
imprudent measures, such as taxing its dilapidated and stressed
banking system to create the illusion of economic progress. If
implemented as intended, the new plan will squander away $92
billion of Japan's pension fund and further chain down an already
hobbled economy. Not a small feat.
On April 22, former Russian President Boris Yeltsin and former
Japanese Prime Minister Ryutaro Hashimoto will meet near Moscow.
Although the meeting's agenda has not been announced, the two
leaders are sure to discuss the transfer of the four southern Kuril
Islands to Tokyo. In 1997, Yeltsin and Hashimoto agreed to sign a
peace agreement by 2000, resolving a dispute between Russian and
Japan over the islands. Now the two men will meet again to clear
the decks for a historic agreement between President-elect Vladimir
Putin and Japanese Prime Minister Yoshiro Mori, who will meet at an
April 29 summit in Russia.
The Kuril Islands offer a number of assets. First, they have
strategic value, as they cut a dotted line through Russia's access
to the Pacific Ocean from the Okhotsko Sea. The waters off their
coasts harvest $4 billion worth of fish each year, and the islands
themselves hold deposits of pyrite, sulfur and various polymetalic
ores. As well, each nation defends its sovereignty over the islands
to nourish nationalist pride, an extremely important factor for two
nations in economic crisis.
But Putin is now ready to focus on rescuing Russia from treacherous
financial straits. The president already secured overwhelming
nationalist support by asserting Russia's strength and sovereignty
in the Chechen War. Now Putin must find a way to avoid defaulting
on the country's approximately $150 billion debt and to finance the
country's 2000 budget amid falling oil prices.
Settling the territorial dispute with Japan offers at least a
partial solution to Russia's quandary. Tokyo has already shown that
it's prepared to pay. As the result of 1997 talks, which yielded
only the "agreement to agree," Hashimoto promised Yeltsin $1.5
billion in loans, of which approximately half has now been
disbursed. The price tag for an actual peace agreement - in effect,
the price for the islands themselves - will be much higher. And
though Japan itself is saddled with a black-hole economy, the
government has proved extremely resourceful at generating a cash
flow.
Fishing rights in the coastal waters will be a major sticking point
of any deal. Currently, Russia only allows Japan a certain quota of
fish - and at a price. Japan will push for rights to a section of
the sea. Russia will fight to hold on as much as possible, but will
likely be willing to concede at least a section of water to Japan.
The potential fish harvest in the region may be huge; however, as a
Moscow Times article noted, the Russian fishing industry is
notoriously adept at hiding the majority of its profits. Very
little ends up in Moscow's coffers.
Talk of a deal will spark frenzied debate within Russia. But
ultimately, Putin will prevail. In October 1999, he said that
signing a peace treaty was both "essential and inevitable,"
reported Agence France-Presse. The promise of Japanese payment will
sidetrack many naysayers. In the past, the Communists have
vehemently opposed ceding the islands. However, Putin has recently
elicited unprecedented cooperation with the Communists, and may be
able to wrangle away some of their votes. In November, the Duma
voted down a Communist initiative to draft a statement asserting
that the parliament would reject any treaty "implying the loss or
restriction of Russian sovereignty over the South Kuril Islands."
The residents of the islands themselves have twice voted to secede
from Russia and join the Japanese. The Russian government supplies
very little money to the Sakhalin regional administration, which,
in turn, all but ignores the Kuril islanders. Earthquakes in 1995
and 1996 destroyed the fisheries supporting the islanders. They
hope that the Japanese, unlike the Russians, will pay to rebuild
them.
For the Japanese government, the issue is simple. Reclaiming the
islands will stir nationalist sentiment, possibly alleviating the
brooding Japanese depression produced by prolonged economic
malaise. The ruling coalition, led by the Liberal Democratic Party
(LDP), needs such a bromide in order to reclaim its shaky mandate.
Lower house elections, which could be called as early as June,
could otherwise result in significant losses for the LDP.
Cartographers, warm the presses.
The local government of Osaka, Japan's second largest city, is set
to follow Tokyo's example and pass a tax on bank profits - one that
will bring in badly needed revenues. The Prefectural Assembly will
vote on the proposal May 30, and the major political parties
support the measure, according to Jiji Press news agency. Faced
with the central government's inability to right the economy, local
governments are trying to take care of themselves. But without a
unified plan, this proliferating set of independent solutions
threatens to multiply Japan's economic problems.
Osaka's Prefectural Assembly is poised to pass a bill that will tax
the gross profits, rather than net profits, of banks with more than
$46 billion in assets, according to the Mainichi Shimbun. In other
words, even banks with negative balance sheets will have to pay
taxes. This scheme is expected to bring in $69 million to the debt-
ridden Osaka government. The proposal mirrors a law passed by
Tokyo's metropolitan government earlier this spring, expected to
raise nearly a billion dollars for the city.
This local insurgency stems from the central government's inability
to bring Japan out of its economic malaise. Rather than force
necessary structural reforms and rebuild the economy, the federal
government has tried to revive the existing system. The government
has stuck with a limited repertoire of economic tools, such as
massive public spending, bailouts and currency interventions to
increase exports. Unfortunately, none of these efforts have been
enough to stop Japan's economy from shrinking by 1 percent and 1.4
percent, respectively, in the latter two quarters of 1999.
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Local governments are taking matters into their own hands.
Decentralization has been discussed for years, but there is now a
very real financial incentive for local governments to go it alone.
At present, they have little control over their own finances.
New bank taxes are not only a symbol of the growing political
independence at local levels. These taxes are the beginning of a
larger pattern of local economic independence. Osaka's actions make
sense; it is Japan's second largest city and the second largest
banking center behind Tokyo. A number of other cities could also
benefit by following a similar tack, including regional banking
centers like Yokohama, Kobe and Nagoya.
The financial reality of the country borders on the absurd; the
Japanese government gives money to banks, which are now taxed by
local governments - to make up for revenues sent to the central
government. The banking system is already reliant on help from the
national government, which spent more than $60 billion propping up
the nation's top 15 banks in early 1999. This is nearly three-
quarters of the $82 billion in bad loans that Japan's banks wrote
off last year.
This spells trouble for a banking system already awash in it.
Japan's banking sector has yet to become internationally
competitive. In some cases, arcane rules allow banks a great deal
of leeway. The majority of international banks must have cash
reserves equal to 8 percent of their loans; Japanese banks need
only 4 percent. About half of South Korea's bank managers lost
their jobs in the restructuring that followed the 1997 Asian
economic meltdown. In Japan, no managers were sacked, according to
the Economist. Meanwhile, Japan's interest rates continue to hover
around zero.
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Besides helping to expose the country's financial shell game, the
bank tax will further hurt the financial system. Already,
struggling banks will be forced to use extra revenues to pay taxes,
further weakening their financial positions. Higher fees or
interest rates can't make up the difference because Japanese
consumers are hesitant to borrow money even at 0 percent interest.
Some banks may even be forced to appeal to the government for yet
another bailout.
The paralysis of Japan's central government has forced local
officials to act in their own best interests. Unfortunately, what
is good for Osaka - increased local tax revenues - is not good for
Japan, which would like a reformed banking system, but absolutely
needs a stable system. Other local governments will likely follow
Osaka's lead - there's a finite pool of cash to draw from, and
nobody wants to be the last to the trough. The result: exponential
decay of an already failing system.
Throughout Southeast Asia, open ocean piracy against commercial
shipping is an increasing concern. A January report by the Piracy
Reporting Center in Kuala Lumpur called the Straits of Malacca and
Singapore the most dangerous waters in the world. Raids on
commercial vessels are also of concern to the government in Tokyo.
Nearly 100 of the 141 pirate attacks on Japanese ships in the last
11 years have occurred off Southeast Asia, according to figures of
the Japanese Transport Ministry.
Citing its concern, Japan's Coast Guard reportedly plans to request
funds - tens of millions of dollars - to purchase two long-range
reconnaissance jets capable of making a 7,500-mile roundtrip flight
from Japan to the Strait of Malacca and back. The Japanese daily
Asahi reported that the Coast Guard is not in the market for
aircraft that would require basing in Southeast Asia. Ruling out
Japan's existing inventory of aircraft, the Coast Guard appears
interested in one of several new commercial long-range aircraft.
Loaded with the proper surveillance and electronics packages, these
jets would be suited to the task.
But this new mission for the Japanese Coast Guard would also
provide Tokyo with an important potential intelligence capability.
Anti-piracy missions launched from Japan would likely hug the
Chinese, Taiwanese and Vietnamese coasts. Such surveillance would
be consistent with the slow but steady redefinition of Japan's
security sphere, as well as recent announcements by the government
that it will operate forces far from home.
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Besides monitoring the Strait of Malacca - which separates
Indonesia, Malaysia and Singapore -- the Coast Guard said it will
use the unarmed aircraft to perform search operations and monitor
suspected Chinese spy ships lurking close to Japan's shores.
Already, however, Japan has a significant inventory of aircraft
suited for maritime patrols; it seems odd that the Coast Guard
would need to add a new, long-range aircraft.
The Maritime Self-Defense Force - which operates closely with the
Coast Guard - has about 100 U.S.-made P-3 Orions, suited both for
hunting submarines and tracking ship traffic. The Air Self-Defense
Force operates two Boeing 767s, fitted as airborne warning and
control aircraft. These aircraft are also suited for tracking
surface targets; similar U.S. Air Force jets track drug smuggling
in the Gulf of Mexico and Pacific Ocean.
Neither of these aircraft, however, has the legs to fly roundtrip
to the Strait of Malacca, loiter for hours, and return without
landing. As well, Japanese forces are not currently capable of
refueling aircraft in mid-air. Basing existing aircraft in
Southeast Asia is still a delicate political issue - a hangover
from World War II - but it is increasingly less so. Singapore, for
example, has given Japanese aircraft permission to use military
bases in an emergency. Also, the nations of Southeast Asia have
agreed in principle to allow Japan to take part in multinational
patrols in the Strait. As a result, existing P-3s could be used as
long as basing rights are secured.
Yet the Japanese Coast Guard has elected to adopt a comparatively
difficult and expensive solution. Why?
In a strategic sense, Tokyo is enlarging its 55-year-old doctrine
of self-defense. Increasingly Japan is redefining this notion to
extend beyond the horizon - not only defending the country, but
defending its vital interests as well. In the space of the last few
years, the government has declared that it will use its forces to
evacuate endangered Japanese nationals abroad. The government is
increasing spending on special operations forces. And earlier this
year, the Japanese parliament announced a formal review of the
nation's pacifist constitution.
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New long-range jets would provide Japanese forces with the
potential for an important new intelligence-gathering. A mission
launched from the Iwakuni Naval Base, for instance, could easily
follow the Chinese coast. The swath of land extending inland
contains the bulk of airfields, supply depots, missile
installations and naval facilities of the People's Liberation Army.
The same mission could easily overfly the contested Spratley
Islands and pick up intelligence on the Vietnamese harbor at Cam
Rahn Bay.
Depending upon the package of sensors, the new aircraft can perform
photo reconnaissance, intercept electronic transmissions, and
gather other intelligence while staying outside other nations'
airspace. Airborne Warning and Control Systems (AWACS) routinely
carry look down radar. New upgrades of the AWACS include passive
detection systems and pulse-Doppler radar able to see small,
stealthy targets. The synthetic aperture radar of a different
platform, such as the U.S. E-8C Joint Stars, can watch ground
targets in excess of 120 miles away.
Greater airborne surveillance would help solve an annoying problem
for the Japanese - their reliance on intelligence from the United
States. When North Korea launched a missile in 1998, the Japanese
government did not receive timely intelligence from the United
States. Washington clearly controls the flow of information to
Tokyo, which is concerned about missile programs in the region.
The real solution for Japan would be the development of its own
constellation of spy satellites. Already, smaller and less-
developed nations - such as Singapore and Turkey - are working on
their own systems. But Washington is loath to lose influence and
has done its best to impede the process in Japan. The Clinton
administration has rebuffed even suggestions from top officials of
the previous government, under the late Prime Minister Obuchi.
In the meantime, greater airborne reconnaissance can help fill
Japan's intelligence gap.