Monthly Economic Report (August 2002)

Assessment of the current state of the Japanese economy

While the economy continues to be in a difficult situation, movements of an incipient recovery can be seen in some areas.

Employment situation continues to be severe with the unemployment rate being at a high level.

While private consumption is flat, firmness can be observed in some areas.

Exports are showing large increase, and industrial production is showing movements of an incipient recovery. Business confidence is improving as a whole. While business investment is declining, there are signs of bottoming out in the future.

As for short-term prospects, the impact of large increase in exports and incipient recovery in industrial production are expected to spread to overall economy, and bring about an incipient recovery of the economy. On the other hand, developments in the world-wide decline in stock prices and depreciation of the US dollar are further increasing uncertainty surrounding the future of the world economy, and there are concerns over the downward pressure on final demand that may be exerted by the development.

Policy stance

The Government will materialize at an early stage the "Basic Policy for Economic and Fiscal Policy Management and Structural Reform 2002." As for the formulation of FY2003 budget, government expenditure reform will be accelerated, and full-scale and packaged tax reform aiming to revitalize the economy will be materialized.

The Government and the Bank of Japan together will also continue to take powerful and comprehensive actions to emerge from deflation.

Detailed explanations

1.Demand trends such as consumption and investment

While private consumption is flat, firmness can be observed in some areas.

Private consumption, in terms of movements on both the demand and supply sides,is flat, but firmness can be observed in some areas. Although private consumption as a whole has yet to go on an improvement trend due to continued weakness of income, increases have been seen in some businesses and expenditure items, reflecting an improvement in consumer confidence.

As for movement on the demand side, robust movement has been seen since last autumn. The Synthetic Consumption Index posted a rise from three months before. As for the movement of each expenditure item, the Family Income and Expenditure Survey shows that basic expenditure items, such as foods, were robust, with foods continuing to post a year-on-year increase, although some items posted a sharp decrease due to temporary factors.

Sales are weakening as a whole. Retail sales still have a weak tone. Chain store sales in June stood at almost the same level as in the year earlier, with the margin of decrease narrowing. Department store sales, which had been moving unevenly since last summer, remained almost unchanged overall. New car sales decreased slightly from a year earlier, as sales of regular cars posted a sharp year-to-year decrease, although sales of mini and compact cars remained brisk. Home appliance sales decreased as a whole, as sales of personal computers and air conditioners posted sharp year-to-year decreases, although sales of TV sets posted a sharp increase. Domestic travel decreased sharply from a year earlier and the margin of year-to-year decrease of overseas travel, which had been narrowing, expanded sharply.

Consumer confidence shows movements of an incipient recovery, although it remains at a low level.

While Business investment is declining, there are signs of bottoming out in the future.

Business investment has been decreasing since the beginning of 2001, due partly to a decline in production and corporate earnings. Financial Statements Statistics of Corporations by Industry, Quarterly, which is a demand-side indicator, shows that business investment has been decreasing since the January-March quarter of 2001. Shipment of capital goods, which is a supply-side indicator of machinery equipment investment and which had been decreasing since the beginning of 2001, has stopped declining. Software investment has been on a relatively firm trend.

Business investment is likely to stop decreasing, as machinery orders, a leading indicator of machinery equipment investment, which had remained on a decreasing trend since the January-March quarter of 2001, show signs of bottoming out. However, after it has stopped declining, business investment is expected to remain at a low level, as machinery orders are expected to decrease in the Bank of Japan short-term business sentiment survey (tankan).

Housing investment is in a weak tone.

Housing construction in FY2001 decreased 3.3% from the preceding fiscal year to 1.173 million units, the first time it has fallen below 1.2 million units in three years, because condominium starts, which posted a solid gain in 2000, have turned steady and because starts of publicly financed owned houses decreased sharply in and after January 2001.

In June, housing construction came to an annual rate of 1.103 million units, as starts of owned houses, houses for rent and houses for sale increased sharply due partly to the sharp increase in the previous month. Factors that decrease housing construction are still observed. For example, consumer sentiment with regard to acquiring houses has been declining due to the severe employment and income environments and the long-term downward trend of real estate prices that has weakened replacement demand.

Public investment has been generally sluggish, although the impact of the second supplementary budget for FY2001 can be seen recently.

Public investment has been generally sluggish. Under the initial national budget for FY2002, public investment-related expenses, including facility expenses, are to be slashed by 10.7% from the previous fiscal year, and under the fiscal plans of local governments for FY2002, of the investment expenses, those for projects to be undertaken by local governments on their own funding are to be slashed by 10.0% from the previous fiscal year. This shows that both the national and local government have conducted thorough review of expenditures and focused allocation of budget.

In the circumstances, the second supplementary budget for FY2002 had an effect of holding up public investment, increasing the contracted amount of public works and orders received by 50 major companies in May over a year earlier. But, for the April-June period, both the contracted amount of public works and orders received by 50 major companies continued to post year-on-year decreases, although the contracted amount of public works was close to the level of a year earlier.

Exports to Asia, among other areas, are increasing sharply. Imports are increasing slightly. The surplus in the trade and services balance is increasing.

Exports have increased sharply as a whole, as exports of electrical devices, mainly electronic components like semiconductors, and general machinery are on a sharp increasing trend and exports of transportation equipment are steady, reflecting the worldwide economic recovery. By region, exports to Asia, especially of electrical devices, general machinery, and transportation equipment increased sharply. Exports to the U.S. increased slightly, mainly of electrical devices and general machinery. Exports to the EU, mainly of electrical devices and transportation equipment, increased. As for the outlook for exports, the improvement in the world economy is likely to support Japanese exports. However, we have to pay attention to further increasing uncertainties about the future course of the world economy caused by recent stock price declines and the worldwide depreciation of the dollar.

Imports as a whole increased slightly, as imports of IT-related machinery equipment increased thanks to a pickup in production, mainly of electrical machinery. By region, imports from Asia increased, as imports of machinery equipment remained firm. Imports from the EU remained flat. Imports from the U.S. increased, as imports of machinery equipment such as aircraft increased.

Looking at the international balance of payments, the surplus in the trade and services account has increased, as export volume increased sharply while import volume increased moderately.

2. Corporate activities and employment

Industrial production is showing movements of an incipient recovery.

Industrial production, which had posted a sharp decrease since the beginning of 2001, increased for two consecutive quarters. Industrial production is showing movements of an incipient recovery, reflecting a sharp increase in exports and an end in inventory adjustment.

There is concern over the prospects of industrial production as uncertainties surrounding the future of the world economy have further increased. Incidentally, according to the Survey of Production Forecast, industrial production is expected to rise in July and August.

Tertiary industry activities remain broadly flat.

Corporate profits show signs that they have stopped their decreasing. Firms' judgement on current business conditions is improving as a whole, although it has remained severe especially in small and medium-sized enterprises. The number of bankrupt companies remains at a high level.

According to Financial Statements Statistics of Corporations by Industry, Quarterly, corporate profits, especially in the manufacturing industries, such as electric machinery, posted a sharp decrease in and after the July-September quarter of 2001. In the January-March quarter of 2002, industries as a whole narrowed the margin of decline in profit, as the non-manufacturing industries increased profits, although the manufacturing industries continued to post a decrease in profits. According to the Bank of Japan short-term business sentiment survey (tankan), industries as a whole expect their profits to remain flat in the first half of FY2002 but to increase sharply in the second half.

The BOJ tankan survey says business sentiment of all sizes of both manufacturing and non-manufacturing enterprises has improved, although business sentiment has remained severe and at low levels especially in small and medium-sized enterprises. As for future prospects, all enterprises forecast improvement, except for small and medium-sized non-manufacturing enterprises, which forecast a slight deterioration of their business.

According to Tokyo Shoko Research, Ltd., 1,439 companies went bankrupt in December, and the total number of bankrupt companies in the October-December quarter was 4,780. It remains at a high level.

The employment situation still remains severe. Although overtime work hours increased, the unemployment rate remained at a high level and wages continued to weaken.

The unemployment rate in June remained unchanged from the previous month at 5.4%. The number of involuntary job leavers, which accounts for the largest proportion of the unemployed, increased at a faster pace than in the previous month. The number of employees has stopped decreasing and posted a month-to-month increase in June.

The number of new job offers decreased but is on a recovering trend. On the other hand, the number of new job seekers decreased sharply at the same time, therefore the new job offer ratio increased from the previous month and the effective job offer ratio remained unchanged from the previous month. Overtime work hours in the manufacturing industries moved sideways in June, reflecting the movements of production, but remains on an increasing trend.

Wages increased slightly from the previous month but continued edging down on a year-to-year basis. Special cash earnings, including bonuses, posted a year-to-year decrease, continuing its downward trend.

3. Prices and the financial market

Domestic Wholesale Prices are moving sideways and Consumer Prices are declining slightly.

Import Prices have been rising both on a contractual currency basis and on a yen basis. Domestic Wholesale Prices have been moving sideways. Recently, the prices of Petroleum & coal products have been rising, reflecting higher crude oil prices, although the prices of Electrical machinery and Electric power, gas & water declined. 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 services moved almost sideways, General commodities declined due to a fall in the prices of Durable goods.

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

Financial market: Stock prices declined. The yen depreciated against the U.S. dollar, after appreciating.

Looking at short-term interest rates, the overnight call rate moved at 0.001-0.002% in July, reflecting the Bank of Japan's monetary easing policy. Two- and three-month contracts moved sideways in July. Long-term interest rates rose in late July on market expectations of selling by financial institutions to lock in profits. The rates fell from late June to mid July, reflecting market concerns about the future course of stock prices and exchange rates.

The stock market fell against the background of the decline in stock prices in the United States.

On the exchange market, the yen (interbank spot central rate) appreciated to the 115-yen level reflecting the outlook for the Japanese and U.S. economies in mid-July after depreciating to the 133-yen level in late March, and then depreciated in late July. Against the Euro, the yen (interbank rate as of 17:00) appreciated slightly in early July after moving in the 117-119.50 yen range in mid and late June, and then moved in the 115-117 yen level.

The growth of the monetary base (monthly average balance) has increased at a fast pace against the background of ample fund supply (The average balance of current deposits at the Bank of Japan stood at 14.9 trillion yen in July) by the Bank of Japan (July: Up 25.1% over a year earlier). The growth rate of M2+CDs (monthly average balance) has remained at around 3.5% (June preliminary report: Up 3.4% over a year earlier). The total amount of loans provided by 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 firms' weak demand for funds and so forth. Interest rates on bank loans have recently remained broadly flat, after being on a falling trend since the beginning of last year, reflecting easier monetary policies. Enterprises' financial conditions have improved slightly and the yield spread between private bonds and government bonds has narrowed recently.

4. Overseas economies

The world economy is recovering moderately, but uncertainties about the future have been rising further.

The economic recovery in the U.S. has become moderate. Private consumption is increasing at a slower pace. Housing construction is at a high level. Business investment, especially in machinery equipment, has stopped decreasing. Production is increasing. Employment is picking up. Prices are stable.

The Asian economy is recovering. The pace of economic growth in China is rising. In South Korea and Thailand, the economy is expanding. In Taiwan, Singapore, and Malaysia, the economy is recovering. Exports to the U.S. are increasing at a slower pace in Korea, Thailand, Taiwan, Singapore and Malaysia recently.

In Europe, (1) The Euro Area economy is generally picking up. A pickup of German economy is losing steam. In France, the economy is generally picking up. (2) The U.K. economy shows movements of a recovery.

As for the international financial situation, U.S. stock prices rose sharply in late July following the passage of the Law on corporate responsibility through both houses of Congress, after remaining on a downward trend depressed by such factors as rising distrust in corporate accounting and the failure of a major telecommunications company. Stock prices in other major markets followed a similar course and rose in late-July. The dollar depreciated until mid July but then appreciated in line with a rise in U.S. stock prices. U.S. long-term interest rates rose in late July, after remaining on a downward trend reflecting a shift in funds into Treasury bonds. Canada raised interest rates in mid July for the third time this year.

As for the international commodity market, crude oil prices levelled off in July.

As for the economic prospect, uncertainties have been rising further because of the recent worldwide declines in stock prices, the dollar depreciation, and the resultant worsening of confidence.