Monthly Economic Report (December 2002)

Assessment of the current state of the Japanese economy

As movements towards an incipient recovery are weakening, the state of the economy remains roughly flat.

Corporate profits are improving; and business investment is bottoming out.

While job offers are on an increasing trend, employment situation continues to be severe with unemployment rate reaching the highest level ever.

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

Export is declining somewhat; and industrial production has become flat.

As for short-term prospects, the economy continues to be expected to move towards an incipient recovery if the world economy shows a gradual recovery. On the other hand, environment, such as concerns over the future of the U.S. and other economies and sluggishness of domestic stock prices, continues to be severe, and there are concerns over downward pressure on final demand that may still be exerted by the development.

Policy stance

The Government is steadily implementing the “Comprehensive Measures to Accelerate Reforms,” which it previously decided. In addition, in recognition of the need to further strengthen measures for structural reform in response to the recent financial and economic situation, the Government approved the “Program to Accelerate Reform,” on December 12, to complement and enhance the Comprehensive Measures. On the basis of the Program, supplementary budget for FY2002 will be formulated in accordance with fiscal prudence, in order to enable the budget to be disbursed throughout the fiscal year without a break.

Furthermore, the Government decided on November 29 the “Guidelines for Formulation of the FY2003 Budget” which remains committed to the realization of the “budget for resolute reform” as in the previous year.

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

Detailed explanations

1.Demand trends such as consumption and investment

Real GDP (gross domestic product) in the third quarter of 2002 was 0.8% (at an annual rate of 3.2%) higher than in the previous quarter, despite the negative growth of Net exports (Exports minus Imports) of Goods and Services, mainly because of the growth of Private Consumption and Private Inventory. Nominal GDP was 0.4% higher than in the previous quarter.

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, has remained flat since the beginning of the year, as the environment surrounding households is severe as can be seen in continued weakness of income. Although private consumption as a whole has yet to go on an improvement trend, firmness can be observed in some areas, such as increases in some businesses and expenditure items.

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 real consumption expenditure decreased from the previous month, partly in reaction to a sharp increase in the previous month and partly due to decreases in education and foods.

Sales are weakening on the whole. Retail sales still have a weak tone. Chain store sales as a whole decreased from a year earlier, although foods continued to post a year-on-year increase. Department store sales as a whole decreased from a year earlier, as sales of clothing suffered a year-on-year decline due partly to weather factors. New car sales increased from a year earlier, as sales of compact cars remained brisk. Home appliance sales as a whole decreased from a year earlier, although sales of TVs continued to increase and the margin of decrease in personal computers narrowed. Domestic travel remained almost flat, and overseas travel increased sharply in reaction to the sharp decrease a year earlier caused in part by the effects of the terrorist attacks in the United States.

Consumer confidence shows movements of an incipient recovery, but the movement has been weakening recently.

Business investment is bottoming out.

Business investment, which has been decreasing since the beginning of 2001, is bottoming out, as production has improved and corporate earnings have been recovering. Financial Statements Statistics of Corporations by Industry Quarterly, which is a demand-side indicator of business investment and which had been decreasing since the January-March quarter of 2001, has been decreasing at a slower pace recently. Shipment of capital goods, which is a supply-side indicator of machinery equipment investment, moved sideways. Software investment, which had been firm, has decreased slightly.

Business investment is likely to increase as machinery orders, a leading indicator of machinery equipment investment is believed to have bottomed out in the first half of FY2002. However, after it has bottomed out, business investment is expected to remain at a low level in view of the weak recovery in machinery orders forecast for the October-December quarter and as machinery orders are expected to decrease according to the Bank of Japan short-term business sentiment survey (tankan).

Housing investment is decreasing moderately.

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. Housing construction in FY2002 has been decreasing moderately due to a decrease in the construction of new condominiums, with housing construction standing at an annual rate of 1.18 million units in the April-June quarter of 2002 and at an annual rate of 1.13 million units in the July-September quarter.

In October, housing construction came to an annual rate of 1.191 million units thanks to increases in the construction of owned houses, houses for rent, houses for sale, and in particular, condominiums. Factors that decrease housing construction are still observed. For example, consumer sentiment with regard to acquiring houses has been declining due to the harsh 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.

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. Under the fiscal plans of local governments for FY2002, regarding 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 governments have conducted a thorough review of expenditures and a focused allocation of budget.

Reflecting this situation, public investment has been generally sluggish. In FY2002, although the supporting effects of the second supplementary budget for FY2001 that was carried over into the current fiscal year have been seen, public investment continued to decline compared to the previous year in the April-June and July-September quarters, respectively. However, turnover of public construction has posted a month-to-month increase for four consecutive months since June.

Public investment in the October-December quarter is likely to continue posting a year-on-year decrease in view of the decreases in the contracted amount of public works in October and November and the budgetary conditions of the state and local governments.

In a supplementary budget, which will be compiled in response to the “Program to Accelerate Reform” (decided on December 12), the Government intends to take budgetary measures for public investment promoting structural reform, including about 1.5 trillion yen on a national expense basis (about 2.6 trillion yen on a project basis).

Exports are declining somewhat. Imports are increasing. The surplus in the trade and services balance has decreased slightly.

Exports are declining somewhat as restocking since the beginning of the year comes to a halt amid a worldwide slowdown in the growth of final demand, such as IT-related equipment, with exports, especially of electrical devices, posting a decrease. By region, exports to Asia moved sideways as a whole and by item. Exports to the U.S. declined slightly as exports of transportation equipment, such as automobiles, moved sideways and exports of general machinery and electrical devices decreased slightly. Exports to the EU decreased against the background of a slowdown in economic activity in the Euro Area. As for the outlook for exports, close monitoring is required for weak movements appearing in the recovery of the world economy.

Imports as a whole increased, as imports of mineral fuels increased, although imports of IT-related machinery equipment slowed down against the background of the leveling-off of production. By region, imports from Asia, especially of metals and materials, increased. Imports from the EU remained flat. Imports from the U.S., which dropped sharply in October due to harbor strikes in the West Coast, remained flat by and large.

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

2. Corporate activities and employment

Industrial production remains flat.

Industrial production had increased for three consecutive quarters reflecting an end in inventory adjustment. However, industrial production has become flat recently, reflecting a slight declining in exports.

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 fall in November but rise in December.

Tertiary industry activities remain broadly flat.

Corporate profits are improving. Firms' judgement on current business conditions continues improving, albeit moderately. The number of bankrupt companies is decreasing.

According to Financial Statements Statistics of Corporations by Industry, Quarterly, corporate profits, which had posted a sharp decrease in and after the July-September quarter of 2001, especially in the manufacturing industries, such as electric machinery, increased in the July-September quarter of 2002 due partly to corporations’ restructuring efforts, although sales continued to decrease. According to the Bank of Japan short-term business sentiment survey (tankan), industries as a whole expect their profits to increase sharply in the second half of FY2002.

The BOJ tankan survey says business sentiment of enterprises, especially of manufacturing industries, has been improving, albeit moderately, although business sentiment of small and medium-sized enterprises has remained severe and at low levels.  As for future prospects, enterprises have become cautious, forecasting a slight deterioration of their business.

According to Tokyo Shoko Research, Ltd., the number of corporate failures decreased, with 1,435 companies going bankrupt in November.

The employment situation still remains severe. While job offers are on an increasing trend, the employment situation continues to be severe with the unemployment rate reaching the highest level ever and wages continued to weaken.

The unemployment rate in October rose 0.1% over the preceding month to 5.5%, the highest-ever level last seen in December of last year. The number of involuntary job leavers, which accounts for the largest proportion of the unemployed, decreased marginally and the number of voluntary job leavers increased in October. The ratio of people out of work for more than one year to the unemployed decreased slightly. The number of employees decreased slightly, posting a month-to-month decrease for three consecutive months.

The number of new job offers remained on an increasing trend. The effective job offer ratio continued to increase moderately. Overtime work hours in the manufacturing industries posted a month-to-month decrease for two consecutive months reflecting the movement of production, weakening its year-to-year increasing trend. The number of corporations saying they have excess employees decreased slightly but still remains at a high level. The proportion of business establishments that implemented employment adjustment, such as "overtime restrictions," in the July-September quarter decreased.

Wages remained weak, with contractual cash earnings continuing a year-to-year decrease, although it posted a month-to-month increase.

3. Prices and the financial market

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

Import prices have been rising on a contractual currency basis but declining on a yen basis recently due to the influence of exchange movements. Domestic Wholesale Prices have been moving sideways. Recently, the prices of Steel and Pulp, paper & related products have been rising reflecting progress in inventory adjustments, and the prices of Petroleum & coal products have been rising at a faster pace reflecting rises in their import prices, although the prices of Electric power, gas & water and Electrical machinery 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 sideways, General commodities declined due to sharper decline in the price of other industrial goods and a fall in the prices of Durable goods, and the margin of decline in the prices of Public services & electricity, gas & water charges widened.

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

Financial market: Stock prices fell after rising to the 9,200 yen level (Nikkei Stock Average) in late November. Long-term interest rates moved in the 0.9-1.0% level range.

Short-term interest rates moved in the 0.001-0.002% range reflecting the Bank of Japan's monetary easing policy. Two- and three-month contracts moved almost sideways. Long-term interest rates, which began to fall in mid October reflecting receding concerns about increased issuance of government bonds, fell 0.9% level in early November and then moved at the 0.9~1.0% level range.

The stock market, as measured both by the Nikkei Stock Average and TOPIX, fell to the lowest level since 1989 in mid November. Later stock prices rose to the 9,200 yen level (Nikkei Stock Average) reflecting a rise in U.S. stock prices, and then fell in early December.

On the exchange market, the yen (interbank spot central rate) depreciated to the 125 yen level in early December after appreciating from 125 yen level to the 119 yen level from late October to mid November, and then moved in the 122-123 yen level. Against the Euro, the yen (interbank rate as of 17:00) depreciated to the 125 yen level in early December after moving in the 120-123 yen level range from early October to late November, and then moved in the 123-125 yen level range.

The growth of the monetary base (monthly average balance) has remained high at about the 20% level against the background of ample fund supplies (the average balance of current deposits at the Bank of Japan stood at 18.1 trillion yen in November). (November: Up 21.8% over a year earlier.) The growth rate of M2+CDs (monthly average balance) has remained at the first half of 3% level (November preliminary report: Up 3.2% 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. (The outstanding balance of loans at major banks as of the end of the first half of FY2002 was down 5.5% from the end of FY2001.) Interest rates on bank loans have recently remained broadly flat, after being on a downward trend since the beginning of last year, reflecting easing monetary policies. Enterprises' financial conditions have remained flat and the yield spread between private bonds and government bonds has remained almost flat.

4. Overseas economies

Weak movements are appearing in the world economic recovery.

The economic recovery in the U.S. is losing momentum. The growth of private consumption continues to slow at large. Housing construction is at a high level. Business investment, especially in machinery equipment, is showing signs of picking up. Production is decreasing. Employment is leveling off, while decreasing in the manufacturing industries. The unemployment rate is rising. Prices are stable.

While the Asian economy is recovering as a whole, the recovery has become moderate in some Asian countries. The pace of economic growth in China is rising. In South Korea, the economy is expanding, but domestic demand shows some signs of slowing. In Thailand, the economy is expanding. In Taiwan and Malaysia, the economy is recovering moderately. In Singapore, the economy is recovering at a more moderate pace.

In Europe, (1) In the Euro Area, the economy is on the verge of deceleration. In Germany and France, the economy is decelerating. (2) The U.K. economy continues movements of a recovery but business confidence is deteriorating.

As for the international financial situation, U.S. stock prices were on an upward trend in November, as business settlement and earnings forecasts of some corporations were better than the market had expected, but then fell slightly due to some events, such as bankruptcy filing by a major U.S. airline company. U.S. long-term interest rates and the dollar strengthened in November, but then weakened.

In the Euro Area, the European Central Bank (ECB) cut the key interest rate (minimum bid rate for the main refinancing operations) by 0.50 percentage points to 2.75% on December 5.

As for the international commodity market, crude oil prices rose on the start of UN inspections of Iraq.