The Outlook for the Japanese Economy

Transcription

1 March 11, 29 (Original Japanese version released February 25, 29) The Outlook for the Japanese Economy Economic Research Office The Bank of Tokyo-Mitsubishi UFJ, Ltd. Economic downturn to further intensify toward the middle of fiscal 29 1.Current Status of the Economy Real GDP growth rate posted the largest negative growth in 35 years The Japanese economy is rapidly deteriorating. Real GDP growth rate for the October-December quarter of 28 was down by an annualized 12.7 percent from a quarter earlier, posting the largest negative growth since the January-March quarter of 1974 during the first oil shock (down 13.1 percent quarter-to-quarter) (Table 1). Looking at the breakdown, exports rapidly dropped by 45. percent from the previous quarter, posting the largest-ever decline, reflecting the worsening overseas economies. Net exports (exports minus imports) declined, due to the second straight quarterly increase in imports of 12. percent quarter-to-quarter, leading to an annualized 1. percent point drop in Real GDP growth rate. Private consumption turned downward again (down 1.6 percent quarter-to-quarter) and business fixed investment accelerated its rate of decline (down 19.5 percent quarter-to-quarter), both of which pushed down Real GDP growth rate. There were some positive factors such as housing investment, which significantly increased by 24.6 percent from a quarter earlier, and government spending, which rose for the first time in four Table 1 : Main Economic Indicators (percent changes from previous quarter or month) 28/ / Nominal GDP Growth Rate (annualized; q/q) Real GDP Growth Rate (annualized; q/q) Index of Business Conditions (coincident index) Index of Business Conditions (leading index) Industrial Production Machinery Orders (private, excl. shipping and electric power) Shipments of Capital Goods (excl. transport equipment) Number of Employees (nonagricultual industries) Nominal Cash Earnings (5 or more workers) Unemployment Rate (SA,%) Aggregated Consumption Index (SA) Consumer Confidence (general households, Tokyo Area, q/q) Exports Volume Imports Volume Consumer Prices (excl. fresh food) Notes: 1. Results for the number of employees, total cash earnings and domestic corporate goods prices are % changes from previous year. 2. Quarterly data for Index of business conditions are results for the end of each quarter. Sources: Compiled by the Research Office, Bank of Tokyo-Mitsubishi UFJ based on Cabinet Office "National Accounts", "Orders Received for Machinery ", "Consumer Confidence Survey ";METI "Industrial Production"; MOF "Trade Statistics"; Ministry of Health, Labour and Welfare "Monthly Labor Statistics", Ministry of Internal Affairs and Comunications "Consumer Price Index", "Labour Force Survey" 1

2 quarters by 3.6 percent quarter-to-quarter. However, these GDP components boosted real GDP growth rate only by an annualized 1.4 percent points in total, indicating that they had a limited impact on the figure as a whole. 2.Outlook <Summary> The economic downturn will further intensify toward the middle of fiscal 29 The economy is likely to remain weak also from the latter half of the fiscal year We expect that the economic downturn will further intensify toward the middle of fiscal 29. Increased production adjustments will significantly drive down business fixed investment, employment and income, as exports are projected to continue decreasing substantially against the backdrop of the downturn in overseas economies. Domestic demand, whose decline has remained modest relative to exports, is likely to further deteriorate at a gradual pace, in line with the spillover effect of production adjustments on non-manufacturing and the worsening employment and income situation. Since the three economic measures hammered out by the Japanese government mainly focus on the support of firms financing and financial stability plans for financial institutions, they are expected to have an effect to some extent as a safety net. However, the economic policy is unlikely to boost the economy significantly, because it seems to have a small effect on demand. From the latter half of the year, we expect that the decline in Japan s exports will start ceasing, as overseas economies are likely to pick up gradually due to the effects of large-scale economic measures by governments, which will become evident. However, it should take more time until the pickup in exports spreads to domestic demand through the improvement in corporate profits or the employment and income situation. Although the rapid recession is expected to come to a halt in the latter half of the year, the economy is likely to remain weak. Real GDP growth rate for fiscal 29 is projected to fall by 4.7 percent from the previous year, registering the largest negative growth in postwar history except for the immediate postwar years (Note 1) (Figure 1). 2

3 (qoq saar,%) Private Consumption Figure1:Real GDP Growth Rate Housing Investment Business-fixed Investment Net Exports Inventory Investment GDP Government Expenditures Outlook Source: Compiled by BTMU Economic Research Office, based on Cabinet Office "National Accounting" Note1: Real GDP growth rates for fiscal 1945 and 1946 can t be calculated, because the SNA statistics results for fiscal 1945 doesn t exist. SNA statistical results prior to 1944 on a calendar year basis exist. Given that real GNP for fiscal 1946 was minus 43.7 percent from 1944, it can be assumed that the average real GDP growth rate of 1945 and 1946 posted a negative growth of slightly more than 2 percent. <Details> (1)Corporate Sector 1Exports Exports have been rapidly decreasing Exports have been rapidly decreasing. Export volume for December 28 was down by 29.9 percent from a year earlier, marking the second largest decline since 196, when the statistics started (Figure 2). Overall exports significantly declined, as exports to emerging economies centered on Asia, which had been relatively robust until last fall, rapidly decreased toward the end of the year, in addition to the continuing decline in exports to advanced economies such as the United States and Europe (yoy, %) Figure 2:Export Volume Source: Compiled by BTMU Economic Research Office based on MOF "Trade Statistics" 3

4 In the latter half of the year, the decline in exports will begin ceasing. Looking ahead, Japan s exports will likely continue their significant decline, as overseas economies are likely to remain sluggish for the time being (Figure 3). The impact of the sharp rise in the yen s value since the fall of last year will become pronounced for the future, which will push exports down. However, as overseas economies will start picking up at a gradual pace due to the effects of economic stimulus measures by governments from the latter half of the year, the decline in Japan s exports is expected to begin ceasing Figure 3:GDP Growth Rate for Japan's Main Export Destinations (yoy, %) GDP growth rate for Japan's main export destinations Real exports (right scale) (yoy, %) 2 Forecast Note: GDP growth rate for Japan's main export destinations is the weighted average of the GDP growth rates for Japan's main export destinations: U.S., Eurozone, U.K., China, NIEs, ASEAN4 and India, based on the the value of Japan's exports to that country. Source: Compiled by BTMU Economic Research Office, based on Cabinet Office "National Accounting"; Ministry of Finance, "Trade Statistics", etc. The decline in net export is likely to continue pushing down real GDP growth rate Imports are projected to follow a declining trend, owing to the decrease in imports of raw materials stemming from the drop in exports and the worsening domestic demand (Figure 4). However, because the rate of change in domestic demand has been small relative to exports and that a strong yen will be a factor boosting imports, the rate of decline in imports is likely to be smaller than that in exports. As a result, net exports (exports minus imports) are likely to decrease as a trend, pushing down real GDP growth rate (yoy, %) Figure 4 : Real Imports Contribution of demand Contribution of exchange rates Imports (estimation) Imports (actual) Projection Figures of projected imports are calculated as follows: ln(real import)= *ln(domestic demand+export) +.22*ln(real effective exchange rate) (t value) (22.59) (35.91) (6.7) Real effective exchange rates are four-quarter backward moving averages reflected one quarter behind. Estimation period:january-march 1996 through October-December 28 adj-r2:.982 D/W ratio: Source: Compiled by BTMU Economic Research Office based on Cabinet Office, "National Accounting"; Bank of Japan, "Real Effective Exchange Rates." 4

5 2Production Production will continue to decrease, due to the decline in exports and inventory adjustments Production has largely decreased, mainly in export-reliant sectors such as transport machinery and electrical parts and devices, amid the rapid fall in exports (Figure 5). Industrial production in December decreased 9.8 percent from the previous month, marking the largest negative growth in history for the second straight month. Looking ahead, production is likely to follow a declining path, as exports are projected to continue decreasing as a trend. In addition, inventory adjustment will be a factor restraining production, since the inventory rate has risen to an all-time high level (Figure 6). We view that it will take more time for the inventory adjustments to ease, though the decline in exports is expected to start ceasing from the latter half of the year. Production is likely to start recovering from around the end of the year at earliest Figure 5:Industrial Production and Export (yoy %) Industrial Production Real Export Outlook Source: Compiled by BTMU Economic Research Office, based on Cabinet Office "National Accounting";METI, "Indices of Industrial Production" Figure 6:Industrial Shipment and Inventory (2=1) Shipment Inventory ratio Inventory Source: Compiled by BTMU Economic Research Office, based on METI, "Indices of Industrial Production" 3Corporate Profits Corporate profits have rapidly worsened Corporate profits have rapidly worsened. Corporate profits have substantially been driven down by the rapid fall in exports owing to the overseas economic slowdown and the yen s appreciation, as well as by declining sales due to sluggish domestic demand, despite the positive effects from falling energy and raw material prices. Since the operating profits of the companies comprising Nikkei Average (excluding financial companies) for the April-December period of 28 dropped by 46.5 percent from a year earlier, it is inevitable that their financial results for fiscal 28 (ending March 29 ) will significantly decline (Figure 7). Sales are likely to pick up their pace of decline (Figure 8) and continue following a declining trend also in fiscal 29 as the recession becomes increasingly severe. If the yen further strengthens or the falling stock prices 5

6 further deteriorates the real economy, due to a renewed tension in global financial markets, downward pressures on corporate earnings would further increase. We view that the situation will continue for the time being where downside risks to corporate profits remain high Figure 7 :Operating Profits of Companies Comprising Nikkei Average (Excluding Financial Companies) (yoy, %) (fiscal year) Note: Figures for 28 are the year-on-year changes for the April-December period. Sources: Compiled by BTMU Economic Research Office based on NEEDS-FQ Figure 8:Sales of Corporate Businesses (yoy, %) Nominal GDP (before deduction of import) Sales of corporate businesses Forecast (fiscal year) Sources: Compiled by BTMU Economic Research Office based on MOF, "Company Statistics Seasonal Report"; Cabinet Office, "National Accounting." 4Business Fixed Investment Business fixed Business fixed investment has decreased at an accelerated pace. Real investment has business fixed investment in the October-December period dropped by an decreased at an annualized 19.5 percent from the previous quarter, increasing its pace of decline accelerated pace for the third consecutive quarter. Machinery orders (private demand, excluding orders of shipbuilding and orders from electric power companies)--a leading indicator of machinery investment-fell for three straight months through December, showing a high possibility of business fixed investment continuing its decline. Looking ahead, business fixed investment will be driven down by further capital stock adjustment reflecting decreased production, by a drop in firms cash flow due to declining profits and by the worsening corporate sentiment stemming from sluggish stock prices. The ratio of business fixed investment to nominal GDP, which currently stands at 15.1 percent, slightly lower than the recent peak (16.2 percent in the January-March quarter of 27), is likely to decline further (Figure 9). If using the recent lowest point of 13.2 percent as a benchmark for a bottom, business fixed investment would decrease by slightly more than 1 percent from the current level. 6

7 (%) Figure 9:Business Fixed Investment/Nominal GDP Ratio Source: Compiled by BTMU Economic Research Office based on Cabinet Office, "National Accounting." Iron and steel, non-ferrous metal and transport machinery have been plagued by huge overcapacity Looking at overcapacity by type of industry, industries such as iron and steel, non-ferrous metal, transport machinery, electric machinery and textile have been plagued by overcapacity which is already at high levels and growing at a faster pace(figure 1). which requires attention. (Rate of change in DI) Stock adjustment could further intensify in these industries, Figure 1:Production Capacity DI(December 28 Survey) (qoq, % points) Business services Information and telecommunications Personal services Wholesale and retail Restaurants and accommodations Precision instruments General machinery Transportation Metal products All industries Chemical products Electricity Petroleum and coal products and gas Foods Leasing Mining Construction and real estate Transport equipment Iron and steel Pulp and paper Wood and wooden products Non-ferrous metals Electrical machinery Textile products Ceramic, stone and clay products DI level (% points, "Excessive"-"Insufficient") Source: Compiled by BTMU Economic Research Office based on Bank of Japan, "Tankan." Although the decline in exports is expected to start ceasing from the latter half of the year, it seems likely to take more time for business fixed investment to recover through a pickup in production and corporate profits. It is highly uncertain when financial markets will recover stability and funding conditions will improve, in reaction to the end of the financial crisis in the United States and Europe. It should take until fiscal 21 for business fixed investment to start recovering fully. 7

8 (2)Government Sector The stimulus Amid the worsening recession, the government has hammered out a string of effects of the economic measures, which amount to about 75 trillion yen in total. However, economic their effects that directly boost the economy seem limited, since about 63 trillion measures seem yen of the total are spent for financial stability measures such as credit guarantee limited for small- and medium-sized enterprises and financial support for financial institutions. Public investment, which had been a key economic measure, has continued to follow a downward trend, with the national budget decreasing 5.2 percent year-on-year in fiscal 29 and the local budget declining 5.1 percent (Table 2). Even if special grants to help revitalize local communities and support households and costs to assist local governments in creating/maintaining jobs both of which are included in the economic stimulus package as local revitalization measures, should be all spent on public works, national and local public investment in fiscal 29 would remain flat from the previous year. Table 2 : National/Local Budget for Public Works fiscal 28 fiscal 29 year-on-year Central government 6,735.2 bil. yen 6,387.6 bil. yen 5.2% Local governments 14,815.1 bil. yen 1,461.7 bil. yen 5.1% Special grants to help revitalize local communities and support households Costs to assist local governments in creating/maintaining jobs Total - 6 bil. Yen bil. yen - 21,55.3 bil yen 21,549.3 bil. yen.% Note: National budget for public works for fiscal 28 is on an initial budget basis. The second supplementary budget is 7,282.4 billion yen. National budget for public works for fiscal 29 is on a basis excluding the amount equivalent to the special grants for local road improvement. Local budget for public works are on a "local public finance program" basis. Source: Compiled by BTMU Economic Research Office based on MOF data; MIC, "Local Public Finance Program." Meanwhile, government spending excluding public investment has trended upward. Among the expenditures included in the national budget for fiscal 29, medical expenses would increase by billion yen, or five percent, from the previous year, and a new emergency reserve fund to provide timely financial assistance would be worth 1 trillion yen (Note 2). According to an estimate, nominal government final consumption expenditure on a GDP basis is projected to increase by around 1-2 percent over the previous year (Figure 11). Given that the rate of growth in deflator remains unchanged from the current level (plus.6 percent year-on-year), real GDP growth rate for fiscal 29 will rise by.1-.3 percent owing to the government final consumption. 8

9 Note 2: The emergency reserve fund has been established to provide timely financial assistance such as employment measures, support of small- and medium-sized enterprises and infrastructure development, in response to a further worsening of the economy. 6 5 (yoy, %) Figure11:Government Final Consumption Expenditure Forecast On a GDP basis 1-1 On a budget basis (fiscal year) Note: Government final consumption expenditure on a budget basis represents general expenditure excluding public workrelated expenditure and national treasury burdens in the pension program. Source: Compiled by BTMU Economic Research Office based on MOF data; Cabinet Office, "National Accounting." The government and the ruling parties have begun to consider additional economic measures, in reaction to the significant negative growth in real GDP in the October-December quarter. The additional measures could boost real GDP growth rate from the middle of the year, depending on their size and content, although the specifics have yet to be determined and it should take a while for such measures to be implemented. (3)Household Sector 1Private Consumption Private Real private consumption (on a GDP basis) in the October-December quarter consumption was down an annualized 1.6 percent from the previous quarter, marking the first marked the first decline in two quarters. Looking at the breakdown, service consumption decline in two increased by 1.3 percent over the previous quarter, maintaining its rise. quarters, due to a However, durable goods, which had been robust until the July-September quarter, sudden fall in significantly declined by 12.3 percent from the previous quarter, mainly in durable goods automobiles, digital appliances and white goods. These declines in durable goods contributed to the drop in real private consumption (Figure 12). 9

10 1.5 Figure 12: Real Final Consumption Expenditure of Households (qoq % chg.) Durable goods Non-durable goods Direct overseas purchase by resident households Semidurable goods Services Real final consumption expenditure of households Source: Compiled by BTMU Economic Research Office based on Cabinet Office, "National Accounting." Looking ahead, employment adjustments are likely to become increasingly severe, mainly in manufacturing Looking at the employment situation, labor input has decreased at a rapid pace in line with large-scale production adjustments, but its decrease is mostly attributable to the reduction of working hours such as overtime work (Figure 13). Thus, the number of employees and the unemployment rate have been prevented from worsening significantly. However, the rate of decline in labor input has been small relative to the rate of decrease in production activities. Looking ahead, companies are likely to become unable to cope with the situation only by reducing working hours and then be forced to adjust employment. (yoy, %) Figure 13 : Corporate Activities and Labor Input Total working hours -4 Number of employees (Labour Force Survey) -5 Indices of All Industrial Activity Labor input Note: Labor input=total working hours(monthly Labour Survey) number of employees(labour Force Survey) Source: Compiled by BTMU Economic Research Office based on METI, "Indices of All Industrial Activity"; MIC, "Labour Force Survey"; "MHLW, "Monthly Labour Survey." Figure 14: Production, Number of Employees, Employment Status by Industry 1 Personal Restaurants and accommodations Retail trade Construction 5 services Real estate (Activity/production index by industry, yoy, %) Transportation Foods and tobacco Information and telecommunications "Insufficient" employment Business services Wholesale trade Chemical products General machinery Iron and steel Metal products Transport machinery Electricity "Excessive" employment (% points, diffusion index of "excessive employment"-"insufficient employment.") Note: The size of the bubble represents the size of employees. Source: Compiled by BTMU Economic Research Office based on METI, "Indices of All Industrial Activity","Indices of Industrial Production"; Bank of Japan,"Tankan", "MHLW, "Monthly Labour Survey." By industry, the manufacturing sector, mainly in three major export-reliant industries (electricity-related, general machinery and transport machinery) which have suffered from substantial excess employment due to the drop in production, will likely decrease employment at a faster pace. We view that the adverse 1

11 impact of job loss in these industries will not be small, in view of the size of employment (Figure 14). Meanwhile, the non-manufacturing sector is likely to make employment adjustments at a comparatively moderate pace, since the sector, whose decline in corporate activities has been limited relative to the manufacturing sector, has less excess employment so far. However, further employment adjustments are likely to be made, mainly in the wholesale and retail trade and the transport industry, both of which have a high correlation with the economy. The medical and welfare industry, which is expected to enjoy an increasing structural demand in line with the aging of the population, will likely grow firmly, but its pace of increase in employment is likely to be moderate, as these occupations require special skills and vocational training. As a result, the unemployment rate is likely to rise to the upper 5 percent range toward the end of the year. Compensation of employees is projected to decline significantly despite the effect of falling prices, since the easing of labor supply-demand balance and the worsening of corporate profits will largely push down nominal wages (Figure 15) (yoy, %) Figure 15:Real Compensation of Employees Number of employees Private consumption deflator (inverse) Per-capita cash earnings Real empensation of employees Note: Compensation of employees=per-capita cash earnings (firms with five persons or more) number of employees(nonfarm). Compensation of employees is deflated by private consumption. Source: Compiled by BTMU Economic Research Office based on MIC, "Labour Force Survey"; MHLW, "Monthly Labour Survey"; Cabinet Office, "National Accountings." Outlook Household sentiment is likely to remain weak due to a further worsening of the employment and income situation Looking at household sentiment, since inflation, which had been a major push-down factor, has rapidly subsided, household sentiment may improve from the January-March quarter, when the inflation rate should turn downward. It can be considered that consumer confidence index (original series) in January increased from the previous month for the first time in four months, albeit marginally, largely due to the abatement of inflation. However, household sentiment is likely to remain weak due to a further worsening of the employment and income situation amid the worsening economy (Figure 16). 11

12 (yoy, %) Figure 16: Component Factors of Consumer Sentiment Employment Prices of petroleum products Consumer sentiment (actual) Stock prices Prices of other goods and services Consumer sentiment (estimated) Note: ln(consumer Confidence Index)= (.85 active job opening to applicant ratio ) + (-1.21 ln(prices of petroleum products) (.73) (7.23) (-1.57) + (-.3 ln(prices, excluding food and energy)) + (.22 ln(nikkei Stock Average) (-.2) (3.62) Active job opening to applicant ratio and prices of petroleum products =the two-quarter average, respectively. Prices excluding food and energy= the three-quarter average. Adj R2:.88. D/W ratio:1.3. Estimation period: 2-"July-September" 28 Source: Compiled by BTMU Economic Research Office based on Cabinet Office, "Consumer Confidence Survey"; MHLW, "General Employment Placement Situation"; MIC, "Consumer Price Index"; Nihon Keizai Shimbun. Our outlook Private consumption is likely to decline for the second consecutive year Looking at past developments, private consumption had been kept at a certain level by raising propensity to consume (by lowering saving rate) even when disposable income declined (ratchet effect). Also in the current economic phase, consumption is expected to be underpinned, to some extent, by the ratchet effect. Private consumption is unlikely to drop significantly, aided by an increase in real purchasing power as the economy slides into deflation. However, private consumption will be forced to decline for the second straight year in fiscal 29, reflecting the worsening employment and income situation and sluggish consumer sentiment. 2Housing Investment Housing starts Real housing investment in the October-December quarter rose by an have already annualized 24.6 percent from the previous quarter, marking the second decreased consecutive increase. However, this is because housing investment on a GDP significantly basis reflects with some lag the reactionary increase in housing starts from the plunge due to the enforcement of the revised Building Standard Law in June 27. Housing starts have been on a declining trend again and signigicantly fell to about 1 million units (seasonally adjusted annualized rate) in December (Figure 17). As for condominium markets, in particular, sales have plunged and inventories have soared, due to the recent rise in unit prices (Figure 18). Condominium sales prices have remained relatively high compared to disposable income, although they have started to decline gradually. In addition, demand for condominiums is unlikely to recover for the time being, amid the worsening employment and income situation. It is likely to take considerable time for the 12

13 inventories to be adjusted. It should also take until fiscal 21 for housing starts for condominiums to pick up. (s.a., ann., 1, units) Figure 17: Housing Starts Decline due to the enforcement of the revised Building Standard Law in June Source: Compiled by BTMU Econonic Research Office based on MLIT, "Statistics on Building Construction Starts." Figure 18: Prices of Collective Housing in the Tokyo and Kinki Areas (yoy, %) (1, yen) 4,6 Total number of condominium units sold(left scale) Collective housing (condominiums) inventory (left scale) 4,5 Sales prices of new condominiums (right scale) 4,4 4,3 4,2 4,1 4, 3,9 3,8 3,7-6 3, Note: Figures are three-month averages. Sales prices of new condominiums: the weighted-averages of sales prices of new condominiums in the Tokyo and Kinki areas using the number of units sold as a weight. Collective housing inventory and total number of condominium units sold: total of Tokyo and Kinki, respectively. Source: Compiled by BTMU Econonic Research Office based on Haseko Corporation, "CSI." The planned expansion of mortgage tax breaks is unlikely to boost housing investment substantially Under these circumstances, the governent included a significant expansion of mortgage tax breaks in the 29 tax reform. Regarding mortgage tax breaks, the maximum tax cut on the purchase of general housing is slated to be largely rasised to 5 million yen from 1.6 million yen (the amount that had been applied until last year) (Note 3). However, the increased tax cut for average household is projected to be no more than 1.9 million yen. The mortgage tax reduction is estimated to boost housing investment in fiscal 29 only by around 2.24 percent and real GDP growth rate only by around.8 percent. The stimulus effect of the mortgage tax reduction seems limited. Note 3 : In case of purchasing long-term high-quality housing, the maximum tax cut is the largest-ever at 6 million yen. (4)Prices Inflation rate has rapidly fallen Inflation rate has rapidly fallen. Consumer prices (general, excluding fresh food), which peaked in July and August at plus 2.4 percent year-on-year, plunged to.2 percent year-on-year in December (Figure 19). Regarding prices of energy such as gasoline, which have been a major cause of the falling inflation rate, crude oil prices are likely to remain sluggish for prolonged periods due to the global recession. Thus, falling crude oil prices are expected to put further downward pressure on inflation toward the latter half of the year. As for food, prices are expected to slow their pace of growth due to the easing material prices, excluding some products such as dairy. 13

14 Figure 19: Consumer Price Index (Japan) (yoy, %) CPI general, excluding fresh food CPI general, excluding food and energy Source: Compiled by BTMU Economic Research Office based on MIC, "Consumer Price A widening deflation gap will lead to a rise in deflationary pressure In addition to the decline in prices of energy and food owing to these declines in upstream resource prices, a widening deflation gap in line with a further worsening of the economy will significantly push prices down. In the retail industry, amid a growing number of companies that have decided to cut prices substantially, downward pressures on prices are likely to increase further, mainly in durable goods such as digital appliances, which has seen rapid declines in sales. As for services, prices are likely to follow a declining trend, as nominal wages are projected to further decline in reaction to the easing of the labor supply-demand balance as well as to the worsening of corporate profits. As a result, consumer prices for fiscal 29 are expected to decline by 1.1 percent from a year earlier, increasing the possibility of deflationary pressure rapidly growing again (Figure 2) (yoy,%) Figure 2:Consumer Price Index Energy Food,excluding fresh food Other goods and services CPI general, excluding fresh food Outlook Note: Energy="electricity", "gas, manufactured & piped", "liquefied propane", "kerosene", "gasoline " Source: Compiled by BTMU Economic Research Office based on MIC, "Consumer Price Index." 14

15 3.Trends in the Financial Market (1)Monetary Policy/Short-term Interest Rates The BOJ has The BOJ has continued its efforts to promote the stabilization of the financial continued its system and the financial support to enterprises. In addition to continuing the efforts to promote supply of ample funds through ordinary market operations, the BOJ has begun the stabilization of new operations and CP purchase to provide financial aid to enterprises in the financial January and resumed its purchase of stocks held by financial institutions in system and the February. The BOJ also plans to start purchasing corporate bonds from March. financial support to The BOJ has announced its policy of lowering interest rates on instruments enterprises longer than overnight, after cutting the uncollateralized overnight call rate (the policy interest rate) to.1 percent in December. The BOJ intends to consider implementing additional measures also in the future. Interbank interest Reflecting these moves by the BOJ, short-tem interest rates have generally rates have followed a declining path. However, the rate of decline in TIBOR (Tokyo continued to hover Interbank Offered Rate) has remained modest, showing money markets are still high under extreme tension (Figure 21). The BOJ could increase the amount of its purchase of short-term government bonds, CP and corporate bonds, since it seeks to induce a further decline in interest rates on term instruments such as TIBOR. 1. (% points) Figure 21:Spreads between TIBOR and Japapanese Government Bond Yields Spreads (3-month yen TIBOR- 3-month Japanese government bond yields) 3-month yen TIBOR /1 7/4 7/7 7/1 8/1 8/4 8/7 8/1 9/1 Source: Compiled by BTMU Economic Research Office based on Bloomberg data. (2)Long-term Interest Rates Yields of newly-issued 1-year government bonds have risen to the 1.2 percent range, after falling to percent on December 3, the lowest level since July 25 (Figure 22). There are growing concerns over a worsening of the supply-demand conditions of government bonds due to the global expansion of government spending, which has curbed the fall in long-term interest rates. 15

16 Long-term interest rates have been kept from falling due to concerns over a worsening of the supply-demand balance of government bonds Looking ahead, a further worsening of the economy and the deepening deflation will likely exert more downward pressure on long-term interest rates, but the expected range of decline seems limited due to concerns over a worsening of the supply-demand balance. However, if measures that help improve the supply-demand conditions of government bonds are released such as the start of outright purchase of long-term government bonds by the U.S. FEB or the increase of the amount of outright purchase of long-term government bonds by the BOJ, downward pressures on long-term interest rates could well increase. (%) 2.2 Figure22:Newly-issued ten-year government bond yields Source: Compiled by BTMU Economic Research Office based on Bloomberg data. (3)Yen-dollar Exchange Rates The yen has hovered around the upper 9 range per dollar In the foreign exchange market, the yen, which had continued to strengthen against the dollar since August 28, has hovered around the upper 9 range per dollar from the beginning of the year (Figure 23). (JPY/USD) Figure23:Dollar-yen exchange rate Source: Compiled by BTMU Economic Research Office based on Bloomberg data Amid a mixture of expectation and disappointment over the large-scale 16

17 The situation will continue where the yen tends to strengthen against the dollar for the time being economic stimulus measures and financial stability plans under the Obama administration, as well as the worsening economies in Japan and the United States, the yen-dollar market has been directionless with a mixture of buying and selling. It can be considered that the yen tends to be bought against other currencies as a quality asset, amid continuing uncertainties about the global economic and financial conditions, because it s a creditor nation s currency. However, the worsening of Japanese economy has become increasingly prominent, with its real GDP growth rate for the October-December quarter marking the largest decline among major advanced countries, indicating that the yen s predominance over other currencies could have started to recede. Looking ahead, we view that the yen-dollar trade will see a mixture of buying and selling and remain unstable in the current range, reflecting that the economies both in Japan and abroad are likely to follow a deteriorating trend. However, there are many potential factors prompting yen-buying--such as the weak management of financial institutions in the United States and Europe, the reconstruction of U.S. leading automotive manufacturers, and concerns over the credibility of the dollar. In case of imbalance between the yen and the dollar, the yen is likely to further strengthen to the dollar rather than depreciate against the currency. 4.Risks and Challenges There are considerable downside risks to the economy Looking ahead, it is likely that the Japanese economy will stop its rapid deterioration from the latter half of the year, in response to a pickup in overseas economies and hit bottom toward fiscal 21. However, it can not be denied that there are considerable downside risks to the economy, as well. The biggest risk factor for the time being is developments in the financial crisis mainly in the United States and Europe. Although the financial crisis is currently in a comparative lull, aided by the measures taken by governments and central banks, the potential risk of a resurgence of the crisis such as weak management of financial institutions has persisted, which is making the situation unpredictable. If the financial system becomes dysfunctional again and stock prices plunge, the real economy may further deteriorate. It can t be denied that there s a possibility of overseas economies failing to pick up because of larger-than-expected pressure for structural adjustment such as household balance sheet adjustment in the United States and deleverage exercised by financial institutions in the United States and Europe despite the economic measures by governments. Growing protectionism could hurt Japan s exports, 17

18 Japan needs to take the crisis as a great opportunity and fully address its economic challenges. which can t be ignored, either. Moreover, there s a risk scenario due to domestic factors that domestic demand will continue to worsen in a spiral, since a pickup in exports, which is expected toward the middle of the year, only has a small impact on business fixed investment and employment. We must assume that the Japanese economy is likely to continue worsening at a rapid pace toward the middle of the year and uncertainties about the economy will continue. It can t be denied that the ongoing recession, which has already reached unprecedented levels, could further worsen. It should be noted that the issues facing the Japanese economy have begun to emerge in this crisis. The financial crisis has shed more light on the problems facing the economy, though having already been pointed out--such as some manufacturing sectors whose economic structure is heavily reliant on exports, insufficient safety net for employment, and enormous existing debt hindering flexible public spending. The appreciation of the yen should have a positive effect on the purchase of overseas assets and companies, the acquisition of interests in resources and the securing of overseas manpower, while undermining Japan s exports. Japan has not fully utilized the merits of a strong yen, which poses a challenge for the country. Taking the crisis as a great opportunity and accelerating its efforts to address these issues marks a big stride for Japan in depicting a mid- and long-term growth strategy. There is already growing debate about the promotion of research and development concerning environment and energy conservation technology, the promotion of the use of new energy sources, the enhancement of the foundation for the medical and welfare system and the revitalization of agriculture. Specific efforts are expected to be taken in the future regarding such issues. In addition, after undergoing the crisis, Japan will be able to enhance its economic growth potential --by enhancing the industrial competitiveness through mergers and acquisitions among Japanese companies or involving foreign companies, by encouraging new businesses in order to nurture new industries, by creating a system that facilitates a smooth flow of the workforce among industries, and by revitalizing local economies through exploiting their unique features. Authored by Toshiki Iwaoka, Shin Takayama and Hayato Nakamura Translated by Naoko Moriya 18

19 For further details, please contact the Economic Research Office (Chief manager Sakuma) Tel: This report is intended only for information purposes and shall not be construed as solicitation to take any action such as purchasing/selling/investing financial market products. In taking any action, each reader is requested to act on the basis of his or her own judgment. This report is based on information believed to be reliable, but we do not guarantee its accuracy. The contents of the report may be revised without advance notice. Also, this report is a literary work protected by the copyright act. No part of this report may be reproduced in any form without express statement of its source. This report is also available for viewing online at 19

20 Outlook for the Japanese Economy Forecast ~3 4~6 7~9 1~12 1~3 4~6 7~9 1~12 1~3 4~6 7~9 1~12 1~3 Economic Research Office Bank of Tokyo-Mitsubishi UFJ ( %, billion yen ) ( percentage change from the previous period at seasonally-adjusted annual rates ) Nominal GDP Real GDP GDP Deflator Private consumption Housing investment Private business fixed investment Business inventories (billion yen) 3,767 3,114 3,293 4,52 Government expenditures Public investment Exports Imports (<> contribution of overseas demand) ,172 2,471 1,57 3,445 2, 2,5 3,5 2, 8 3,226 2,335 2, <1.2> < 1.2> < 1.4> Final Demand ( Private Demand) Industrial Production Index Domestic Corporate Goods Price Index (YOY,%) (1.4) (1.8) (1.6) (2.4) (3.5) (4.9) (7.1) (2.9) ( 1.1) ( 3.) ( 3.8) ( 3.4) ( 1.4) (2.3) (3.4) ( 2.9) Consumer Price Index (excl. fresh food YOY, %) (.1) (.1) (.1) (.5) (1.) (1.5) (2.3) (1.) (.1) (.9) ( 2.) ( 1.) (.4) (.3) (1.2) ( 1.1) FY27 FY28 FY29 Trade Balance (billion yen) 2,984 2,876 3,415 3,48 2,348 1, , , Current Balance (billion yen) 6,83 5,64 6,859 5,51 6,58 3,838 4,195 1, ,61 2,238 2,215 24,544 1,375 6,97 Uncollateralized overnight call rate Euro-Yen TIBOR (3-mo.) Newly Issued 1-Year Government Bonds Yield Exchange Rate ( Yen / U.S.$ ) Note: Uncollateralized overnight call rate is end-of-period rate. Euro-Yen TIBOR (3-mo.), newly issued 1-year government bonds yield, and exchange rate (Yen/U.S.$) are period average.domestic Corporate Goods Price and Consumer prices reflect 25 base revision. 2

21 1.Main Economic Indicators MAIN ECONOMIC AND FINANCIAL INDICATORS (JAPAN) Fiscal Fiscal Q As of Mar/12/ Q 3Q 4Q 1M 11M 12M 1M 2M Real GDP Growth Rate <% changes from previous period at SA annual rate> (1.5) (.7) (-.2) (-4.6) *** *** *** *** *** Index of All Industries Activity #N/A #N/A (.4) (-.5) (-1.2) (-4.9) (-2.4) (-6.) (-6.1) #N/A #N/A Industrial Production Index #N/A Production (2.3) (1.) (-1.4) (-14.8) (-7.1) (-16.6) (-2.8) (-3.8) #N/A #N/A Shipments (3.1) (1.2) (-1.4) (-15.) (-7.3) (-17.) (-2.6) (-31.6) #N/A #N/A Inventory (2.1) (2.7) (3.2) (4.7) (4.4) (4.3) (4.7) (2.8) #N/A Inventory/Shipments Ratio #N/A (2=1) [99.8] [1.2] [1.9] [1.5] [99.1] [11.1] [11.3] [99.7] [98.3] Domestic Corporate Goods Price Index (2=1) (3.5) (4.9) (7.1) (2.9) (5.) (2.8) (1.1) (-.3) (-1.1) Consumer Price Index(excl.fresh foods) #N/A (25=1) (1.) (1.5) (2.3) (1.) (1.9) (1.) (.2) (.) #N/A Index of Capacity Utilization #N/A #N/A (2=1) [12.6] [12.4] [14.1] [15.5] [16.2] [14.9] [15.4] [14.4] [16.3] Machinery Orders(Private Demand, #N/A Excl.Electric Power and Shipbuilding) (.8) (5.3) (-6.9) (-23.7) (-15.5) (-27.7) (-26.8) (-39.5) #N/A Manufacturing #N/A (-1.5) (4.9) (-8.5) (-33.1) (-18.4) (-43.7) (-35.9) (-56.7) #N/A Non-manufacturing #N/A Excl.Electric Power & Shipbuilding (2.6) (8.) (-5.7) (-15.8) (-13.7) (-14.3) (-18.9) (-24.9) #N/A Shipments of Capital Goods #N/A (Excl.Transport Equipment) (-1.) (-5.3) (-11.2) (-18.7) (-11.7) (-21.3) (-22.3) (-3.3) #N/A Construction Orders (7.3) (-15.2) (15.2) (-4.1) (47.2) (-12.5) (-27.3) (-38.3) #N/A Private (2.4) (-21.) (1.7) (-14.1) (5.) (-13.9) (-26.1) (-39.1) #N/A Public (18.8) (17.4) (3.7) (58.3) (242.) (3.9) (11.9) (-26.) #N/A Public Works Contracts (-5.2) (-8.4) (4.7) (-2.8) (-.4) (-2.8) (-6.4) (1.9) #N/A Housing Starts #N/A 1, units at Annual Rate, SA (2.9) (-19.4) (-9.) (-11.) (4.2) (4.1) (19.8) (.) (-5.8) (-18.7) #N/A Total floor (1.9) (-18.7) (-9.8) (-12.7) (32.8) (-.6) (9.9) (-3.4) (-7.9) (-18.7) #N/A Sales at Retailers (1.8) (.2) (.8) (-1.5) (-.7) (-.9) (-2.7) (-2.4) #N/A Real Consumption Expenditures #N/A of Households over 2 persons (SA) (.6) (-2.6) (-2.3) (-3.2) (-3.8) (-.5) (-4.6) (-5.9) #N/A Propensity to Consume #N/A (SA,%) [72.] [72.2] [74.4] [73.7] [74.7] [72.9] [74.7] [75.6] [72.6] Overtime Hours Worked #N/A (All Industries, 5 employees or more) (.7) (-1.2) (-2.3) (-7.7) (-4.5) (-7.) (-11.3) (-15.2) #N/A Total Cash Earnings (Regular Employees Only; All Industries, 5 employees or more) (1.6) (.7) (.2) (-.5) (.1) (-.7) (-.8) (-1.3) #N/A Employment Index(Regular Employees Only;'All Industries, #N/A 5 employees or more)(change over the M/Q/Y) [67.] [72.9] [71.] [84.1] [75.8] [91.] [85.6] [84.4] [86.4] Ratio of Job Offers to Applicants #N/A (SA,Times) [1.6] [1.5] [1.4] [1.1] [1.2] [1.] [1.] [.99] [.98] Unemployment Rate #N/A (SA,%) [4.] [3.8] [3.8] [3.8] [4.] [3.8] [3.7] [3.8] [3.9] Economy Watcher Survey (Judgment of the present condition D.I,%) [49.1] [47.5] [43.9] [39.] [41.5] [38.8] [36.6] [31.8] [33.6] Bankruptcies (Number of cases) 13,337 14,366 3,715 3,829 4,34 4,68 1,429 1,277 1,362 1,36 1,318 (1.2) (7.7) (7.9) (5.8) (16.4) (13.9) (13.4) (5.2) (24.1) (15.8) (1.3) Notes: Unless otherwise indicated, tabulated figures and those in parentheses show % changes from previous quarter/month as applicable. The figures in ( ) indicate % changes from previous year. [ ] show the comparable figure of the previous year

22 2.Balance of Payments As of Mar/12/29 Fiscal Fiscal Q 2Q 3Q 4Q 1M 11M 12M 1M 2M Customs Clearance(Exports in Yen Terms) ( 6.) (1.8) (3.2) (-23.1) (-7.8) (-26.7) (-35.) (-45.7) #N/A Value (-3.2) (-3.3) (.6) (-4.9) (-1.5) (-5.9) (-7.3) (-7.7) #N/A Volumes (9.5) (5.3) (2.6) (-19.5) (-6.4) (-22.2) (-29.9) (-41.1) #N/A Imports(In Yen terms) (1.2) (1.9) (21.2) (-9.5) (7.4) (-14.4) (-21.5) (-31.7) #N/A Value (8.8) (8.5) (19.9) (-3.4) (9.8) (-4.1) (-15.5) (-22.7) #N/A Volumes 3.. (1.4) (2.2) (1.3) (-6.6) (-2.1) (-1.7) (-7.1) (-11.7) #N/A Current Balance(1 mil. yen) 211, ,443 65,83 38,379 41,949 16,671 9,65 5,812 1,254-1,728 #N/A Trade Balance(1 mil. yen) 14, ,862 23,48 13,448 4,864-1,455 1, ,979-8,444 #N/A Services(1 mil. yen) -22,977-25,961-4,41-6,52-4,921-6,92-2, ,217-2,558 #N/A Capital and Financial Accounts(1 mil. yen) -152, ,531-71,233-43,836-31,684-48,85-8,511-24,227-16,67-21,77 #N/A Gold & Foreign Exchange Reserves($1mil.) 98,958 1,15,587 1,15,587 1,1, ,89 1,3, ,723 1,2,861 1,3,647 1,1,958 1,9,354 Exchange Rate(\/$) Financial Market Indicators Fiscal Fiscal Q 2Q 3Q 4Q 1M 11M 12M 1M 2M Uncollateralized Overnight Call Rates [.378] [.514] [.498] [.51] [.56] [.5] [.497] [.52] [.54] Euro Yen TIBOR (3 Months) [.619] [.683] [.814] [.853] [.845] [.864] [.851] [.842] [.849] Newly Issued Japanese Government Bonds Yields (1 Years) [1.658] [1.742] [1.688] [1.52] [1.6] [1.46] [1.5] [1.44] [1.355] Average Contracted Interest Rates on Loans and Discounts(City Banks) #N/A (% changes from previous period) (-.14) (-.17) (.3) (-.64) (-.16) (-.26) (-.22) (-.55) #N/A The Nikkei Stock Average 17,288 12,526 12,526 13,481 11,26 8,86 8,577 8,512 8,86 7,994 7,568 (TSE 225 Issues) [17,288] [18,138] [16,786] [15,38] [16,738] [15,681] [15,38] [13,592] [13,63] M2(Average) (.9) (1.9) (2.3) (2.1) (2.2) (1.8) (1.8) (1.8) (1.8) (2.) (2.1) Broadly-defined Liquidity(Average) (3.3) (2.9) (2.4) (1.1) (.7) (-.2) (-.1) (-.2) (-.2) (-.3) (-.2) Principal Figures of Financial Institutions Banks & Shinkin (1.4) (.6) (.8) (1.5) (1.8) (3.) (2.1) (3.2) (3.6) (3.6) (3.5) Loans and Banks (1.5) (.7) (.9) (1.6) (2.) (3.3) (2.3) (3.6) (4.1) (4.) (3.8) Discount City Banks etc. (.5) (-.7) (-.6) (.3) (1.) (3.) (1.4) (3.4) (4.2) (3.6) (3.2) (Average) Regional Banks (2.8) (2.5) (2.7) (3.2) (3.3) (4.1) (3.6) (4.2) (4.5) (5.) (5.1) Regional Banks Ⅱ (2.4) (1.5) (2.3) (2.7) (2.5) (2.4) (2.5) (2.6) (2.1) (2.2) (2.3) Shinkin (1.) (.2) (.1) (.5) (.5) (.8) (.6) (.8) (1.) (1.5) (1.9) Total(3 Business Condition) (.1) (1.3) (1.9) (1.8) (1.8) (1.5) (1.4) (1.5) (1.5) (1.6) (1.9) Deposits City Banks (-.8) (.1) (1.3) (1.4) (1.5) (1.7) (1.2) (1.9) (1.9) (1.9) (2.2) and CDs Regional Banks (1.2) (2.6) (2.5) (2.1) (2.2) (1.4) (1.7) (1.3) (1.3) (1.6) (1.9) (Average) Regional Banks Ⅱ (.7) (1.7) (2.2) (2.) (1.8) (.8) (1.1) (.8) (.6) (.6) (.7) Notes : Interest rates are averages. The Nikkei Stock Average is as of month-end. Sources : Cabinet Office, National Accounts, Machinery Orders; METI, Indices of Tertiary Industry Activity, Industrial Production, Current Survey of Commerce; MOF, Trade Statistics, Balance of Payments; MPMHAPT, Consumer Price Index, Family Income and Expenditure Survey, Labour Force Survey; MHLW, Monthly Labour Survey; Ministry of Land, Infrastructure, and Transport, Economic Construction Statistics; BOJ, Corporate Price Index, Financial and Economic Statistics Monthly, etc