Monthly Economic Report (June 2002)

Assessment of the current state of the Japanese economy

While the economy continues to be in a difficult situation, it has bottomed out.

Business investment is declining. 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 to Asia, among other areas, are increasing; some areas in industrial production are showing movements of an incipient recovery; and corporate profits are showing signs of bottoming out.

As for short-term prospects, the impact of increase in exports and completion of inventory adjustment in general are expected to spread to overall economy, and bring about an incipient recovery of the economy. On the other hand, there are concerns over the downward pressure on final demand that may be exerted by such factors as severe employment and wage situations.

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 compile in late June the "Basic Policy for Economic and Fiscal Policy Management and Structural Reform (tentative title),"which would include 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 actions to emerge from deflation.

Detailed explanations

1.Demand trends such as consumption and investment

Real GDP (Gross Domestic Product) in the first quarter of 2002 was 1.4% (at an annual rate of 5.7%) higher than in the previous quarter, despite the negative growth of Non-residential Investment, mainly because of the growth of Private Consumption. Nominal GDP was 1.1% 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, 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.

Sales are weakening as a whole. Retail sales still have a weak tone. Chain store sales decreased but at a much slower pace. Home appliance sales continued to be weak due to a continued sharp decrease in personal computer sales. Both domestic and overseas travels were lower than a year earlier, although the margin of decrease in overseas travel narrowed sharply. Meanwhile, department store sales, which have been moving unevenly since last summer, remained almost unchanged overall. New car sales increased from a year earlier, as sales of compact cars posted a year-to-year increase due partly to the effect of new models.

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

Business investment is decreasing.

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, has been decreasing since the beginning of 2001. Software investment has been on a relatively firm trend.

Business investment is likely to continue its decrease, as 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 post a decrease in the April-June quarter of 2002 and business investment in fiscal 2002, both in the manufacturing and non-manufacturing industries, is 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.

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.

In April 2002, housing construction remained low at an annual rate of 1.14 million units, as starts of houses for sale decreased, although starts of owned houses and houses for rent increased. Factors that decrease housing construction are still observed. For example, the number of applications for housing financing to the Housing Loan Corporation has been on a downward trend.

Public investment has been generally sluggish.

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.

Although the public investment-related budget for FY2002 has been slashed from the preceding fiscal year, public investment in the April-June quarter is expected to be held up, as most of the second supplementary budget for FY2001 are believed to have been brought forward from the previous fiscal year.

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

Exports have increased as a whole, as exports of electrical devices, mainly electronic components like semiconductors, are on an increasing trend and exports of general machinery remains flat, reflecting production recovery worldwide. By region, exports to Asia, especially of electrical devices and general machinery, increased. Exports to the U.S. remained flat as a whole, as exports of electrical devices were firm. Exports to the EU, mainly of electrical devices, have stopped decreasing. As for the outlook for exports, the improvement in the world economy is likely to support Japanese exports.

Imports as a whole moved sideways, as imports of crude materials and mineral fuel decreased, while imports of machinery equipment increased thanks to progress in IT-related inventory adjustment in Japan. By region, imports from Asia increased moderately, as imports of machinery equipment remained firm. Imports from the EU decreased. Imports from the U.S. were flat, as imports of machinery equipment, which had been continuing to decline, stopped decreasing.

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 has stopped decreasing, with some sectors 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 it also increased in April. Industrial production has stopped decreasing, reflecting an increase in exports and an end in inventory adjustment, and especially producer goods, showed movements of an incipient recovery.

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 rise in May but fall in June.

Tertiary industry activities remain broadly flat.

Corporate profits show signs it has stopped decreasing. Firms' judgement on current business conditions has remained severe, but large enterprises' judgement has almost stopped deteriorating. The number of bankrupt companies remains at a high level.

According to Financial Statements Statistics of Corporations by Industry, Quarterly, corporate profits, especially 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 an increase in their profits both in the first half and the second half of FY2002.

The BOJ tankan survey says business sentiment has remained severe. The business sentiment of small and medium-sized enterprises has remained severe but that of large enterprises almost stopped deteriorating. As for future prospects, small and medium-sized enterprises forecast further deterioration of their business, while large enterprises forecast improvement. According to the Business and Investment Survey of Incorporated Enterprises, the width of the large and medium-sized firms forecasting deterioration in their business sentiment outnumbered those forecasting improvement, the difference being contracting.

According to Tokyo Shoko Research, Ltd., the number of corporate failures remains at a high level, with 1,611 companies going bankrupt in April.

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 April remained unchanged from the previous month at 5.2%. 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 ratio of people out of work for more than one year to the unemployed continued increasing. The number of employees has stopped decreasing, posting an increase for two consecutive months.

The number of new job offers continued to post a year-on-year decrease, although it increased from the preceding month. As the number of new job seekers decreased sharply at the same time, the labor market showed no improvement, with the new job offer ratio declining from the preceding month and the effective job offer ratio remaining almost unchanged from the preceding month. Overtime work hours in the manufacturing industries increased for four consecutive months, reflecting the movement of production. The proportion of business establishments that implemented employment adjustment, such as "overtime restrictions," in the January-March quarter continued to increase as a whole, but decreased in the manufacturing industries, especially in large enterprises.

Wages continued edging down, with contractual cash earnings posting a year-on-year decrease for 16 consecutive months and the margin of decline remaining almost unchanged, although it increased 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 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 (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 in mid-May through late May but fell slightly thereafter. 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 May through early June, reflecting the Bank of Japan's monetary easing policy. Two- and three-month contracts moved sideways in May through early June. Long-term interest rates moved sideways until early June, after falling slightly from early February to early April.

The stock market rose in mid-May through late May on expectations of a bottoming out of the economy, but then fell slightly.

On the exchange market, the yen (interbank spot central rate) depreciated to the 133-yen level in late March but later moved in an upward trend reflecting the outlook for the Japanese and U.S. economies and appreciated to the 123-yen level temporarily in early June. Against the Euro, the yen (interbank rate as of 17:00) appreciated to the 112 yen level in early March but depreciated to the 116 yen level in mid and late March, then moved in the 114.5~117 yen level.

The growth of the monetary base (monthly average balance) has increased at a fast pace against the background of ample fund supply by the Bank of Japan (Average balance of current deposits at the Bank of Japan stood at 15.7 trillion yen) (May: Up 29.7% over a year earlier). The growth rate of M2+CDs (monthly average balance) has remained at around 3.5% (May preliminary report: Up 3.5% 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 corporate borrower's credit ratings, etc.

4. Overseas economies

The world economy begins to recover.

The U.S. economy continues recovering. Private consumption is increasing. Housing construction is on a rising trend but housing starts fell after having been boosted by mild winter. Business investment is decreasing at a slower pace than before, while orders for non-military capital goods increased. Production is increasing. Employment is picking up. Prices are generally stable, although energy prices are rising.

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

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

As for the international financial situation, the dollar stayed almost unchanged until mid May and then weakened, reflecting a rise in the attractiveness of non-dollar assets. U.S. stock prices rose until mid May, following a higher-than-expected rise in labor productivity, but later fell on concerns about terrorism and bleak corporate earnings. U.S. long-term interest rates rose until mid May but later fell. The Bank of Canada and the Reserve Bank of Australia raised interest rates in early June for the second time this year.

As for the international commodity market, crude oil prices, which had stayed at a high level, were on a downward trend in and after the second half of May, reflecting moves toward a production increase by non-OPEC member countries.