Monthly Economic Report (February 2002)

Assessment of the current state of the Japanese Economy

The economy continues to deteriorate.

Private consumption is weakening.

Employment situation has become increasingly severe with the unemployment rate rising to a new record.

While exports are showing signs of bottoming out and industrial production declining at a slower pace, business investment is declining.

As for short-term prospects, there are concerns over the downward pressure on private demands that may be exerted by severe employment and wage situations and capital market developments.On the other hand, external condition is expected to improve as the U.S. economy and some economies in Asia are showing signs of bottoming out.

Policy stance

While taking decisive actions for structural reform, the Government is paying full attention to the prevention of the economy from falling into a deflationary spiral, and is firmly resolved, in close cooperation with the Bank of Japan, to emerge from the deflation.

On January 25, the Government made a cabinet decision on the "Structural Reform and Medium-Term Economic and Fiscal Perspective" which sets out a vision of the economy and society that Japan should build, and sketches a clear picture of the medium-term economic and fiscal management, centered on structural reform, that will make this vision a reality. On the same day, the Government also made a cabinet decision on the "Fiscal Year 2002 Economic Outlook and Basic Stance for Economic and Fiscal Management," and submitted the "Draft General Account Budget for Fiscal Year 2002" to the Diet.

The Government is steadily implementing the supplementary budgets for the Fiscal Year 2002 and other measures, and will endeavour to see an early approval of the "Budget for Fiscal Year 2002" by the Diet.

Detailed explanations

1. Demand trends such as consumption and investment

Personal consumptionis weakening.

Personal consumption, in terms of movements on both the demand and supply sides, is weakening. The weak movement since the middle of last year has yet to show signs of improvement, as the increases that were seen in some businesses and expenditure items in recent months began to decrease again. Behind this are the facts that income continues to decrease and consumer confidence remains at a low level.

Looking at the Family Income and Expenditure Survey, which is a demand-side indicator, real consumption expenses decreased as a whole due to decreases in spending on automobiles and housing-related items, posting a sharp month-to-month fall in December, 2001. The Synthetic Consumption Index posted a slight rise over three months before.

Sales are weaking as a whole. Retail sales and chain store sales still have a weak tone. Department store sales decreased from a year earlier in reaction to strong performance in the previous month thanks to brisk sales of winter clothing and earlier implementation of year-end gift sales campaigns. New car sales increased over a year earlier thanks to year-to-year increases in sales of subcompact and mini cars due to the effect of new models. Home appliance sales continued to be weak due in part to a continued decrease in personal computer sales. Domestic travel increased slightly over a year earlier but overseas travel posted a sharp decrease due in part to the effects of the terrorist attacks in the United States.

As for the movement of household income, which has a large impact on the movement of personal consumption, contractual cash earnings (total of scheduled and overtime earnings) continued to be smaller than a year earlier. Cash earnings continued to decrease from a year earlier. Winter bonus payments decreased sharply from a year earlier.

Consumer confidence remains severe after deteriorating sharply.

Business investment is decreasing.

Business investment has been decreasing since the beginning of 2001 due partly to a slowdown in production and a decline in corporate earnings. Financial Statements Statistics of Corporations by Industry, Quarterly, which is a demand-side indicator, shows that business investment decreased in the April-June quarter and the July-September quarter. Shipment of capital goods, which is a supply-side indicator of machinery equipment investment, has been decreasing since the beginning of 2001. Software investment has been on an upward trend.

Business investment is likely to continue its decrease, as business investment in fiscal 2001, both in the manufacturing and non-manufacturing industries, is expected to decrease in the Bank of Japan short-term business sentiment survey (tankan) and machinery orders, a leading indicator of machinery equipment investment, has remained on a decreasing trend since the January-March quarter of 2001 and is expected to have posted a decrease in the January-March quarter of 2002.

Housing investment remains broadly flat.

Housing construction moved at an annual rate of 1.15~1.20 million units throughout 2001 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. As a result, housing construction in 2001 decreased 4.6% from a year earlier to 1.174 million units, the first fall below 1.2 million units in three years.

Behind this lies the fact that consumer sentiment with regard to acquiring houses has been declining due to the severe employment and income environments and a long-term downward trend of real estate prices that has weakened replacement demand.

Factors that decrease housing construction are still observed. For example, the number of applications for housing financing to the Housing Loan Corporation has fallen.

Public investment has been generally sluggish.

Public investment has been generally sluggish. Looking at the second supplementary budget for fiscal 2001, the government's public investment-related budget for the year decreased sharply from the previous year. However, the government intends to provide non-interest bearing loans of a total of 2.5 trillion yen, 1.5 trillion yen for public works projects and 1 trillion yen for facility expenses, by implementing special measures for "Reform-Promotion Public Investment" that makes the most of the government's funds without easily resorting to an additional issuance of government bonds under the policy of restraining "government bond issuance to less than 30 trillion yen."If the special measures and facility expenses are included, the government's public investment-related budget comes is close to the same amount as in the previous fiscal year, but local governments have continued to curb investment expenses because of their tight financial positions.

Reflecting the situation, the contracted amount of public works in the October-December quarter continued to be lower for the 11th consecutive quarter, with orders received by 50 major companies posting a year-on-year decrease for four consecutive quarters. The magnitude of the decline, which had shrunk in the January-March and April-June quarters, expanded again in the October-December quarter.

In view of the decreasing trend of local governments' investment expenses, public investment is likely to continue to post a year-on-year decrease in the January-March quarter.

Exports show signs of stopping decreasing. Imports are decreasing at a slower pace. The surplus in the trade and services balance has increased slightly.

Exports show signs of stopping decreasing, as exports of electrical devices and general machinery narrowed the magnitude of decline thanks to progress in IT-related inventory adjustment worldwide. Exports to the U.S. and Asia remained almost unchanged. The increase in automobile exports to the U.S. is expected to be temporary, as it has been brought about by sales promotional campaigns of zero-interest rates on automobile loans launched by carmakers. Exports to the EU have continued decreasing.  As for the outlook for exports, the yen's recent weakness and the signs of bottoming out of the U.S. and Asian economies are likely to support Japanese exports, although the slowdown of the European economies is continuing.

The margin of decline in imports has narrowed despite weak domestic demand and the yen's weakness. Behind this are the facts that imports of machinery equipment have begun to stop decreasing thanks to progress in IT-related inventory adjustment in Japan and that imports of foods and textile products from China have increased. But, the increase in imports from China may be temporary. By region, imports from the EU have increased. Imports from Asia have remained broadly flat, although imports from China have been increasing. Imports from the U.S., especially of machinery equipment, have decreased.

Looking at the international balance of payments, the surplus in the trade and services account has increased slightly, thanks to the combined effects of a slower decrease in import volume, lower import value caused by a decline in crude oil prices, and a decrease in service account deficits as a result of a decline in the number of travelers overseas.

2. Corporate activities and employment

Industrial production has decreased at a slower pace but the inventory/shipment ratio has remained at a high level.

Industrial production, which had posted a sharp decrease since the beginning of 2001, has narrowed the margin of its decrease, posting a quarter-to-quarter decrease of 2.3% in the October-December quarter. The contribution of IT-related items to the decrease in industrial production has declined due to progress in inventory adjustment of IT-related items, especially of producer goods.

There is concern over the prospects of industrial production as the inventory/shipments ratio remains at a high level and business investment is expected to continue declining, although production may stop decreasing in view of the bottoming out in exports and a rundown in inventory. Incidentally, according to the Survey of Production Forecast, industrial production is expected to rise in January and February.

Tertiary industry activities are decreasing in recent months.

Corporate profits have decreased sharply, especially in the manufacturing sector. Firms' judgement on current business conditions has deteriorated further. The number of bankrupt companies remains at a high level.

According to the Quarterly Survey of Corporate Enterprises, corporate profits as a whole have hit a ceiling partly due to a slower decrease in personnel expenses since the beginning of 2001 and partly to a smaller increase in sales, although they had been improving since 1999. Manufacturing industries, especially electric machinery, posted a sharp decrease in profits in the July-September quarter as sales also decreased. According to the Bank of Japan short-term business sentiment survey (tankan), industries as a whole, and the manufacturing industries in particular, are expected to see their profits decline sharply in the second half of fiscal 2001, as they did in the first half.

The BOJ tankan survey says business sentiment has been deteriorating sharply. The business sentiment of steel and electric machinery firms in the manufacturing sector and of construction and wholesale firms in the non-manufacturing sector are particularly severe. As for future prospects, corporations, in particular small and medium-sized enterprises, forecast further deterioration of their business.

According to Tokyo Shoko Research, Ltd., 1,532 companies went bankrupt in December, and the total number of bankrupt companies in the October-December quarter was 5,188. It remains at a high level.

The employment situation has become increasingly severe, with the unemployment rate rising to an all-time high and the number of job offers, overtime hours worked and wages continuing to weaken.

The unemployment rate in December rose 0.1% over the preceding month to hit an all-time high of 5.6%. As for the unemployed, the number of involuntary job leavers has exceeded that of voluntary job leavers since November and is increasing at a faster pace.

The number of new job offers decreased both from the preceding month and from a year earlier. Overtime work hours in the manufacturing industries, although increasing slightly over the preceding month, remained on a downward trend.

Wages continued edging down, with total cash earnings and contractual cash earnings continuing to decrease from a year earlier. Special cash earnings, including bonuses, decreased from a year earlier.

3. Prices and the financial market

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

Import Prices have been falling on a contractual currency basis but rising on a yen basis reflecting the yen's recent weakness. Domestic Wholesale Prices have been declining. Recently, prices have been falling as a whole as prices of Electrical machinery have decreased, reflecting technological innovation and a slowdown in demand and as prices of Petroleum & coal products and Chemicals declined, reflecting a fall in crude oil prices, although prices of Nonferrous metals have been rising. 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 remained flat, 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 and long-term interest rates rose slightly.

Looking at the short-term interest rates, the overnight call rate moved at 0.001-0.002% in January, reflecting the Bank of Japan's monetary easing policy. Two- and three-month contracts, which had continued to move at a low level since April, slightly rose recently ahead of end-March book closing. Long-term interest rates, which had moved sideways since mid-August, rose slightly in January reflecting a market view that financial institutions will sell long-term government bonds for position adjustment ahead of end-March book closing.

The stock market, which had moved broadly flat since October, declined in January, with the TOPIX falling below 1,000 points and the Nikkei Stock Average falling below 10,000 yen.

On the exchange market, the yen (interbank spot central rate) moved broadly flat after depreciating to the 134 yen level against the dollar in late January from the 120 yen level in early November. Against the Euro, the yen (interbank rate as of 17:00) appreciated to the 114 yen level in late January, after depreciating to the 118 level in early January from the 107 level in mid-November.

The growth rate of M2+CDs (monthly average balance) has slightly increased recently due partly to a rise in the growth rate of liquid deposits (December 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. The difference in fund-raising conditions has expanded depending on a corporate borrower's credit rating, etc.

4. Overseas economies

The economy has been slowing in Europe but shows movements of bottoming out in the U.S. and some Asian countries.

Although the economy has been slowing in Europe, there are movements of bottoming out in the U.S. and some Asian countries.

The U.S. economy shows movements of bottoming out. Private consumption shows slight improvement. Housing investment has been declining. Although business investment continues to decrease sharply, orders for non-military capital goods and business confidence show improvement. Production has begun to stop declining thanks to progress in inventory adjustment in the IT-related sector. Total employment decreased while employment rose in the service sector. The unemployment rate dropped. Prices declined slightly due to a fall in energy prices.

In Europe, the German economy is receding. In France and the U.K., the economy is slowing.

In Asia, the pace of economic growth has been slowing in China. Prices are on a downward trend. South Korea's economy has bottomed out.

As for the international financial situation, the dollar remained on an upward trend, reflecting increased expectations of an early recovery in the U.S. economy. U.S. stock prices remained weak, reflecting concerns about future corporate earnings. The target range of the U.S. Federal-Fund rate, which had been lowered by a total of 4.75% through rate cuts for 11 times since January 2001, was kept unchanged at the Federal Open Market Committee meetings on January 29 and 30.

As for the international commodity market, crude oil prices declined slightly, reflecting an increase in inventory caused by decreasing demand and the warm weather in North America.