Monthly Economic Report (July 2001)

Assessment of the current state of the Japanese Economy

The economy is deteriorating.

Private consumption has remained broadly flat, with some weakness in recent months. The unemployment rate has hovered at high levels.

Exports and industrial production continue to decline.

Corporate profits and business investment have flattened.

Short-term prospects involve some concerns, such as increases in business inventories and signs of weaker business investment.

Policy stance

Based on the report by the Council on Economic and Fiscal Policy (CEFP), the Government decided, at the Cabinet meeting on June 26th, the "Basic Policies for Macroeconomic Management and Structural Reform of the Japanese Economy." The Government carries out resolutely ceaseless structural reforms to revitalize the Japanese economy along the lines indicated in the Basic Policies, which include thorough resolution of the non-performing loan problem, and implementation of the seven programs of structural reform as a package.

Detailed explanations

1. Demand trends such as consumption and investment

Although personal consumption has remained broadly flat, it shows signs of weakness recently.

The Synthetic Consumption Index has recently been showing signs of weakness.

Looking at the Family Income and Expenditure Survey, which is a statistic of the demand side, the real consumption expenses increased in May 2001 after posting a month-to-month decrease for two consecutive months.

Sales statistics show that retail sales still have a weak tone, moving laterally in May after posting a month-to-month decrease for two consecutive months. Chain store sales also maintain a weak tone, continuing their year-on-year declines. Meanwhile, the magnitude of decline in department store sales shrank due in part to the extension of business hours.

Looking at durable consumer goods, auto sales remain at a low level. Home appliance sales continued to post a year-on-year decrease due, in part, to a continued large decrease in personal computer sales.

Travel expenses as a whole continued to show signs of slowing down, with domestic travel was better than last year and travel abroad, which posted a decrease last month, expanding its year-on-year decline in May.

In terms of such movement on both the demand and supply sides, personal consumption shows signs of weakness recently, although it has remained broadly flat.

As for the movement of household income that has a large impact on the movement of personal consumption, contractual cash earnings in May posted a year-on-year decreased for the fifth consecutive month. Cash earnings in May decreased from a year earlier for the first time in two months.

Business investment has hit a ceiling. Looking at industries, although business investment of the manufacturing industries has been increasing steadily, that of the non-manufacturing industries has been rather weak.

Business investment has been on an increase trend since it turned to recovery in 1999 and has been a supporting factor for the economy. However, the Quarterly Survey of Corporate Enterprises shows that, in the January-March period, although business investment of the manufacturing industries increased steadily, that of the non-manufacturing industries decreased on a year-on-year basis, causing the total business investment to hit a ceiling. Shipment of capital goods which is a reference indicator of machinery equipment investment has been weak recently.

There are signs of weakness in the future business investment, as business investment in fiscal 2001, especially in the non-manufacturing industries, is expected to decrease in the BOJ's tankan short-term business sentiment survey and that machinery orders, a leading indicator of machinery equipment investment, decreased from the previous period in the January-March period and is expected to nearly level off in the April-June period.

Housing investment has a weak tone.

Housing construction has been weak since February 2001, although approximately 1.2 million units had been constructed each year since 1999. This is mainly because condominium starts have turned steady, as seen last year, and because starts of publicly financed owned houses decreased sharply after the turn of the year. However, housing construction in May rose to an annual rate of 1.2 million units due to a sharp month-to-month increase in the starts of privately financed houses for rent.

Factors which decrease housing construction are still observed. For example, the number of applications for the housing finance by the House Loan Corporation has fallen.

Public investment has been generally sluggish.

Public investment has been generally sluggish. The government's public investment-related budget for fiscal 2000 was smaller than that in the previous year when the Government's revised budget was comparatively high, and local governments have continued to curb investment expenses because of their tight financial positions. Reflecting such a situation, the contracted amount of public works based on the guarantee contracts of advanced payment had continued to lower on a year-on-year basis from June 2000 to March 2001. There were also some indications of a sharp decrease from the previous year in the orders received in the January-March period when many fiscal-year-end orders are placed.

Since the beginning of the new fiscal year, although the total amount of orders received and contracts concluded by 50 major companies in April were larger than in the previous fiscal year, they decreased sharply in May. This may be because, in the previous fiscal year, many orders were placed in and after May, rather than in April, greatly pushing down the order amount of April. We should also note that the amount of orders placed at the start of a new fiscal year is comparatively small and tends to make the year-on-year comparison volatile.

Public investment in the April-June quarter is not expected to post the kind of sharp decline recorded in the January-March quarter, as public investment earmarked in the initial national budget for fiscal 2001 is almost the same amount as in the preceding year and as the amount of investment expenses to be slashed by local governments is smaller than in the preceding year.

Both exports and imports have been decreasing. The surplus in the trade and services balance has remained broadly flat.

Against the backdrop of a slowdown of the U.S. and Asian economies, exports, especially of electrical devices such as semiconductors and other electronic parts, have decreased for all regions of Asia, the U.S. and the EU.

Imports, especially of IT-related goods such as semiconductors and other electronic parts have also decreased, reflecting slower demand for IT-related goods. By region, imports from Asia have been weak, as imports from the NIEs, especially of machinery equipment, have decreased. Imports from the U.S. and the EU have decreased.

Looking at the international balance of payments, the surplus in the trade and services account, which had been decreasing due to smaller exports since last fall, have recently remained broadly flat.

2. Corporate activities and employment

While industrial production continues to decrease, inventories have increased.

Industrial production has been decreasing since the beginning of this year. The main reason for this is that production of IT-related items has been decreasing due to their fewer exports.

Industrial production is expected to rise in June and fall in July. However, we should note that if it follows this expected course of rise and fall, industrial production in the April-June period will decline from the preceding quarter. Furthermore, there is concern over the prospects of industrial production that inventories, especially of producer goods such as electronic parts, chemicals and steel, have been increasing.

On the other hand, tertiary industry activities, especially in the service industry, have been increasing moderately.

Corporate profits have leveled off. Business sentiments are deteriorating sharply, especially in manufacturing industries. The number of bankrupt companies is rather high.

Corporate profits have been improving since 1999 and especially since mid-2000, they have been improving greatly. The first reason for this improvement is corporations' efforts to restructure their business and the second and third, which are also strong reasons, are that sales in manufacturing industries have been increasing and non-manufacturing industries had been cutting non-fixed costs until early 2000. However, the BOJ's tankan survey predicts that corporate profits will slow down in the first half of fiscal 2001 and the Quarterly Survey of Corporate Enterprises shows that ordinary profits in the January-March 2001 period remained at the same level on a year-on-year basis.

The tankan survey says business sentiments of all segments, large or small-and-medium, manufacturing or non-manufacturing, have been deteriorating. Those of manufacturing industries, especially of electrical machinery, have been deteriorating sharply. The "Business and Investment Survey of Incorporated Enterprises" shows that, although the business sentiments of large non-manufacturing industries have remained unchanged, those of manufacturing industries, especially electric machinery, have been deteriorating sharply.

According to Tokyo Shoko Research Ltd., 1,664 companies went bankrupt in May, which was a rather high level.

The employment situation remains severe, with the unemployment rate hitting an all-time high. Although robustness is seen in some industries, employment remains weak in the manufacturing industry.

The unemployment rate in May rose 0.1% from the previous month to match the all-time high of 4.9%.

Movements that reflect a decrease in production are seen especially in the manufacturing industry. Although the number of new job offers increased in May (up 3.0% over the previous month) as in April, it decreased in the manufacturing industry. Overtime work hours decreased for 7 consecutive months on a month-to-month basis. The number of employees as a whole increased in the last 2 months as the number in the non-manufacturing industry increased, although it decreased in the manufacturing industry. The number of corporations saying they have excess employees has been increasing, especially among medium- and smaller manufacturers.

3. Prices and the financial market

Domestic Wholesale Prices and Consumer Prices are both declining slightly.

Import Prices have been rising on a yen basis due to the yen's depreciation, although they fell on a contractual currency basis. Domestic Wholesale Prices have been declining slightly since the beginning of 2001. Recently, prices of petroleum & coal products have increased but those of Electrical machinery and Transportation equipment have decreased. The corporate service price index has continued to decline from a year earlier.

Consumer Prices have been declining slightly since the fall of 2000. Although general service prices rose slightly from a year earlier as the effect of a price-down of Eating out had run its course, commodity product prices extended their downtrend due to sharper declines in the prices of textile products and smaller rises in the prices of oil products.

Taken together, these movements show that the Japanese economy is in a mild deflationary phase in that the decline in prices is continuing.

The financial market: Long-term interest rates have been on a downward trend since last fall due in part to the market's concern over the economy's prospects, and fell further in June.

Looking at the short-term interest rates, overnight rates were generally moving at 0.01% up to mid-June, then began to rise and hit 0.06% at the end of the month. 2- and 3-month contracts moved laterally in June, after having remained on a downward trend since the beginning of this year. Long-term interest rates, reflecting in part the market's concern over the economy's prospects, had been on a downward trend since last fall, until they reached the 1.0% level in March. Although they picked up for a while thereafter, they turned downward again and fell further in June.

The stock market had been on a falling trend since the spring of last year, until it turned upward in mid-March. After rising from the end of April through early May against the backdrop of the rising expectations towards the Government's structural reforms and the firm movements of the U.S. stock prices, it moved toward a downward trend in late June.

On the exchange market, the yen had continued falling against the dollar since the end of last year and hit the 126 yen level in April. After rising to the 119 yen level, pushed up by a low Euro, the yen again turned downward in June and fell to the 124 yen level. The yen had moved indecisively at around 110 against the Euro since March but rose sharply to the 100 yen level from late May to early June, before falling again to the 107 yen level in late June.

While M2 + CDs (monthly average balance) had been growing 2.0% on a year-on-year basis since the second half of last year, its growth rate has been accelerating slightly since the beginning of this year, reflecting the shift of funds from the postal savings and so on (June preliminary report: up 3.2% over a year earlier). The total amount of the loans provided by the private financial institutions (average balance of all loans) has been decreasing on a year-on-year basis since the fall of 1996. It remains at a low level, reflecting the corporations' slow demand for funds and so on. Although interest rates on bank loans had been rising slowly after the termination of the zero interest-rate policy, they have been on a falling trend since the beginning of this year.

4. Overseas economy

The U.S. economy is weak while in Asia, the economy is slowing down.

The world economy as a whole is slowing down its growth.

In the U.S., solid movements are seen in private consumption and housing investment, and the fall of consumer sentiment is coming to a halt. Meanwhile, domestic demand is growing only at a moderate pace, as corporations restrain capital spending due to worsening corporate profits. Amid the continuing inventory adjustment, manufacturing activities are slowing down, pushing capacity utilization down.Employment is falling mainly in manufacturing and the unemployment rate is on a rising trend. The U.S. economy is now weak. There are concerns over the prospects such as worsening corporate profits and a declining capacity utilization rate.

In Europe, the pace of economic expansion has been slowing down in Germany. In France, stable economic growth is continuing, while its business prospects are worsening. In the U.K., the economy is expanding moderately.

In Asia, the pace of economic growth is rising slightly in China, supported by the steady movements of personal consumption and fixed asset investment. South Korea's economy is slowing down, because industrial production and private consumption as well as exports have slowed.

As for the international monetary situation, the target range of short-term interest rates in the U.S. was lowered by a quarter percentage point to 3.75% at the Federal Open Market Committee meeting held on June 26 and 27.

As for movements in the international commodity market, crude oil prices fell as concerns about shortages of gasoline supply receded due to an increase in inventories.