Monthly Economic Report(August 2003)

Assessment of the current state of the Japanese economy

The economy remains roughly flat. The environment surrounding the economy, such as the developments of stock prices and the U.S. economy, is showing signs of change.

As for short-term prospects, the economy is expected to move towards an incipient recovery if the recovery in the U.S. and other economies is sustained. On the other hand, attention should be given to the developments of stock prices and long-term interest rates as well as to those of the overseas economy.

Policy stance

The Government will pursue further strengthening of structural reform through early implementation of the Basic Policies for Economic and Fiscal Policy Management and Structural Reform 2003."As for the FY2004 budget, reforms will be further accelerated on both expenditure and revenue sides as well as on both quality and quantity aspects.
The Government, with the Bank of Japan, will continue to take powerful and comprehensive actions to secure stability of money and capital markets and to emerge from deflation.

Detailed explanations

1.Demand trends such as consumption and investment

Private consumption remains generally flat.

Private consumption remains generally flat. Behind this are the facts that income has become roughly flat and that consumer confidence has been showing a moderate incipient recovery recently, though it remains at a low level. The Synthetic Consumption Index, which synthesizes demand-side statistics (Family Income and Expenditure Survey) and supply-side statistics (Indices of Industrial Producer's Shipment, etc.), rose in June from the previous month.
Among individual economic indicators, the Family Income and Expenditure Survey shows that real consumption expenditure increased from the previous month. Out of sales indicators, retail sales decreased from the previous month, as sales of automobiles posted a decrease. Chain store sales remained below the level of the previous year. The decline of department store sales was not as large as in the previous month due to the effect of earlier implementation of clearance sales and in reaction to sharp declines in April and May. New car sales continued to decrease. Home appliance sales decreased at a slower pace, especially sales of personal computers one of the major home appliance items. Domestic travel in June increased from a year earlier. Overseas travel continued to decrease sharply in June from a year earlier as the Severe Acute Respiratory Syndrome (SARS) outbreak discouraged people from going abroad.
Private consumption is expected to continue the current trend for the immediate future. Given the still severe employment situation, private consumption still needs to be watched closely.

Business investment has continued to pick up moderately.

Business investment has continued to pick up moderately due to an improvement of corporate profits and progress in capital stock adjustment. The Quarterly Financial Statements Statistics of Corporations by Industry, which is a demand-side indicator of business investment, shows that business investment is on a moderate recovery trend, although it fell back slightly in the January-March quarter of 2003 after turning up in the October-December quarter of 2002 from the previous quarter on a seasonally adjusted basis. Shipments of capital goods, a supply-side indicator of machinery equipment investment, remained flat. Software investment remained roughly flat.
As for leading indicators and annual plans, according to the Bank of Japan short-term business sentiment survey (tankan), business investment in fiscal 2003 in the manufacturing industry is expected to increase for the first time in three years and corporations' sense of excess capacity, which indicates future business investment, has continued its improvement. Machinery orders, a leading indicator of machinery equipment investment, has been picking up, and building construction starts (floor area), a leading indicator of construction investment, has remained roughly flat. Business investment as a whole is expected to stay moderate for the immediate future. However, business investment is likely to resume recovery, if uncertainty is wiped out about the future course of final demand including overseas demand.

Housing construction is increasing recently.

Housing construction in fiscal 2002 remained below 1.2 million units for two years on end, as consumer sentiment on acquisition of houses had been declining due to the harsh employment and income environments and the long-term downward trend of real estate prices that has made replacement difficult.
Housing construction in June rose 8.7% from the previous month to an annual rate of 1.268 million units, posting a gain for three consecutive months, due mainly to a more than 20% increase over the previous month in the construction of owner-occupied houses. Total floor space generally followed the same movement. However, consumer sentiment on acquisition of houses has been weak. This is expected to become a factor to depress housing starts.

Public investment has been generally sluggish.

Reflecting the budget situations of the state and local governments, public investment has been generally sluggish.
In the national budget for fiscal 2003, the Government slashed public investment-related expenses by 3.7% from the previous fiscal year and prioritized budget allocations to areas that would contribute to the expansion of employment and private demand, focusing on four priority areas such as "attractive urban and rural communities rich in unique characteristics and inventiveness." Out of local public investment expenses under the fiscal plans of local governments for fiscal 2003, those for projects undertaken by local governments on their own funding have been slashed by 5.5% from the previous year and subjected to systematic curbs and priority-based allocations.
Reflecting this situation, the public works contract value and orders received by 50 major companies in the April-June quarter of 2003 decreased from a year earlier, as they did in the previous quarter.

Exports have been declining somewhat recently. Imports are increasing moderately. The surplus in the trade and services balance is flat.

Exports have been declining somewhat recently. By region, exports to Asia have recently been declining, especially to China, due to the effects of SARS. Exports to the U.S. as a whole have remained flat, although they have decreased recently in reaction to a rise in exports of automobiles in the previous month. Exports to the EU have recently been declining as a rise in automobile exports accompanying the introduction of new models since the beginning of the year has come to a halt. The outlook for exports is likely to increase moderately if the recovery in the U.S. and other economies is sustained.
Imports, especially of machinery equipment, have increased moderately. By region, imports from Asia have increased moderately as a whole, as imports from China, ASEAN and NIEs increased moderately. Imports from the U.S. have been on a decreasing trend, although monthly fluctuation has become bigger. Imports from the EU have been generally flat.
Looking at the international balance of payments, the surplus in the trade and services account has been flat as exports in volume have been declining somewhat recently and as imports increased moderately in volume, although the deficit in the services account decreased due to a decline in Japanese tourists abroad.

2. Corporate activities and employment

Industrial production has become flat.

Industrial production, which had been declining somewhat since the beginning of the year, has become flat, as information-related producer goods have remained firm. Although inventory is at a low level, corporations are cautious about inventory building due to uncertainty about the future course of external demand and other final demand, failing to lead to an increase in production.
As for the prospects of industrial production, the potential for production recovery is expected to increase gradually, as inventories are expected to have little downward pressure on production and as production is expected to move towards an incipient recovery through exports if the recovery in the U.S. and other economies is sustained, although domestic final demand is likely to stay sluggish. Incidentally, the Survey of Production Forecasts indicates industrial production is expected to increase both in July and August.
Tertiary industry activities remain flat.

Corporate profits have continued to improve moderately. Firms' judgement on current business conditions continues improving, albeit moderately. The number of bankrupt companies is decreasing moderately.

According to the Quarterly Financial Statements Statistics of Corporations by Industry, corporate profits in the January-March quarter of 2003 continued to increase from the level of the previous year, reflecting corporations' restructuring efforts including personnel cost reductions. But the year-on-year increase slowed in the quarter as profits turned down from the previous quarter on a seasonally adjusted basis. According to the Bank of Japan short-term business sentiment survey (tankan), corporate profits posted a double-digit year-on-year increase in the second half of fiscal 2002 and are expected to continue increasing in fiscal 2003. Among industries, the manufacturing industry, including electrical machinery and steel manufacturers, posted a year-on-year profit increase of 50% in the second half of fiscal 2002 and is expected to post a double-digit rise in fiscal 2003. On the other hand, the non-manufacturing industry is expected to post a profit decline in the first half of fiscal 2003 but a double-digit year-on-year profit increase in the second half. By size, big, medium and small corporations are all expected to see their profits increase in fiscal 2003 as they did in fiscal 2002.
The BOJ tankan survey shows that business sentiment continued improving, albeit moderately, among manufacturers. But non-manufacturers stopped seeing business sentiment improvement. As for the future, enterprises as a whole expect a slight improvement in their business conditions.
The number of corporate failures has been falling slowly as the number of applications for safety net guarantees has been increasing.

While the employment situation still remains severe with the unemployment rate remaining at a high level, movements of an incipient recovery can be seen in some areas.

The employment situation remains severe with the unemployment rate remaining at a high level due to labor demand factors, such as corporations' personnel expense reduction stance, and structural factors, such as a mismatch between job offers and seekers.
The unemployment rate in June declined 0.1 point to 5.3%. By gender, while the unemployment rate for men rose, the unemployment rate for women dropped. The number of employees shows an incipient recovery.
The number of job offers, which had been flat, has been on an increasing trend again. The effective ratio of job offers to applicants has leveled off. Overtime hours worked in the manufacturing industry have also stayed flat.
The initial trend of summer bonuses, as judged from special cash earnings in June, is higher than a year earlier. On the other hand, contractual cash earnings have remained flat and the underlying trend of wages has also remained flat.

3. Prices and the financial market

 Domestic corporate goods prices are declining slightly. Consumer prices are moving sideways.

Domestic corporate goods prices are declining slightly. Breaking down the recent trend by type of goods, iron & steel prices, which had been rising, remained flat in June from the previous month and prices of electrical machinery & equipment and petroleum & coal have continued a downward trend. Import prices (yen basis), which had been declining moderately, showed the impact of the firm oil prices in June.
Corporate services prices have remained below the levels of the previous year.
Consumer prices, which had been weakening since the autumn of 2000, have remained flat on a month-to-month basis supported by a rise in some sectors. Prices of general commodities as a whole declined at almost the same pace as in the previous year, as prices of petroleum products continued to decline. On the other hand, general services prices remained generally flat, though corporations' low-price strategies have begun to show signs of changing, with eating out declining at a slower pace in July. Public utility charges rose from a year earlier due partly to a hike of the cigarette tax in July.
Although consumer prices are now leveling off, price-supporting factors may prove to be short-lived. Taken together, these movements show that the Japanese economy is in a mild deflationary phase.

Stock prices have moved sideways after rising from late April.

As for the stock market, the key Nikkei average has generally moved at above the 9,500 yen level after turning higher in late April and hitting the yen's highs in early July. The U.S. dollar has been moving at the \117-120 level since June.
Short-term interest rates are stable. Long-term interest rates, which had been on a downward trend, have moved at around 1% since mid-July after turning higher in mid-June. Enterprises' financial conditions have improved, and the yield spread between corporate and government bonds has remained at a low level.
The growth of the monetary base has remained high (at 16.3% if current deposits by Japan Post are excluded) against the background of ample fund provision from the BOJ. The growth rate of the M2+CD money supply has been slowing down since late last year.

4. Overseas economies

The recovery of the U.S. economy is gathering momentum.

The recovery of the U.S. economy is gathering momentum as movements of a recovery appear in the corporate sector as well.

Consumer and business sentiments are improving moderately. Backed by this, private consumption is increasing moderately. Movements of a recovery appear in the corporate sector as well, with downward trend in production coming to an end and business investment picking up. Reflecting an improvement in earnings of major corporations, stock prices are generally on a rising trend.
It is highly likely that the U.S. growth rate is going to rise in the second half of this year, as the tax-cut package is expected to stimulate consumption and investment.
On the other hand, if long-term interest rates, which have been rising since mid-June reflecting the expectation for recovery, continue to rise, they may have negative effects on housing investment and consumption.
Fed chairman Greenspan clarified a policy stance in his congressional testimony in mid-July that Fed would maintain its current easy monetary policy until the U.S. economy recovers fully.

Asia has seen continued economic expansion in China and Thailand, and deceleration in South Korea and some other economies.

In China, April-June quarter GDP growth rate slackened due to SARS scares. But, consumption and production have improved as SARS scares came to an end. In addition, with investment and exports increasing steadily, Chinese economy is expanding. Thailand is continuing economic expansion led by consumption and investment. Malaysia is seeing moderate economic expansion due to slower growth of consumption and exports. In Taiwan, the economy shows movements of picking up, with production turning up. In South Korea, consumption is weakening due to worsening consumer confidence caused by a rise in the unemployment rate. The economy is decelerating as business investment has weakened due to slower growth in exports. In Singapore, the economy is decelerating, with April-June GDP posting a substantial negative growth due to a decrease in production. Meanwhile, many of the Asian countries and regions saw their exports to the U.S. and other countries pick up.

The Euro area economy is weakened and the U.K. economy is flat.

In the euro area, the economy is weakening as exports are on a downward trend due to the appreciation of the euro since last autumn and as production shows a weak movement. In Germany, there are concerns about an economic recession, as the inflation rate stays at a low level amid a continuing decline in production. The French economy is flat but shows signs of weakening in some areas, such as a slight decline in consumption.
In the U.K., the economy is flat, with consumption showing signs of picking up. On the other hand, production and investment show weak movements. The Bank of England cut the official interest rate (repo rate) by 0.25 percentage points to 3.50% in early July.

International financial situations

As for international financial situations, U.S. stock prices are on an upward trend and prices of major Asian and European stocks also keep an upward trend.  Long-term interest rates are rising worldwide. The U.S. dollar has strengthened since early July because of the prospects for the U.S. economic recovery. In order to cope with economic deceleration, interest rates were cut in South Korea in early July and in Canada in mid-July.
Oil prices remained generally flat, though they rose temporarily on expectations of a decrease in crude oil stock in the U.S.