Annual Report on the Japanese

Economy and Public Finance


- No Gains Without Reforms IV -

July 2004

Cabinet Office

Government of Japan

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Chapter 1

Reform and Recovery in the Japanese Economy

Key Points of Chapter 1

Section 1 Toward Economic Growth Based on Private Demand
The current economic recovery is characterized by: (i) recovery driven by private demand with restrained government spending, (ii) a strengthening of management of the business sector with reduction of its excessive debts and employment, and (iii) Japanese companies demonstrating their originality in such areas as digital electronics.

Section 2 Business Sector Benefiting from Reform
The improvement in corporate profits is characterized by higher revenue and higher profits.
With the progress of non-performing loan disposal, debts were reduced and profitability rose in real estate, wholesale and retail, and construction industries.
Companies strengthened their financial condition through restructuring, including the reduction of labor costs and debt and business reorganization.
Despite increases in capital investment, the level of capital stock is stable, and old equipment is being eliminated.

Section 3 Improvement in the Labor Market and Household Sector
Growth in employment was modest, but there was a halt in restructuring and the unemployment rate declined for the first time in 13 years.
Wages are rising in well-performed industries but are flat in the economy as a whole due to an increasing proportion of part-time workers.
Consumer confidence due to the improved employment situation and effect of creation of private demand by new products contributed to the recovery in growth of consumption.

Section 4 Prospects of Overcoming Deflation
Behind the ease in deflation was tightening under the condition of supply and demand resulting from the economic recovery and a narrowing of declining factors on the supply side including deregulation, increases in imports and technological innovation.
From the monetary perspective as well, there was a movement toward the soundness of finance with a moderation in the decline of the money multiplier and the velocity.
A recovery in soundness of finance is necessary in order to completely eliminate deflation such that it will not reoccur. Support in terms of monetary policy is important for reducing deflation risk.

Section 5 Progress in Structural Reform in Fiscal Policy and the Financial System
Annual expenditures are being restrained, and the fiscal deficit of the central and local governments is projected to decline in FY2004. Attention must be given, however, to movements in interest rates.
The disposal of non-performing loans by major banks is progressing, but the pace of improvement at regional banks is slow. Comprehensive measures are needed in order to improve profitability through regional revitalization.
The presence of public financing is growing relatively due to lower financial transaction in the private sector. Capital distribution needs to be made to function effectively through fiscal investment and loan reform, reform of special public institutions and privatization of postal services.

Section 6 Future Economic Prospects
The foundations of continued recovery based on private demand in the future are being built including the strengthening of the condition of companies, brisk consumption reflecting the improved employment situation and a virtuous cycle of production and demand of new products.
Risk factors include a slowdown in overseas economies and a sharp appreciation of the yen. It is necessary to be mindful of the effect of a rise in US interest rates.

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