Monthly Economic Report (May 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; and industrial production has bottomed out. Business sentiment of large-sized enterprises is bottoming out.

As for short-term prospects, there are concerns over the downward pressure on private demands that way be exerted by such factors as severe employment and wage situations. On the other hand, increase in exports and progress in inventory adjustment are expected to prevent the economy from deteriorating further.

Policy stance

With the aim of fostering the bottoming out of the economy to a sustainable private-demand led growth, the Government will continue to take decisive actions for structural reform, and remains to be firmly resolved, in close cooperation with the Bank of Japan, 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 be 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 the movement on the demand side, a 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. On the other hand, relatively high-expenditure items, such as tuition and automobile purchases, decreased. Spending on furniture and household utensils decreased from a year earlier in reaction to the last-minute purchases of home appliances prior to the enforcement of the Home Appliances Recycling Law a year earlier.

Sales are weakening as a whole. Retail sales still have a weak tone. Chain store sales decreased but at a much slower pace as sales of foods and clothing were brisk thanks to weather factors, etc. Home appliance sales continued to be weak due in part to a continued decrease in personal computer sales and in part to a decrease in sales of the four home appliances covered by the Home Appliance Recycling Law in reaction to the last-minute purchases prior to the enforcement of the Law. Domestic travel was almost flat from a year earlier but overseas travel remained sharply lower than a year earlier, although the margin of decrease narrowed. Meanwhile, department store sales in March increased over a year earlier thanks to brisk sales of spring and early summer clothing. However, overall department store sales, which have been moving unevenly since last summer, remained almost unchanged. 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 shows 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 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 and expanded the margin of decrease in the October-December quarter. According to the Business and Investment Survey of Incorporated Enterprises, investment (expected results) by large and medium-sized enterprises as a whole posted an increase during the January-March quarter thanks to an increase by non-manufacturing companies, although investment by manufacturing companies remained decreasing. 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 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 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 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.

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 March 2002, housing construction came to an annual rate of 1.112 million units, down 6.1% from the previous month, as starts of houses for rent and houses for sale decreased, although starts of owned houses 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 fiscal 2001, the government's public investment-related budget, including facility expenses, 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 priorities. 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.

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 are bottoming out, reflecting production recovery in the manufacturing industry worldwide. Exports of automobiles mainly to the U.S. remained firm. By region, exports to Asia, especially of electrical devices and general machinery, increased. Exports to the U.S. remained flat, as exports of electrical devices and automobiles were firm. Exports to the EU have continued decreasing. As for the outlook for exports, the yen's weakness and the improvement in external conditions, such as movements of recovery in the U.S. economy, are likely to support Japanese exports.

Imports as a whole moved sideways, partly due to the fact that imports of machinery equipment remained flat thanks to progress in IT-related inventory adjustment in Japan. By region, imports from Asia remained flat, as imports from China, which had contributed to an increase in Japan's imports of foods and textile products, leveled off, although imports of machinery equipment were steady. Imports from the EU decreased slightly, as imports of foods, which had contributed to an increase in imports, decreased. 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, as export volume increased while import volume moved sideways.

2. Corporate activities and employment

Industrial production has stopped decreasing.

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. Industrial production, especially of IT-related items, has stopped decreasing, reflecting an increase in exports and progress 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 rise in April and May.

Tertiary industry activities remain broadly flat.

Corporate profits have decreased sharply, especially in the manufacturing sector. Firms' judgement on current business conditions has remained severe, but large enterprises' judgement almost stopped deteriorating. The number of bankrupt companies remains at a high level.

According to Financial Statements Statistics of Corporations by Industry, Quarterly, manufacturing industries, especially electric machinery, have posted a sharp decrease in profits in and after the July-September quarter of 2001. According to the Bank of Japan short-term business sentiment survey (tankan), industries as a whole, and the manufacturing industries in particular, expect a sharp decrease in their profits in the second half of FY2001 but an increase in FY2002. According to the Business and Investment Survey of Incorporated Enterprises, width of the large and medium-sized firms forecasting a decline in their ordinary profits for the January-March quarter of 2002 outnumbered those forecasting an increase, the difference being contracting.

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 of their business.

According to the Business and Investment Survey of Incorporated Enterprises, 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 1,741 companies going bankrupt in March.

The employment situation still remains severe, with the unemployment rate remaining at a high level and the number of job offers and wages continuing to weaken.

The unemployment rate in March fell 0.1% from the previous month to 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 number of employees has stopped decreasing.

Job offers continue to show weak movement, with the number of new job offers decreasing and the number of effective job offers continuing its decrease, although the new job offer ratio rose due to a sharp decrease in the number of new job applications. Overtime work hours in the manufacturing industries increased slightly, reflecting the bottoming out in production.

Wages continued edging down, with contractual cash earnings decreasing from the previous 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 and Nonferrous metals have been rising, reflecting higher crude oil prices and the yen's depreciation, 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, 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 moved almost sideways. The yen appreciated against the U.S. dollar.

Looking at short-term interest rates, the overnight call rate moved at 0.001-0.003% in April through early May, reflecting the Bank of Japan's monetary easing policy. Two- and three-month contracts moved sideways in April through early May. Long-term interest rates moved sideways until early May, after falling slightly from early February to early April.

The stock market has moved almost sideways after rising sharply from late February to early March.

On the exchange market, the yen (interbank spot central rate) appreciated to the 127 yen level temporarily in early March but depreciated to the 133 yen level in mid and late March. It appreciated to the 126 yen level temporarily in early May, reflecting receding expectations of recovery in the U.S. economy. 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 at the 115~117 yen level range.

The growth of the monetary base (monthly average balance) has increased at a faster 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 20.0 trillion yen) (April: Up 36.3% over a year earlier). 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 (April preliminary report: Up 3.6% 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 U.S. economic recovery is leading to recovery of production, mainly in the manufacturing sector, of the world's major economies.

The U.S. economy is recovering. Private consumption has increased. Housing construction is on a rising trend. While business investment is decreasing at a slower pace than before, orders for non-military capital goods decreased. Production is continuing its improvement and capacity utilization is rising. Total employment begins to pick up, although the unemployment rate rose. Prices are stable.

In Asia, there are signs of economic recovery. The pace of economic growth in China is rising slightly because of greater government expenditures. South Korea's economy is expanding moderately. In Taiwan, Singapore, and Malaysia, there are signs of economic recovery. In Thailand, the economy is recovering.

In Europe, (1) The Euro Area economy is stagnant, but production stopped declining. The German economy is stagnant. In France, the economy is slowing, but production stopped declining. (2) The U.K. economy is slowing but shows signs of picking up.

As for the international financial situation, U.S. stock prices remained on a downward trend in April, reflecting concerns about corporate earnings and a cautious view of the U.S. economic prospects. The dollar also remained on a downward trend. U.S. long-term interest rates remained slightly lower. The Bank of Canada raised interest rates in mid April, followed by the central bank in South Korea and Australia in early May.

As for the international commodity market, crude oil prices rose again, reflecting the continued tension in the Middle East situation, after falling slightly in the first half of April.