Monthly Economic Report (July 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.

The 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 a 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 a bottoming out in the future.

In public investment, the impact of the second supplementary budget for FY2001 can be seen recently.

As for short-term prospects, the impact of large increase in exports and the 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, worldwide decline in stock prices and depreciation of the U.S. dollar are increasing uncertainty surrounding the future of the world economy, and there are concerns over the downward pressure on final demand that may be expected by the development.

Policy stance

With the aim of realizing a self-sustaining economic growth, the Government will implement structural reform giving emphasis to measures to increase private demand and employment. For this end, the Government will materialize at an early stage the "Basic Policy for Economic and Fiscal Policy Management and Structural Reform 2002" (cabinet decision made on June 25), which includes economic revitalization strategies, tax reform, government expenditure reform and others.

The Government and the Bank of Japan together will also continue to take powerful and comprehensive action 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 decreased but at a much slower pace. Department store sales, which have 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 at much slower pace as a whole, as sales of TV sets posted a sharp increase, although sales of personal computers continued to decrease sharply. Domestic travel was almost flat from a year earlier but overseas travel remained lower than a year earlier, although the margin of decrease narrowed.

Consumer confidence is showing signs of a slight improvement, although it remains at a low level.

As to the effects of the World Cup on personal consumption, it had a temporary positive effect of increasing sales of TV sets. But it is believed to have had a major negative effect of reducing the number of visitors to retailers and restaurants, etc.. The number of foreign visitors to Japan increased by about 30,000 from a year earlier.

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 and 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 May, housing construction came to an annual rate of 1.269 million units, as starts of houses for rent and houses for sale increased sharply thanks to the starts of many large projects, although starts of owned houses decreased from 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, but the impact of the second supplementary budget for FY2001 can be seen recently.

Public investment has been generally sluggish. Looking at the second supplementary budget for FY2001, the government's public investment-related budget for the year comes close to the same amount as in the previous fiscal year, thanks partly to special measures for "Reform-Promotion Public Investment." 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 January-March quarter continued to be lower for the 12th consecutive quarter, with orders received by 50 major companies posting a year-on-year decrease for five consecutive quarters.

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, while the seven focused areas in the "Basic Policy on Budget Compilation" are to be given priority. 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 funds are to be slashed by 10.0% from the previous fiscal year and a thorough review of expenditures and focused budget allocation are to be carried out in line with the national expenditure budget.

Public investment in the April-June quarter is expected to be held up, as most of the second supplementary budget for FY2001 is believed to have been brought forward from the previous fiscal year. The contracted amount of public works and orders received by 50 major companies both posted year-on-year increases in May.

Exports to Asia, among other areas, are increasing sharply.Imports remain flat.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 and general machinery, increased sharply. Exports to the U.S. increased modestly, mainly of electrical devices and general machinery. Exports to the EU, mainly of electrical devices and transportation equipment, have begun increasing. 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 increasing uncertainties about the future course of the world economy caused by recent stock price declines and the depreciation of the dollar worldwide.

Imports as a whole moved sideways, as imports of mineral fuel decreased, while imports of IT-related machinery equipment increased thanks to a pickup in production, mainly of electrical machinery. By region, imports from Asia increased moderately, 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 while import volume moved sideways.

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 in the January-March quarter for the first time in five quarters and also increased in April and May. 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 business investment is expected to continue declining. Incidentally, according to the Survey of Production Forecast, industrial production is expected to remain flat in June and rise in July.

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 the business sentiment has remained severe, at low levels especially in small and medium-sized enterprises. As for future prospects, all enterprises forecast improvement, except for non-manufacturing small and medium-sized enterprises forecast a slight deterioration of their business.

According to Tokyo Shoko Research, Ltd., the number of corporate failures remains at a high level, with 1,730 companies going bankrupt in May.

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

In May, the unemployment rate rose 0.2% from the previous month to 5.4%. The number of involuntary job leavers, which accounts for the largest proportion of the unemployed, increased at the same pace as in the previous month. The number of employees, which had stopped decreasing, posted a month-to-month decrease in May.

The number of new job offers increased for two consecutive months, with the new job offer ratio and the effective job offer ratio rising. Overtime work hours in the manufacturing industries increased for five consecutive months, reflecting the movement of production. The number of corporations saying they have excess employees remains at a high level, although it decreased among manufacturers.

Wages continued edging down, with contractual cash earnings decreasing from the preceding month.

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 (such as Eating out) rose slightly, 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 rose slightly after declining sharply. The yen appreciated against the U.S. dollar.

Looking at short-term interest rates, the overnight call rate moved at 0.001-0.002% in June, reflecting the Bank of Japan's monetary easing policy. Two- and three-month contracts moved sideways in June. Long-term interest rates fell in late June, reflecting market concerns about the future course of stock prices and exchange rates. The rates moved sideways until early June, after falling slightly from early February to early April.

The stock market rose slightly in late June, after falling sharply against the background of a decline in stock prices in the United States.

On the exchange market, the yen (interbank spot central rate) depreciated to the 133-yen level in late March but later moved on an upward trend reflecting the outlook for the Japanese and U.S. economies and appreciated to the 119-yen level in June. Against the Euro, the yen (interbank rate as of 17:00) depreciated slightly in early June after moving sideways in the 114.5-117 yen level, and then moved in the 117~119 yen level in mid and late June.

The growth of the monetary base (monthly average balance) has increased at a fast pace against the background of ample fund supply by the Bank of Japan (The average balance of current deposits at the Bank of Japan stood at 15.0 trillion yen) (June: Up 27.6% 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.

The economic recovery in the U.S. has become moderate. Private consumption is increasing moderately. Housing construction is on a rising trend. Business investment is decreasing at a slower pace than before, while orders for non-military capital goods have increased. Production is increasing moderately. Employment is picking up, but the unemployment rate has risen. Prices are stable.

The Asian economy is recovering. The pace of economic growth in China is rising slightly. In South Korea and Thailand, the economy is expanding. In Taiwan, Singapore, and Malaysia, the economy is recovering.

In Europe, (1) The Euro Area economy is picking up. The German economy is picking up moderately. In France, the economy is picking up steadily. (2) The U.K. economy is picking up.

As for the international financial situation, the dollar depreciated sharply in and after mid-June, facing expanding U.S. trade deficits, a decline in stock prices, and concerns about the future course of the economy. U.S. stock prices remained on a downward trend throughout June, depressed by such factors as rising distrust in corporate accounting, downward revision of earnings estimates, and concern about possible terrorist attacks. Stock prices in other major markets remained on a downward trend as well. U.S. long-term interest rates fell until the second half of June, reflecting a shift in funds into Treasury bonds, and then leveled off. Taiwan lowered interest rates in late June.

As for the international commodity market, crude oil prices eased in early June but later moved on an upward trend, reflecting a decrease in U.S. crude oil inventory and the OPEC's decision to continue cutting production at its extraordinary meeting.

As for the near-term world economic outlook, recent worldwide stock price declines and the dollar depreciation are adding uncertainty to the prospect of economic recovery.