Monthly Economic Report (January 2002)

Assessment of the current state of the Japanese Economy

The economy continues to deteriorate.

Private consumption is weakening.

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

While exports are showing signs of bottoming out, industrial production and corporate profits are falling substantially, and business investment is declining as well.

As for short-term prospects, there are concerns over a simultaneous slowdown of the world economy, although progress in inventory adjustment can be seen in IT-related sectors in the United States and other areas.

Policy stance

The Government endeavours to forcefully implement the "Immediate Action Program for Structural Reform" and other measures, in order to further accelerate structural reform and to prevent the economy from falling into a deflationary spiral.

Furthermore, the Government made a cabinet approval of the "Fiscal Year 2002 Economic Outlook and Basic Stance for Economic and Fiscal Management" on December 19, and cabinet decisions on the "Second Supplementary Budget for Fiscal Year 2001" on December 20, and on the "Estimated Budget for Fiscal Year 2002" on December 24.

Meanwhile, the Bank of Japan decided on December 19 to change the guideline for money market operation, fixing the target level of outstanding balance of the current accounts at the Bank at around 10 to 15 trillion yen, as well as increasing the outright purchase of long-term government bonds to 800 billion yen per month.

Detailed explanations

1. Demand trends such as consumption and investment

Personal consumption is weakening.

Personal consumption, in terms of movements on both the demand and supply sides, is weakening, as income continues to decrease and consumer confidence remains at a low level. However, the weak movement since the middle of last year is not likely to have intensified, as increases are seen in some businesses and expenditure items.

As for the movement on the demand side, the Synthetic Consumption Index posted a rise for the first time in seven month. As for the movement of each expenditure item, the Family Income and Expenditure Survey shows that spending on winter clothing and hobby/leisure-related consumption increased in November 2001. However, real consumption expenses as a whole decreased from the previous month.

Sales are weakening as a whole. Retail sales and chain store sales still have a weak tone. As for new car sales, standard car sales decreased, although mini car sales increased over a year earlier 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. Meanwhile, department store sales increased over a year earlier thanks to brisk sales of winter clothing and earlier implementation of year-end gift sales campaigns.

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.

Consumer confidence has been weakening due to the deterioration of the employment situation.

As for the case of mad cow disease (bovine spongiform encephalopathy), although expenditure on beef and sales at yakiniku beef barbecue restaurants continued to decrease, they account for a small share of personal consumption as a whole and therefore the effect is not likely to have a major impact on total consumption. Nevertheless, continued attention is needed in this area.

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. The Quarterly Survey of Corporate Enterprises, 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 October-December quarter.

Housing investment remains broadly flat.

Housing construction posted two consecutive quarter-to-quarter decreases in the January-March and April-June quarters of 2001, although approximately 1.2 million units had been constructed each year since 1999. This is mainly 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. 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. Since then, however, housing construction stood at an annual rate of 1.15~1.20 million units with minor fluctuations thanks to an increase in starts of houses for rent. In November, housing construction came to an annual rate of 1.238 million units, as starts of owned houses, houses for rent, and houses for sale all posted increases.

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 initial budget for fiscal 2001, the government's public investment-related budget for the year 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 July-September quarter continued to be lower on a year-on-year basis, with orders received by 50 major companies posting a year-on-year decrease for three consecutive quarters. But the magnitude of the decline shrank in comparison with the January-March and April-June quarters. In recent months although the magnitude of decline in the contracted amount of public works has been shrinking, orders received by 50 major companies have posted sharp year-on-year decreases.

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 October-December quarter.

In the Second Supplementary Budget for Fiscal 2001, which will be compiled in response to the "Emergency Response Program" (decided on December 14th), the government intends to secure projects worth about 4.1 trillion yen by providing 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."

Exports show signs of stopping decreasing. Imports are decreasing. 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, which had been decreasing sharply against the backdrop of sluggish IT-related demand, narrowed the magnitude of decline. Exports to the U.S. increased on the whole on the strength of an increase in exports of automobiles. However, the increase in automobile exports is expected to be temporary, as it has been brought about by sales promotional campaigns of zero-interest rate on automobile loans launched by carmakers. Exports to Asia have been decreasing at a sharply slower pace recently. Exports to the EU have decreased. As for the outlook for exports, the yen's recent weakness and progress in IT-related inventory adjustment worldwide are likely to support Japanese exports, although the simultaneous slowdown of the world economy, if it continues for a long period, may put further downward pressure on Japanese exports.

Imports have decreased, reflecting weak domestic demand. By item, imports of machinery equipment such as IT-related goods have continued to decrease, although imports of foods and textile products have been firm. By region, imports from the U.S., especially of machinery equipment, have decreased. Imports from Asia have been decreasing at a slower pace as a whole thanks to continued steady imports of textile products and foods from China, although imports of machinery equipment have been decreasing. Imports from the EU have remained broadly flat.

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 sharply and the inventory/shipment ratio has remained at a high level.

Industrial production has posted a sharp decrease since the beginning of 2001. The contribution of IT-related items to the decrease in industrial production has declined due to progress in inventory adjustment of IT-related items.

Industrial production is expected to rise in December and January. There is concern over the prospects of industrial production as the inventory/shipments ratio remains at a high level, although inventories decreased.

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., 1,813 companies went bankrupt in November, higher than a year earlier.

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 November rose 0.1% over the preceding month to hit an all-time high of 5.5%. As for the unemployed, the number of involuntary job leavers has increased.

The number of new job offers continued to decrease on a year-to-year basis due to a continued decrease in the manufacturing industries, although the number increased in November on a month-to-month basis as it did in October. Overtime work hours in the manufacturing industries decreased for 13 consecutive months on a month-to-month basis.

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

3. Prices and the financial market

Domestic Wholesale Prices expanded the margin of decline and Consumer Prices are declining slightly.

Import Prices have been falling both on a yen basis and on a contractual currency basis. Domestic wholesale prices have been declining slightly since the beginning of 2001. Recently, the margin of price decline has expanded slightly, as prices of Electrical machinery have decreased, reflecting technological innovation and a slowdown in demand and as crude oil prices 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 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 : The yen depreciated significantly.

Looking at the short-term interest rates, the overnight call rate moved at 0.001-0.002% in December, 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, remained broadly flat in December, with three-month contracts rising slightly in late December ahead of end-March book closing. Long-term interest rates rose in July and early August but then moved sideways, after being on a downward trend since the fall of 2000.

The stock market declined further in September due partly to the terrorist attacks in the United States, but rose in October to the level before the terrorist attacks and remained broadly flat thereafter.

On the exchange market against the dollar, the yen (interbank spot central rate) depreciated to the 132 yen level in early January, after appreciating from the 123 level to the 120 level from late October to early November. Against the Euro, the yen (interbank rate as of 17:00) depreciated to the 118 level in early January, after appreciating to 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, while redemptions of mutual funds have increased (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 corporations' 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 world economy has been slowing down simultaneously.

The world economy has been slowing down simultaneously.

Although the U.S. economy is in its recession phase, it shows signs of bottoming out. Although private consumption remains weak compared with the period before the terrorist attacks, consumer confidence has begun to pick up. Housing investment has leveled off. Although business investment continued to decrease sharply, orders for non-military capital goods and business confidence show signs of improvement. Although manufacturing activities are slowing down, inventory adjustment in the IT-related sector is making progress. Employment is falling and the unemployment rate is rising. Prices declined recently due to a fall in energy prices, although they remain basically stable.

In Europe, the economy is slowing down in Germany. In France, the pace of economic expansion has been decelerating. In the U.K., the economy is expanding moderately.

In Asia, the pace of economic growth has been slowing down in China due to the deceleration of export growth, although personal consumption is buoyant. South Korea's economy is slowing down due to a decrease in exports, although there are some bright spots, such as recovery in consumption.

As for the international financial situation, the dollar appreciated sharply against the yen amid movements to test the lows of the yen regarding the economic perspective of Japan.

Argentina went into an virtual default situation in late December 2001 and the government devaluated the peso at the rate of 1.4 peso to the U.S. dollar on January 6 this year and announced a plan to adopt a two-tier exchange rate with an official rate of 1.4 peso per dollar and a floating rate.

As for movements in the international commodity market, crude oil prices, which had plunged on speculation of slower demand, rebounded following concerted cutbacks of production by OPEC and non-OPEC oil members.