Monthly Economic Report(September 2003)

Assessment of the current state of the Japanese economy

The economy is showing movements toward incipient recovery. As for short-term prospects, the economy is expected to show an incipient recovery as the US 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 long-term interest 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 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

Real GDP (Gross Domestic Product) in the second quarter of 2003 was 1.0% (at an annual rate of 3.9%) higher than in the previous quarter, despite the negative growth of Private Inventory Increases and Public Fixed Capital Formation, mainly because of the growth of Non-residential Investment, Private Final Consumption Expenditure, and Net Exports (Exports minus Imports) of Goods and Services. Nominal GDP was 0.3% higher than in the previous quarter.

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 an incipient recovery recently due to a rise in stock prices. 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.), declined in July from the previous month, partly in reaction to a sharp rise in June.
Among individual economic indicators, the Family Income and Expenditure Survey shows that real consumption expenditure decreased sharply from the previous month. Out of sales indicators, retail sales decreased 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 and the sluggish performance of midyear present sales campaigns. New car sales continued to decrease. Home appliance sales as a whole decreased at a faster pace due mainly to a sharp decrease in sales of air conditioners as a result of the cold summer, although sales of personal computers, one of the major home appliance items, showed signs of picking up. Domestic travel increased from a year earlier. Overseas travel continued to decrease sharply from a year earlier, but the margin of decline narrowed.
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 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. Shipments of capital goods, a supply-side indicator of machinery equipment investment, remained flat. Software investment shows an incipient recovery.
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 is expected to remain on an increasing trend for the immediate future, as corporate profits are expected to continue their improvement.

Housing construction has been 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 remained firm, although it suffered a month-to-month decline of 8.6% to an annual rate of 1.159 million units in July after rising 8.7% to an annual rate of 1.268 million units in June. Total floor space generally followed the same movement. Housing starts are expected to strengthen its firm trend 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, the public works orders, 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 public works contract value in July decreased from a year earlier and in view of the budget situations of the state and local governments.

Exports are showing incipient recovery. Imports are increasing. The surplus in the trade and services balance is flat.

Exports are showing incipient recovery. By region, exports to Asia as a whole have remained flat, as exports to NIEs and ASEAN countries picked up following the termination of the effect of 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. Exports to the EU have been declining, although exports of transportation equipment have been increasing recently. The outlook for exports is likely to increase moderately, as the recovery of the U.S. economy has picked up momentum.
Imports, especially of machinery equipment, have increased, as business investment has been increasing. By region, imports from Asia have increased as a whole, as imports from China, ASEAN and NIEs increased. Imports from the U.S. have been generally flat. 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, although imports have increased in volume as exports in volume are showing incipient recovery and the deficit in the services account decreased due to a decline in the number of Japanese tourists abroad.

2. Corporate activities and employment

Industrial production remains flat.

Industrial production, which had been declining somewhat since the beginning of the year, remains flat, as 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 August and September.
Tertiary industry activities are increasing moderately.

Corporate profits have continued to improve. Firms' judgement on current business conditions continues to improve, 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 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 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.

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 July remained unchanged from the previous month at 5.3%. By gender, while the unemployment rate for men dropped, the unemployment rate for women rose. The number of employees has been on an increasing trend.
The number of job offers has been on an increasing trend. The effective ratio of job offers to applicants has been rising moderately. Overtime hours worked in the manufacturing industry have been on a rising trend again. The proportion of business establishments that implemented employment adjustment, such as "overtime restrictions," in the April-June quarter remained flat.
In July, contractual cash earnings increased marginally both from a year earlier and from the previous month. Special cash earnings, including bonuses, suffered a sharp year-on-year decrease in July after posting a sharp year-on-year rise in June, 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 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 the hike in the cigarette tax in July.
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.
Stock prices have remained on a rising trend, with the key Nikkei average recovering to above the 10,000-yen level. Long-term interest rates have been rising.

Stock prices have been on a rising trend backed by a rising expectation of economic recovery, with the key Nikkei average rising above the 10,000 yen level for the first time since August last year. The U.S. dollar has been moving downward since August, falling to the \116 level.
Short-term interest rates are stable. Long-term interest rates have been rising since mid-August and temporarily hit the 1.6% level in early September. 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 15.3% 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, which had been slowing down since late last year, has recently been rising slightly.

4. Overseas economies

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

In the United States, economic recovery is gathering momentum.

Private consumption is increasing. The recovery of the corporate sector has strengthened momentum, with production increasing moderately and business investment picking up. Moreover, as the tax-cut package is expected to have a positive impact on consumption and investment, the general view is that the U.S. economy will post a high growth rate of around 4% in the second half of the year. Against this background stock prices are rising.
On the other hand, there are concerns about a delay in recovery in employment such as a low level of willingness to hire among corporations, and likely negative effects on housing investment and consumption from the rising trend of long-term interest rates.
The Federal Reserve Board at its Federal Open Market Committee (FOMC) meeting on August 12 clarified a policy stance that the Fed would maintain its current easy monetary policy for a considerable period of time.

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

In China, the economy has been expanding due to solid domestic and external demand. Consumption and production have resumed growing as rapidly as before the SARS scare. Exports, mainly to the United States, increased, although some industries were affected by the SARS scare. Thailand is continuing economic expansion led by consumption and investment. Malaysia is seeing moderate economic expansion due to sluggish consumption and exports. In Taiwan, while April-June quarter GDP contracted due to the SARS scare, the economy is picking up, with production turning up recently. In South Korea, the economy is in recession due to declines in consumption and business investment. Production is also decreasing due to strikes. In Singapore, the economy is stagnant, with investment continuing a sharp decline and production decreasing.

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

In the euro area, the economy is weakening as exports and production are on a downward trend due to the appreciation of the euro since last autumn. As for the short-term outlook, the economy in the euro area is expected to pick up, as exports to the U.S. are likely to increase against the background of the rising growth rate of the U.S. economy and the correction of the strong euro. In Germany, the economy is in recession with GDP posting a negative growth for three consecutive quarters due to a decrease in exports and weak movements of personal consumption and investment. On the other hand, business sentiment is improving due to a rise in stock prices. The French economy is weakened, as consumption shows signs of weakening and as business investment is decreasing.
In the U.K., the economy is flat, as business investment is decreasing, although consumption is on an increasing trend.

International financial situations

As for international financial situations, U.S. stock prices remain on an upward trend and prices of major Asian and European stocks are also rising. Long-term interest rates are generally on an upward trend. The U.S. dollar depreciated against the yen in August but has strengthened mainly against the euro, reflecting the high growth rate of the U.S. economy.
In order to cope with economic deceleration, interest rates were cut in Canada in early September.
Oil prices remained generally flat, though they rose slightly due to concerns about tight market conditions in the U.S.