Monthly Economic Report (February 2003)

Assessment of the current state of the Japanese economy

While movements of an incipient recovery can be seen in some areas of the economy, the state of the economy has weakened somewhat.

Corporate profits are improving; and business investment has bottomed out.

While job offers are on an increasing trend, employment situation continues to be severe with unemployment rate reaching the highest level ever.

While private consumption remains generally flat, weak movements can be seen most recently.

Export has become flat; and industrial production has declined somewhat.

As for short-term prospects, the economy is expected to move towards an incipient recovery if the recovery in U.S. and other economies sustains. On the other hand, there are concerns that the uncertainty surrounding the future of the world economy and the weakening of consumer confidence may still exert a downward pressure on final demand.

Policy stance

The Government decided the "Fiscal 2003 Economic Outlook and Basic Stance for Economic and Fiscal Management," and submitted the budget for FY2003 before the Diet, on January 24. In the FY2003 budget, priority is given to appropriation to those areas that contribute in revitalizing the economy and lead to future development. In the FY2003 tax reform, advanced tax cut amounting to roughly 1.8 trillion yen will be implemented. Together with the steady implementation of the FY2002 supplementary budget, the FY2003 budget and tax reform will be implemented throughout both fiscal years without a break. On the same day, the Government also decided the "Structural Reform and Medium-Term Economic and Fiscal Perspectives: FY2002 Revision."

The Government and the Bank of Japan together will continue to take powerful and comprehensive actions to emerge from deflation and achieve a positive rate of price change as soon as possible.

Detailed explanations

1.Demand trends such as consumption and investment
Real GDP (gross domestic product) in the fourth quarter of 2002 was 0.5% (at an annual rate of 2.0%) higher than in the previous quarter, despite the negative growth of Private Residential Investment and Public Investment, mainly because of the growth of Net Exports (Exports minus Imports) of Goods and Services and Private Non-residential Investment. Nominal GDP was 0.1% lower than in the previous quarter.

While Private consumption is remains generally flat, weak movements have been seen most recently.

Private consumption, in terms of movements on both the demand and supply sides, is generally flat, but weak movements have been seen most recently. Behind this are the facts that the environment surrounding households has become severe, such as continued weakness of income, and that consumer confidence has weakened recently.

As for movement on the demand side, although there had been robust movement, weak movements have been seen recently. The Synthetic Consumption Index posted a decrease in December from three months before, although it posted a rise until November. As for the movement of each expenditure item, the Family Income and Expenditure Survey shows that real consumption expenditure decreased sharply from the previous month. The increasing trend of basic expenditure items has become moderate, as foods continued to decrease from the previous year.

Sales are weakening on the whole. Retail sales still have a weak tone. Chain store sales continued to decrease from a year earlier. Department store sales as a whole decreased sharply due partly to a greater decrease in sales of clothing, their staple merchandise, and partly to reaction to earlier implementation of year-end gift sales campaigns in November. New car sales increased from a year earlier, as sales of compact cars remained brisk. Home appliance sales as a whole decreased from a year earlier, as sales of personal computers remained slower than a year earlier, although sales of TVs continued to increase. Domestic travel decreased from a year earlier, but overseas travel increased sharply in reaction to the sharp decrease a year earlier caused in part by the effects of the terrorist attacks in the United States.

Consumer confidence has weakened recently.

Business investment has bottomed out.

Business investment, which had been decreasing since the beginning of 2001, has bottomed out, as corporate earnings have been recovering. 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, has been decreasing at a slower pace recently. According to the Business and Investment Survey of Incorporated Enterprises (with capital of 100 million yen or more), business investment (expected results) during the October-December quarter of 2002 almost bottomed out. Shipment of capital goods, which is a supply-side indicator of machinery equipment investment, moved sideways. Software investment has decreased slightly.

The potential for recovery in business investment is weak as machinery orders, a leading indicator of machinery equipment investment, has been moving sideways since bottoming out in the first half of FY2002. Even though it has stopped decreasing, business investment is expected to remain at a low level in view of the weak movement of production and as it is expected to decrease in FY2002 according to the Bank of Japan short-term business sentiment survey (tankan).

Housing investment is decreasing moderately.

Housing construction in 2002 decreased 1.9% from the preceding fiscal year to 1.151 million units, falling below 1.2 million units for two consecutive years, as construction of owned houses and houses for sale decreased although construction of houses for rent increased. Housing construction in FY2002 has been decreasing moderately due to a decrease in the construction of new condominiums, with housing construction standing at an annual rate of 1.175 million units in the April-June quarter of 2002, at an annual rate of 1.136 million units in the July-September quarter, and at an annual rate of 1.125 million units in the October-December quarter.

In December, housing construction came to an annual rate of 1.119 million units due to decreases in the construction of owned houses and houses for rent, although construction of houses for sale increased. 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.

In a supplementary national budget for FY2002, the Government took budgetary measures for public investment promoting structural reform and for disaster contingency planning, including about 2.0 trillion yen on a national expense basis (about 3.4 trillion yen on a project basis). However, the size of the public investment after the supplementary budget was much smaller than that in the previous fiscal year, when special measures for "Reform-Promotion Public Investment" were implemented. 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.

Reflecting this situation, public investment has been generally sluggish. In FY2002, although the supporting effects of the second supplementary budget for FY2001 that was carried over into the current fiscal year have been seen, public investment continued to decline compared to the previous year in the April-June quarter and the contracted amount of public works in the July-September and October-December quarters decreased from the previous year.

Public investment in the January-March quarter is likely to continue posting a year-on-year decrease in view of the decreases in the contracted amount of public works in January and the budgetary conditions of the state and local governments.

Exports have become flat. Imports are increasing at a slower pace. The surplus in the trade and services balance has remained almost flat.

Exports, which had been declining somewhat as restocking since the beginning of the year came to a halt, moved sideways as a whole, as machinery equipment, such as transport equipment, remained relatively firm. By region, exports to Asia moved sideways as a whole. Exports to the U.S. moved sideways as a whole, although they decreased in December in reaction to a sharp increase in November following the end of a harbor strikes. Exports to the EU decreased as a whole against the background of a slowdown in economic activity in the Euro Area. As for the outlook for exports, close monitoring is required for the slowdown in economic activity in the Euro Area and risks concerning the Middle East, although the world economy shows a steady movement.

Imports as a whole slackened against the background of a slight decrease in production, although imports of mineral fuels continued to increase. By region, imports from Asia, especially of IT-related machinery equipment, slackened. Imports from the EU remained flat. Imports from the U.S., especially of machinery equipment, decreased.

Looking at the international balance of payments, the surplus in the trade and services account has remained almost flat, as export volume moved sideways while import increased at a slower pace.

2. Corporate activities and employment

Industrial production has declined somewhat.

Industrial production, which had increased last year reflecting an increase in exports and a progress and an end in inventory adjustment, has declined somewhat, as exports leveled off, domestic final consumption is weak and corporations are cautious about inventory buildup.

According to the Survey of Production Forecast, industrial production is expected to rise in January 2003 but fall in February. Close monitoring is required for the movement of domestic final demand and the U.S. and the world economy.

Tertiary industry activities have declined somewhat.

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

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, increased in the July-September quarter of 2002 due partly to corporations' restructuring efforts, although sales continued to decrease. According to the Bank of Japan short-term business sentiment survey (tankan), industries as a whole expect their profits to increase sharply in the second half of FY2002. According to the Business and Investment Survey of Incorporated Enterprises, the large and medium-sized firms forecasting a decline in their ordinary profits for the October-December quarter of 2002 outnumbered those forecasting an increase by a narrower margin.

The BOJ tankan survey says business sentiment of enterprises, especially of manufacturing industries, has been improving, albeit moderately, although business sentiment of small and medium-sized enterprises has remained severe and at low levels. According to the Business and Investment Survey of Incorporated Enterprises, which shows business trend earlier than the BOJ tankan, the large and medium-sized firms forecasting deterioration in their business sentiment outnumbered those forecasting improvement by a slightly wider margin.

According to Tokyo Shoko Research Ltd., the number of corporate failures decreased, with 1,444 companies going bankrupt in January.

The employment situation still remains severe. While job offers are on an increasing trend, the employment situation continues to be severe with the unemployment rate reaching the highest previous level and wages continuing to weaken.

The unemployment rate in December rose 0.2% from the preceding month to 5.5%, the highest previous level. The number of men and women not in the labor force decreased, while the number of unemployed women increased and the number of employed men increased. The number of involuntary job leavers, which accounts for the largest proportion of the unemployed, increased slightly and the number of voluntary job leavers also increased. The number of employees is decreasing as a trend, although it increased slightly for two consecutive months.

The number of new job offers has been on an increasing trend. The effective job offer ratio continued to increase moderately. Overtime work hours in the manufacturing industries remained flat from the previous month, weakening its increasing trend.

Wages remained weak, with contractual cash earnings posting a slight decrease from the previous month and continuing a year-to-year decrease, and special cash earnings, including bonuses, also decreasing from a year earlier.

3. Prices and the financial market

Domestic Corporate Goods Prices and Consumer Prices are declining slightly.

Import prices have been rising on a contractual currency basis but declining on a yen basis recently due to the influence of exchange movements. Domestic Corporate Goods Prices have declined slightly. Recently, the prices of Petroleum & coal products have been rising and the price of Iron & Steel has been rising reflecting an end in inventory adjustments, although the prices of Electrical machinery, transportation equipment, and Agricultural, forestry & fishery products have been declining.

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 moved sideways, General commodities declined due to declines in the prices of Durable goods and other industrial goods, and the prices of Public services & electricity, gas & water charges also declined.

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 moved at around the 8,500 yen level (Nikkei Stock Average). Long-term interest rates continued their downward trend.

Short-term interest rates moved in the 0.001-0.002% range reflecting the Bank of Japan's monetary easing policy. Two- and three-month contracts moved almost sideways. Long-term interest rates continued their downward trend supported by strong demand from investors, falling to 0.75% temporarily in late January.

The stock market on the whole has moved at around the 8,500 yen level (Nikkei Stock Average) since late December, although it declined in late January after rising slightly in the middle of January on reports of capital increases by major banks.

On the exchange market, the yen (interbank spot central rate) moved sideways in late January after appreciating from the 125 yen level in the beginning of December to the 118 yen level in the middle of January, and then depreciated slightly in the beginning of February. Against the Euro, the yen (interbank rate as of 17:00) depreciated to the 130 yen level in early February from the 124 yen level in early January, after moving in the 122-125 yen level range in December. Against the Euro, the dollar (as of 17:00) depreciated to a 47-month low in the beginning of February.

The growth of the monetary base (monthly average balance) has remained at a high level against the background of ample fund supplies (the average balance of current deposits at the Bank of Japan stood at 20.1 trillion yen in January), but the growth rate has slackened. (January: Up 13.4% over a year earlier) The growth rate of M2+CDs (monthly average balance) has remained at the lower 2% level (January preliminary report: Up 2.0% over a year earlier) since December last year, after moving at the lower 3% level for most of the second half of 2002. 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 downward trend since the beginning of last year, reflecting easing monetary policies. Enterprises' financial conditions have remained flat and the yield spread between private bonds and government bonds has remained almost flat.

4. Overseas economies

World economy shows some resiliency in its recovery, although the Euro Area economy is decelerating.

The U.S. economy continues to show some signs of resilient recovery. Private consumption has been picking up. Housing construction is at a high level. Business investment, especially in machinery equipment, has been picking up, however orders for non-military capital goods are decreasing. Production is leveling off. Employment shows signs of improvement. Prices are stable.

The Asian economy continues to recover, although the recovery in some countries is moderate. The pace of economic growth in China is rising. In South Korea and Thailand, the economy is expanding. In Taiwan, Singapore, and Malaysia, the economy is recovering moderately.

In Europe, (1) the Euro Area economy is decelerating. In Germany, the economy has weakened. In France, the economy is decelerating. (2) In the U.K. movements for economic recovery have weakened.

As for the international financial situation, U.S. stock prices rose in the first half of January, but then moved on a downward trend, reflecting a tightening situation over Iraq and concerns about corporate performance. U.S. long-term interest rates strengthened in early January but then moved on a downward trend. The dollar has remained weak, especially against the Euro, since the middle of January. In the U.K., the Bank of England cut the official interest rate (repo rate) by 0.25 percentage points to 3.75%.

Crude oil prices were on an upward trend reflecting a tightening situation over Iraq, and surged to the highest level since the autumn of 2000.