Monthly Economic Report (September 2002)

Assessment of the current state of the Japanese economy

Movements of an incipient recovery can be seen 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.

Corporate profits have become flat; and business investment is showing signs of bottoming out in the future.

Exports are showing increase; and pace of an incipient recovery in industrial production 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," implementation of "financial system reform," "tax reform," and other structural reform measures will be accelerated, and emergence from deflation will be promoted.

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 second quarter of 2002 was 0.6% (at an annual rate of 2.6%) higher than in the previous quarter, despite the negative growth of Non-residential Investment, mainly because of the growth of Net Exports (Exports minus Imports) of Goods and Services. Nominal GDP was 0.1% lower than in the previous quarter.

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

Private consumption, in terms of movements in 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 remained almost unchanged 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 as a whole due to temporary factors, such as weather. Retail sales still have a weak tone. Chain store sales as a whole decreased sharply from a year earlier, although foods remained almost flat. 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 and especially compact car sales increased sharply. Home appliance sales decreased sharply as a whole, as sales of personal computers and air conditioners posted sharp year-to-year decreases, although sales of TV sets continued to post an increase. Both domestic and overseas travels were lower than a year earlier, although the margin of decrease narrowed 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, due partly to declines in production and corporate earnings, is showing signs of bottoming out. 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 and which had been decreasing since the beginning of 2001, 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 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. This is because construction of new condominiums, which posted a solid gain in 2000, have become steady, and because 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 July, housing construction came to an annual rate of 1.136 million units due to a sharp decrease in the construction of new condominiums, although the construction of houses 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 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.

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, of 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.

In the circumstances, the second supplementary budget for FY2002 had an effect of holding up public investment, increasing the contracted amount of public works and orders received by 50 major companies in May over a 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 in July and the budgetary conditions of the state and local governments.

Exports to Asia, among other areas, are increasing. Imports are increasing slightly.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, and general machinery are on an increasing trend and exports of transportation equipment are steady, reflecting a worldwide economic recovery. 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, mainly of electrical devices and transportation equipment, increased slightly. As for the outlook for exports, the moderate 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 U.S. and other economies.

Imports as a whole increased slightly, as imports of IT-related machinery equipment increased thanks to a pickup in production, mainly of electrical machinery. By region, imports from Asia increased, as imports of machinery equipment and chemical products 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 the increase in export volume has been larger than the increase in import volume.

2. Corporate activities and employment

Pace of an incipient recovery in Industrial production has become moderate.

Industrial production, which had increased for two consecutive quarters reflecting an increase in exports and an end in inventory adjustment, has remained broadly flat and the pace of an incipient recovery has become moderate.

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 August but fall in September.

Tertiary industry activities remain broadly flat.

Corporate profits remain flat. 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 April-June quarter of 2002, the margin of decline in profit remained flat overall, as the manufacturing industries sharply narrowed the margin of decline in profit. 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. According to the Business and Investment Survey of Incorporated Enterprises, the excess of large and medium-sized firms forecasting decline in their ordinary profits for the April-June quarter of 2002, outnumbered those forecasting improvement the decrease being contracting.

The BOJ tankan survey says business sentiment of all sizes of both manufacturing and non-manufacturing enterprises has improved, although business sentiment has remained severe and at low levels especially in small and medium-sized enterprises. As for future prospects, all enterprises forecast improvement, except for small and medium-sized non-manufacturing enterprises, which forecast a slight deterioration of their business. According to the Business and Investment Survey of Incorporated Enterprises, the width of 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 1,578 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 has stopped decreasing, the unemployment rate remained at a high level and wages continued to weaken.

The unemployment rate in July remained unchanged from the previous month at 5.4%. The increase width of involuntary job leavers, which accounts for the largest proportion of the unemployed, decreased in July. 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 a month-to-month increase for two consecutive months.

The number of new job offers is on an increasing trend. On the other hand, the number of new job seekers increased at the same time, therefore the new job offer ratio decreased from the previous month, but the effective job offer ratio increased slightly from the previous month. Overtime work hours in the manufacturing industries remained on an increasing trend. The proportion of business establishments that implemented employment adjustment, such as "overtime restrictions," in the April-June quarter decreased.

Contractual cash earnings increased from the previous month but continued edging down on a year-to-year basis. Special cash earnings, including bonuses, posted a year-to-year decrease. Wages are continuing its downward trend.

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.

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 declined in and after late August. Long-term interest rates decline in and after late August.

Looking at short-term interest rates, the overnight call rate moved to 0.001-0.002% in August, reflecting the Bank of Japan's monetary easing policy. Two- and three-month contracts moved sideways in August. Long-term interest rates moved sideways until mid August and then fell partly due to a rise in demand for bonds caused by declining stock prices.

The stock market moved sideways until mid August and then fell, reflecting increased uncertainties about the future course of the Japanese and U.S. economies.

On the exchange market, the yen (interbank spot central rate) moved in the 117-120 yen range after depreciating from the 115-yen level in mid July to the 121-yen level in early August. Against the Euro, the yen (interbank rate as of 17:00) appreciated to the 114 yen level in mid August after moving in the 115-117 yen range in mid and late July, and then moved in the 115-117 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, but the growth rate has slackened. (The average balance of current deposits at the Bank of Japan stood at 15.1 trillion yen in August by the Bank of Japan.) (August: Up 26.1% 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 falling 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 are moving sideways.

4. Overseas economies

The world economy is recovering moderately, but 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 moderate, leading to a concern about the effect of deterioration in confidence. Private consumption, especially on durable goods, has been increasing recently, but consumer confidence continues declining. Housing construction is at a high level. Business investment, especially in machinery equipment, has stopped decreasing. Production is increasing at a slower pace and business confidence is declining. 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 exports to the U.S. is slowing. In Thailand, the economy is expanding. In Taiwan, Singapore, and Malaysia, the economy is recovering.

In Europe, (1) The Euro Area economy is generally picking up. A pickup of the German economy is losing steam further. Adverse effects of the recent flood are a matter of concern. In France, the economy is generally picking up. (2) The U.K. economy shows movements of a recovery.

As for the international financial situation, the dollar fluctuated in the first half of August ahead of the FOMC meeting on August 13, but then levelled off. U.S. stock prices were on an upward trend until mid August as distrust in corporate accounting abated. But then they declined reflecting a concern about the future prospect of the economy. U.S. long-term interest rates fell throughout August, reflecting a shift in funds into Treasury bonds.

As for the international commodity market, crude oil prices were on an upward trend, reflecting a tight situation over Iraq.