Monthly Economic Report(October 2003)

Assessment of the current state of the Japanese economy

The economy is showing movements toward an incipient recovery. As for short-term prospects, the economy is expected to show an incipient recovery as the U.S. and other economies recover at a time of an incipient recovery in the domestic corporate sector. On the other hand, attention should be given to the developments of stock prices and exchange rates as well as to those of the overseas economy and others.

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."
The Bank of Japan extended the period for purchasing stocks held by banks to end-September 2004. In addition, the Bank, on October 10, raised the upper limit of the target balance of current accounts held at the Bank, resulting in the new target balance of around 27 to 32 trillion yen. 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 signs of an incipient recovery recently. 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 August from the previous month, partly in reaction to a sharp decline in July.
Among individual economic indicators, the Family Income and Expenditure Survey shows that real consumption expenditure increased sharply from the previous month. Out of sales indicators, retail sales increased from the previous month. Chain store sales remained below the level of the previous year. Department store sales continued to decline due to unseasonable weather. New car sales remained below the level of the previous year. Home appliance sales increased from a year earlier thanks to a pickup in sales of personal computers, one of the major home appliance items, and to brisk sales of DVDs and digital cameras. Domestic travel increased from a year earlier. Overseas travel continued to decrease sharply from a year earlier, but the margin of decline narrowed.
As for short-term prospects, private consumption is expected to continue the current trend for the immediate future. However, if the income environment of households improves, private consumption is expected to show movements toward an incipient recovery.

Business investment is increasing.
Business investment is increasing thanks 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 an increasing trend after turning up in the October-December quarter of 2002 from the previous quarter on a seasonally adjusted basis. Software investment shows signs of an incipient recovery.
According to the Bank of Japan short-term business sentiment survey (tankan), business investment in fiscal 2003 in all industries of all sizes 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. As for leading indicators, machinery orders has been generally picking up and building construction starts (floor area) has remained roughly flat. Business investment is expected to remain on an increasing trend for the immediate future, as corporate profits are expected to continue their improvement.

Housing construction has remained roughly flat.
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, which had remained roughly flat since the beginning of fiscal 2003, fell to an annual rate of 1.061 million units in August, posting a decline for two consecutive months due mainly to a decrease in construction of houses for rent, after posting an increase to an annual rate of 1.268 million units in June. Total floor space generally followed the same movement. Housing starts are expected to move steadily if the employment and income environments improve and consumer sentiment on acquisition of houses picks up.

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, public works orders, 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.
Public investment in the July-September quarter is also expected to decrease from the same period of the previous year, as the public works contract value, etc. in July and August decreased from a year earlier and in view of the budget situations of the state and local governments.

Exports are showing a trend of an incipient recovery. Imports are generally increasing. The surplus in the trade and services balance is flat.
Exports are showing a trend of an incipient recovery, although exports of transportation equipment such as ships decreased. By region exports to Asia as a whole increased moderately, as exports to China and NIEs, mainly of transportation equipment, picked up following the termination of the effect of the Severe Acute Respiratory Syndrome (SARS) scare. Exports to the U.S. as a whole have remained flat, although exports of transportation equipment have decreased recently due to a rise in local production of automobiles. Exports to the EU have begun to show signs of stopping decreasing, as exports of transportation equipment increased. As for the outlook for exports, close monitoring is required for the recent movement of exchange rates, although exports are expected to increase moderately in line with the growing signs of recovery in the world economy.
Imports are generally increasing as business investment has been increasing, although imports of machinery equipment and foods have posted a sharp decrease recently. By region, imports from Asia are generally increasing, although imports of mineral fuels and textile products have decreased recently. Imports from the U.S., especially of machinery equipment such as aircraft, have decreased. Imports from the EU have been generally flat, although the monthly fluctuation has become bigger.
Looking at the international balance of payments, the surplus in the trade and services account has been flat, as exports in volume are showing trend of an incipient recovery and the deficit in the services account decreased due to a decline in the number of Japanese tourists abroad, although imports have been on an increasing trend in volume.

2. Corporate activities and employment

Industrial production remains flat.
Industrial production as a whole remains flat, although information-related producer goods have remained firm. Although inventory is at a low level, corporations are cautious about inventory building.
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 on the strength of the recovery in the U.S. economy. Incidentally, the Survey of Production Forecasts indicates industrial production is expected to increase both in September and October.
Tertiary industry activities remain flat.
As for agricultural production, the paddy rice crop situation index (as of September 15) stood at "92,"or below average, due to the effects of low temperatures and lack of sunshine.

Corporate profits have continued to improve. Firms' judgement on current business conditions shows improvement. The number of bankrupt companies is decreasing moderately.
According to the Quarterly Financial Statements Statistics of Corporations by Industry, corporate profits in the April-June quarter of 2003 continued to increase from the level of the previous year, reflecting corporations' restructuring efforts including personnel cost reductions, and an increase in sales. Corporate profits on a seasonally adjusted basis also posted a year-on-year increase in the quarter. According to the Bank of Japan short-term business sentiment survey (tankan), corporate profits are expected to continue increasing in fiscal 2003. Among industries, the manufacturing industry, including electrical machinery and steel manufacturers, is expected to post a double-digit year-on-year profit increase in the first and second half of 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.
The BOJ tankan survey shows that business sentiment continued improving among manufacturers and showed an improvement among non-manufacturers. 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.
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 August dropped 0.2 point from the previous month to 5.1%. Although the number of unemployed workers decreased, the number of employed persons also decreased.
The number of job offers has been on an increasing trend. The effective ratio of job offers to applicants has been rising moderately. The number of employees has been on an increasing trend. Overtime hours worked in the manufacturing industry have been on a rising trend. The number of corporations saying they have excess employees has been on a downward trend.
In August, contractual cash earnings decreased marginally from a year earlier but increased slightly from the previous month. Special cash earnings during the June-August period, including bonuses, remained flat from a year earlier, and the underlying trend of wages has remained flat.

3. Prices and the financial market

Domestic corporate goods prices and Consumer prices are moving sideways.
Domestic corporate goods prices are moving sideways. Breaking down the recent trend by type of goods, prices of petroleum & coal, which had been declining, turned upward in July and prices of non-ferrous metals and iron & steel prices have been rising, although prices of electrical machinery & equipment have continued a downward trend. Import prices (yen basis) have been rising moderately due mainly to the effect of firm oil prices.
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, which had been declining, moved sideways. 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 posting a year-on-year rise in August. Public utility charges rose from a year earlier.
Although domestic corporate good prices and 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.

The yen appreciated against the U.S. dollar. Stock prices have moved above the 10,000-yen level (the Nikkei average) mostly.
The yen against the U.S. dollar, which had been on an upward trend since August, rose further in late September, hitting the 109 yen level. Stock prices, which had been on a rising trend since late April, gained further momentum, with the Nikkei average hitting this year's high in mid-September before moving above the 10,000 yen level.
Short-term interest rates are stable. Long-term interest rates rose to the 1.6% level in early September and then dropped to the 1.3% level. Enterprises' financial conditions have remained almost unchanged, and the yield spread between corporate and government bonds has widened slightly.
The growth of the monetary base has remained high (at 17.9% 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, which had been slowing down since late last year, has recently been rising slightly.

4. Overseas economies

The world economy, especially of the U.S. and China, shows growing signs of recovery.

In the United States, the economy is recovering steadily.
Private consumption is increasing due to the effect of the tax-cut package. The recovery of the corporate sector has been continuing, with production increasing moderately and business investment picking up. Productivity growth is high, supporting corporate profits. The general view is that the U.S. economy will post a high growth rate of the 4% level in the second half of 2003.
On the other hand, the outlook for employment is uncertain as the unemployment rate is at a high level, although employment shows movements of picking up. Against this background, consumer sentiment is declining, raising concerns about the future consumption.

Asia has seen continued economic expansion in China and Thailand, but Korean economy is in recession.
In China, the economy has been expanding due to a steady increase in consumption and high growth of production and investment. Thailand is continuing economic expansion led by consumption and investment. Malaysia's economic expansion is slowing further due to sluggish consumption and exports. In Taiwan, the economy is picking up, with consumption and production turning up recently. In South Korea, the economy is in recession due to declines in consumption and business investment. In Singapore, the economy is stagnant, with investment continuing a sharp decline.

The Euro area economy is weakening and the U.K. economy shows movements towards picking up.
In the euro area, the economy is weakening, as production is on a downward trend due to a decrease in exports caused by the appreciation of the euro since last autumn. On the other hand, business sentiment is improving, as exports to the U.S. are likely to increase against the background of the rising growth rate of the U.S. economy. In Germany, the economy is in recession due to a decrease in personal consumption. The French economy is weakening, as consumption shows signs of weakening and as production is on a decreasing trend.
In the U.K., the economy shows movements toward picking up, with consumption and housing investment increasing.

International financial situations
As for international financial situations, U.S. stock prices eased temporarily in late September as market participants became cautious about the sharp rise of stock prices by then, but later stock prices rose. Asian and European stocks are also rising after weakening slightly in late September. Long-term interest rates are rising in October after remaining on a downward trend in September. The U.S. dollar remained on a downtrend after mid-September. The finance ministers of the Group of Seven (G-7) industrial countries issued a statement in late September, emphasizing the desirability of more flexibility in exchange rates.
Oil prices remained on a downward trend till late September, but then rose as OPEC ministers agreed on a cutback of oil production.