Monthly Economic Report (October 2002)

Assessment of the current state of the Japanese economy

Movements of a moderate incipient recovery continue to be observable in some areas of the economy, though environment has become more severe.

While movements towards improvement can be seen in some areas, employment situation continues to be severe with unemployment rate being at a high level.

While private consumption is flat, firmness can be observed in some areas.

There are signs that corporate profits are improving; and business investment is showing signs of bottoming out in the future.

Pace of export growth has slowed down; and moderate incipient recovery in industrial production is continuing. Improvement in business confidence can be seen, though its pace has become moderate.

As for short-term prospects, the economy is expected to move towards an incipient recovery. On the other hand, environment, such as concerns over the future of the US and other economies and decline in domestic stock prices, has become more severe, and concerns over downward pressure on final demand that may be exerted by the development is deepening.

Policy stance

In materializing at an early stage the "Basic Policy for Economic and Fiscal Policy Management and Structural Reform 2002," measures to accelerate "financial system reform," "tax reform," and other structural reforms will be strengthened, and emergence from deflation will be promoted. For this end, measures will be prepared by the end of October.

The Government and the Bank of Japan together will also continue to take powerful and comprehensive actions to emerge from deflation and to stabilize financial system.

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 in both the demand and supply side, 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.

As for movement on the demand side, robust movement has been seen since last autumn. The Synthetic Consumption Index posted a slight rise from three months before. As for the movement of each expenditure item, the Family Income and Expenditure Survey shows that basic expenditure items remained firm, although fluctuations caused by temporary factors were seen.

Sales are weakening on the whole, though they have recovered from a sharp decline last month caused by temporary factors. Retail sales still have a weak tone. The margin of year-to-year decrease of chain store sales as a whole narrowed, as foods increased from a year earlier. Department store sales, which have been moving unevenly since last summer, is weakening recently. New car sales increased sharply from a year earlier, as sales of mini- and compact cars remained brisk. Home appliance sales increased as a whole from a year earlier, as sales of TVs continued to increase and sales of air conditioners posted a sharp year-to-year increase, and the margin of decrease in personal computers narrowed sharply. Domestic travel increased over a year earlier, and overseas travel expanded by the margin of the year-to-year decrease from the previous month.

Consumer confidence shows movements of an incipient recovery, although it remains at a low level.

Business investment shows signs of bottoming out.

Business investment, which has been decreasing since the beginning of 2001, is showing signs of bottoming out, as production has improved and corporate earnings have stopped declining. Financial Statements Statistics of Corporations by Industry Quarterly, which is a demand-side indicator of business investment and which had been decreasing since the January-March quarter of 2001, decreased at a slower pace. The margin of decline is larger in smaller companies than in large and medium-sized companies. Shipment of capital goods, which is a supply-side indicator of machinery equipment investment, has stopped declining. Software investment, which had been firm, has decreased slightly.

Business investment is likely to increase, as machinery orders a leading indicator of machinery equipment investment, which had been on a decreasing trend since the January-March quarter of 2001, is showing signs of bottoming out and picking up. However, after it has bottomed out, business investment is expected to remain at a low level as machinery orders are expected to decrease according to the Bank of Japan short-term business sentiment survey (tankan).

Housing investment is decreasing moderately.

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. This is because construction of new condominiums, which posted a solid gain in 2000, has become steady, and starts of publicly financed owned houses decreased sharply in and after January 2001. Housing construction in the April-June quarter of 2002 came to an annual rate of 1.18 million units.

In August, housing construction came to an annual rate of 1.125 million units due to sharp decreases in the construction of owned houses and houses for rent, although construction of houses for sale posted an increase. Factors that decrease housing construction are still observed. For example, consumer sentiment with regard to acquiring houses has been declining due to the harsh 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.

Public investment has been generally sluggish. 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. Under the fiscal plans of local governments for FY2002, regarding the investment expenses, those for projects to be undertaken by local governments on their own funding are to be slashed by 10.0% from the previous fiscal year. This shows that both the national and local government have conducted a thorough review of expenditures and a focused allocation of budget.

Under the circumstances, the second supplementary budget for FY2002 had an effect of holding up public investment and increasing the contracted amount of public works and orders received by 50 major companies in May over one year earlier. But, for the April-June period, both the contracted amount of public works and orders received by 50 major companies continued to post year-on-year decreases.

Public investment in the July-September quarter is likely to continue posting a year-on-year decrease in view of the decrease in the contracted amount of public works, etc. in July and August and the budgetary conditions of the state and local governments.

Pace of export growth has slowed down. Imports are increasing slightly.The surplus in the trade and services balance has decreased slightly.

Pace of export growth, especially of electrical devices, mainly electronic components like semiconductors, and general machinery, has slowed down, as growth of final demand, such as for IT-related equipments, has slowed down worldwide. By region, exports to Asia, especially of electrical devices, general machinery, and transportation equipment increased. Exports to the U.S. increased slightly, mainly electrical devices and general machinery. Exports to the EU remained flat. As for the outlook for exports, close monitoring is required to slower improvements in the world economy and increasing uncertainties about the future course of the U.S. and other economies.

Imports as a whole increased slightly, reflecting a pickup in production. By region, imports from Asia increased as a whole, as imports of chemical products, metals remained firm, although imports of IT-related machinery equipment have slowed down. 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 decreased slightly, as import volume increased moderately while the pace of increase in export volume has become moderate.

2. Corporate activities and employment

Moderate recovery in Industrial production is continuing.

Industrial production had increased for two consecutive quarters reflecting an end in inventory adjustment. But, the pace of increase in industrial production has become moderate, reflecting a slower increase in exports.

There is concern over the prospects of industrial production as uncertainties surrounding the future of the world economy have further increased. Incidentally, according to the Survey of Production Forecast, industrial production is expected to rise in September and October.

Tertiary industry activities remain broadly flat.

As for agricultural production, the rice crop is "average."

Corporate profits show signs of improvement. Firm's judgement on current business conditions is improving, but the pace of improvement is moderate. The number of bankrupt companies remains at a high level.

According to Financial Statements Statistics of Corporations by Industry, Quarterly, corporate profits, which had posted a sharp decrease in and after the July-September quarter of 2001, especially in the manufacturing industries, such as electric machinery, decreased at a slower pace in the January-March quarter of 2002 and the margin of decrease remained flat in the April-June quarter of 2002. According to the Bank of Japan short-term business sentiment survey (tankan), industries as a whole expect their profits to decline slightly in the first half of FY2002, but to increase sharply in the second half.

The BOJ tankan survey says business sentiment of enterprises has been improving after hitting bottom in the March 2002 survey, but the pace of improvement has become moderate, with the September survey showing only a slight improvement. Business sentiment of small and medium-sized enterprises has remained severe and at low levels. As for future prospects, all enterprises forecast a slight improvement.

According to Tokyo Shoko Research, Ltd., the number of corporate failures remains at a high level, with 1,578 companies going bankrupt in August.

The employment situation still remains severe. Although movements towards improvement are seen in some areas, such as the number of employees that shows movements of a moderate incipient recovery, the unemployment rate remained at a high level and wages continued to weaken.

The unemployment rate in August remained unchanged from the previous month at 5.4%. The number of involuntary job leavers, which accounts for the largest proportion of the unemployed, remained flat in August. The number of employees decreased from the previous month, but shows movements of a moderate incipient recovery mainly in part-timers and other temporary workers.

The number of new job offers, although it remained on an increasing trend, posted a month-to-month decrease in August. The new job offer ratio increased from the previous month, and the effective job offer ratio remained flat from the previous month. Overtime work hours in the manufacturing industries remained on an increasing trend. The number of corporations saying they have excess employees remains at a high level, although it decreased.

Wages continued edging down, with contractual cash earnings continuing to decrease on a year-to-year basis, and special cash earnings, including bonuses, posted a sharp year-to-year decrease. But, contractual cash earnings posted a month-to-month increase for two consecutive months.

3. Prices and the financial market

Domestic Wholesale Prices are moving sideways and Consumer Pricesare declining slightly.

Import Prices have been rising on a contractual currency basis. On a yen basis, Import Prices have begun to rise after falling due to the yen's appreciation and the dollar's weakness. Domestic Wholesale Prices have been moving sideways. Recently, the prices of Electrical machinery and Non-ferrous metals have been declining, but the price of Steel has been rising thanks to progress in inventory adjustments, and the prices of Petroleum & coal products have also begun to rise.

Consumer Prices have been declining slightly since the fall of 2000. Although General services moved almost sideways, General commodities declined due to a fall in the prices of Durable goods and Public services & electricity, gas & water charges.

Taken together, these movements show that the Japanese economy is in a mild deflationary phase in that the decline of prices is continuing.

Financial market: Stock prices remained broadly flat after declining in early September. The yen depreciated.

Looking at short-term interest rates, the overnight call rate rose at the end of September reflecting fund needs for the term-end transaction, after moving in the 0.001-0.002% range reflecting the Bank of Japan's monetary easing policy. Two- and three-month contracts moved sideways. Long-term interest rates, which increased their downward trend in late August reflecting a decline in stock prices, fell to the 1.0% level in mid September, moved at the 1.0~1.1% level after rising to the 1.25% level following the Bank of Japan's announcement that it would consider the possibility of purchasing stocks held by banks.

The stock market has moved almost sideways after falling from late August to early September reflecting increased uncertainties about the future course of the Japanese and U.S. economies, and on October 3, the Nikkei Stock Average hit 8,936 yen and the TOPIX 883 points (the lowest since 1989).

On the exchange market, the yen (interbank spot central rate) depreciated to the 122 yen level in mid September after moving in the 117-120 yen range from mid August to early September, and then moved in the 121-123 yen level. Against the Euro, the yen (interbank rate as of 17:00) depreciated to the 121 yen level in mid September after moving in the 115-117 yen range from late August to early September, and then moved in the 119-121 yen level.

The growth of the monetary base (monthly average balance) has remained high at the 20% level against the background of ample fund supplies (the average balance of current deposits at the Bank of Japan stood at 15.2 trillion yen in September), but the growth rate has slackened. (September: Up 21.4% over a year earlier). The growth rate of M2+CDs (monthly average balance) has remained at around 3.5% (August 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 doward trend since the beginning of last year, reflecting easing monetary policies. Enterprises' financial conditions have improved slightly and the yield spread between private bonds and government bonds has been slightly expanding.

4. Overseas economies

The world economy is recovering at a more moderate pace, and a concern about the future prospects of some economies including the U.S. has been rising.

The economic recovery in the U.S. has become more moderate, leading to a concern about the effect of deterioration in confidence. The growth of private consumption has slowed and consumer confidence continues declining. Housing construction is at a high level. Business investment, especially in machinery equipment, has stopped decreasing. The growth of production has slowed and business confidence in the manufacturing industry has deteriorated. Employment pick-up is losing its momentum as a decline continues in the manufacturing sector, although the unemployment rate fell. Prices are stable.

The Asian economy is recovering. The pace of economic growth in China is rising. In South Korea, the economy is expanding, but domestic demand shows some signs of slowing. In Thailand, the economy is expanding. In Singapore and Malaysia, the economy is recovering. In Taiwan, the economy is recovering at a moderate pace.

In Europe, (1) A pickup of the Euro Area economy is losing steam. The German economy is decelerating, and a pickup of the French economy is losing steam. (2) The U.K. economy continues movements of a recovery.

As for the international financial situation, U.S. stock prices fell throughout September reflecting weak prospects of recovery in employment and production, and hit a 5-year low in early October. Amid a shift in funds into Treasury bonds reflecting a tight situation over Iraq, U.S. long-term interest rates fell, with 10-year bonds hitting their lowest level since January 1963, and the dollar remained on an upward trend.

As for the international commodity market, crude oil prices were on a rising trend, reflecting a tight situation over Iraq and the agreement reached by the OPEC to keep production quotas unchanged.