Monthly Economic Report(July 2003)

Assessment of the current state of the Japanese economy

While the economy remains roughly flat, weak movements are seen recently in some areas. As for short-term prospects, the economy is expected to move towards an incipient recovery if the recovery in the US and other economies is sustained. On the other hand, attention should be given to the uncertainties surrounding the future of the overseas economy, and to the developments of stock prices and long-term interest rates.

Policy stance

The Government, in order to realize sustainable economic growth, made a cabinet decision on the Basic Policies for Economic and Fiscal Policy Management and Structural Reform 2003,"on June 27, which aims to vitalize the economy, to assure the people of their security, and to establish public finance accounting for future generations. Further strengthening of structural reform will be pursued through early implementation of the Basic Policies.
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 becomes roughly flat and that consumer confidence has decreased its rate of decline, 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.), posted a small gain in May from the previous month.
Among individual economic indicators, the Family Income and Expenditure Survey shows that real consumption expenditure decreased from the previous month. Out of sales indicators, retail sales increased from the previous month, as sales of automobiles posted an increase. Chain store sales remained below the level of the previous year. Department store sales remained at a low level due to bad weather, such as typhoons, though the margin of decline narrowed from the previous month. New car sales in the April-June quarter decreased on the average from the previous quarter in reaction to last-minute purchases in connection with a reform of the greening of the automobile tax system. Home appliance sales remained below the previous year's level as sales of personal computers, a staple merchandise item, continued to decrease substantially from a year earlier. Domestic travel continued to decrease from a year earlier. Overseas travel decreased sharply in May from a year earlier as the Severe Acute Respiratory Syndrome (SARS) outbreak discouraged people from going abroad. Incidentally, the WHO announced on July 5 that it had removed Taiwan, the last hotspot, from its list of SARS-infected areas.
Private consumption is expected to continue the current trend for the immediate future. Given the still severe employment situation, a continued close watch will be required on private consumption.

Business investment has continued to be picking up moderately.

Business investment has continued to be picking 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. However shipments of capital goods, a supply-side indicator of machinery equipment investment, weakened slightly until May. 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 almost flat.

Housing construction in fiscal 2002 remained below 1.2 million units for two years on end, as consumer sentiment on acquisition of houses has 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 declined consecutively in February and March before rising to an annual rate of 1.16 million units in April and 1.166 million units in May. Total floor space followed the same movement until April, but decreased in May. The decrease can be attributed to the fact that while construction of houses for rent increased, construction of houses for sale that are larger in floor space than houses for rent decreased.
However, consumer sentiment on acquisition of houses has been declining. 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 supplementary national budget for fiscal 2002, the Government took budgetary measures for public investment promoting structural reform. However, the size of fiscal 2002 public investment after the supplementary budget was much smaller than in the previous year, when special measures for "Reform-Promoting Public Investment" were implemented. Out of local public investment expenses under the fiscal plans of local governments for fiscal 2002, those for projects undertaken by local governments on their own funding were slashed by 10.0% from the previous fiscal year.
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 public works orders posted year-on-year decreases from the April-June quarter of 2002 to the January-March quarter of 2003, although the second supplementary budget for fiscal 2001 that was carried over into fiscal 2002 worked to support public investment.
Public investment in the April-June quarter is likely to remain below the level of the previous year, given the state and local budget conditions. In April and May, the contracted value of public construction, etc. dropped from a year earlier.

Exports and Imports have become flat. The surplus in the trade and services balance is increasing slightly.

Exports have become flat. By region, exports to Asia have recently been declining. Exports to the U.S. as a whole have remained flat, although they have increased recently due to a rise in exports of automobiles. 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 remain flat if the current situation of the world economy remains unchanged. However, exports will move towards an incipient recovery if the recovery in the U.S. economy is sustained.
Imports as a whole have become flat as domestic production has declined somewhat. By region, imports from Asia have increased moderately as a whole, as imports from China increased, although imports from NIEs and ASEAN have become flat. Imports from the U.S. have been on a decreasing trend, although monthly fluctuation has become bigger. Imports from the EU, especially of machinery equipment, decreased.
Looking at the international balance of payments, the surplus in the trade and services account has been increasing slightly due to flat exports and imports in volume, a fall in oil prices and a reduction of the deficit in the services account due to a decrease in Japanese tourists abroad.

2. Corporate activities and employment

Industrial production has declined somewhat.

Industrial production has declined somewhat, as export has become flat amid the continuing weak movement of final demand. 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 remain weak, as domestic final demand is likely to stay sluggish and exports are expected to have no strong power to trigger production recovery due to uncertainty about the future course of the U.S. economy, although inventories are expected to have little downward pressure on production. Incidentally, the Survey of Production Forecasts indicates industrial production is expected to increase in June and decrease in July.
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.

The employment situation still remains severe with the unemployment rate remaining at a high level.

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 May remained at 5.4%, the same level as in April. The number of employees remained flat as a whole.
The number of job offers, which had been on an increasing trend since the first half of 2002, has remained roughly flat. The effective ratio of job offers to applicants has also leveled off. Overtime hours worked in the manufacturing industry have stayed flat. The number of corporations saying they have excess employees increased slightly.
The underlying trend of wages has become flat, although fix wages in May increased both from a year earlier and from the previous month.

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 and some other prices have been rising. Processed foodstuffs prices have also soared since a liquor tax on low-malt beer was hiked in May. On the other hand, electrical machinery & equipment prices have continued a downward trend. Prices of petroleum & coal products and chemicals have also declined in line with the commodity market weakness. Import prices (yen basis) fell in May due to an oil price fall and foreign exchange market developments.
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 fell in May. On the other hand, general services prices remained flat, though personal services prices dropped. Corporations' low-price strategies have begun to show signs of changing, with some restaurants believed to have raised prices 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 remained on an upward trend and long-term interest rates have been rising.

As for the stock market, the key Nikkei average has been on an upward trend backed by a U.S. market rally and an improvement in corporations' business sentiment, hitting the year' highs. The U.S. dollar has been moving at the \117-119 level since June.
Short-term interest rates are stable. Long-term interest rates, which had been on a downward trend, turned higher and rose above 1.0% on a market perception that the global downtrend in interest rate has run its course. Enterprises' financial conditions have improved, and the yield spread between corporate and government bonds has narrowed recently.
   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

While some Asian economies continue to expand, the global economy has continued its weak recovery.

The U.S. economy has continued its weak recovery.

Consumer sentiment has been improving moderately. Backed by this, private consumption is increasing moderately. Downward trend in production is coming to an end, as IT-related sectors are leading a pick up.
However, business investment decreased in the first quarter and capital goods orders decreased. Employment decreased and the unemployment rate climbed up to the highest level since 1994. The weakness of the corporate sector is the background of weak recovery.
With the inflation rate remaining on a downward trend, the Federal Open Market Committee (FOMC) decided on June 25 to lower the federal funds rate target by a quarter percentage point for the first time since last November.
It is highly likely that US growth rate is going to rise in the second half of this year, as business investment is expected to pick up backed by an improvement in corporate profits and as a tax-cut package is expected to stimulate consumption and investment. On the other hand, concerns remain about slow recovery of investment and employment.
Against this expectation for recovery, business sentiment continues its improvement. Stock prices, especially of IT-related stocks, have been on an upward trend since June. Long-term interest rates, which had continued to decline until early June on expectation of a fall in the inflation rate, turned higher partly because of the prospects for economic recovery.

Asia has seen continued economic expansion in China and Thailand, and deceleration in South Korea and Taiwan.

In China, the economy is expanding due to steady growth in investment and exports but the growth of consumption and production has slackened recently due to SARS scares. 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 is decelerating due to sluggish investment and slower growth in consumption and production caused by SARS scares. In South Korea, the economy is decelerating due to slower growth in consumption and investment as well as sluggish production. In Singapore the economy is decelerating due to sluggish consumption and production. Meanwhile, the exports from Asian countries and regions to the U.S. are picking up.
With no new infected patients reported, the SARS epidemic appears to have come to an end.

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

In the euro area, exports are on a downward trend due to the appreciation of the euro since last autumn. With production remaining flat amid deteriorating business sentiment, the euro area economy is weakened. On the other hand, stock prices rose following an interest rate cut by the European Central Bank in early June. In Germany, there are concerns about an economic recession, as the inflation rate stays at a low level amid continuing decline in production and consumption. The French economy is flat as domestic demand has increased moderately.
In the U.K., the economy is decelerating, as domestic demand, mainly housing investment, slowed.

International financial situations

As for international financial situations, prices of major Asian and European stocks are on an upward trend against the background of a continuing rise in U.S. stock prices. Long-term interest rates have been rising worldwide since late June partly because of the prospects for economic recovery.
Oil prices, which rose in early June, continued a downward trend after OPEC at a general meeting decided to keep the ceiling on oil output unchanged.