VOL2.NO.2 January 2007 Outlook for the Japanese Economy in 2007 Economic recovery surpasses Izanagi in length The economy is continuing its longest post-war economic recovery. Nearly five years have passed since the economy bottomed out in early 2002 and entered the current phase of economic recovery. The Izanagi boom (1965-1970), the last boom of the post-war high growth period, has now been surpassed in length. While some say that the recovery is difficult to perceive in reality, the fact itself that the economy has sustained the prolonged recovery, by overcoming the negative legacies from the bubble s collapse with support from overseas economies high growth, is clearly good news. Looking back at 2006, despite several negative factors the economy continued to expand steadily in the first half of the year, well-balanced between the corporate and household sectors. In the latter half, however, uncertainty gradually emerged, due to the deceleration in overseas economies. At the beginning of the year, there was concern for negative impact from the temporary slide in stock prices due to the Livedoor Shock, as well as the severe cold and heavy snow. But the economy steadily moved forward on its recovery path with the corporate and household sectors both intact despite these setbacks. In addition to exports regaining momentum after emerging from the global adjustment phase of the IT sector that continued until the 2005 first half, business fixed investments was firm on the back of rising corporate expectations for growth. Private consumption also remained steady, underpinned by the increase in compensation of employees and favorable consumer sentiment. Additionally, year-on-year change in consumer prices remained positive, albeit modestly, confirming that supply-demand conditions were 1
improving. Following these changes in the economic environment, the Bank of Japan (BoJ) took a step forward towards the normalization of financial policy in March by ending the quantitative easing policy continued since March 2001 and shifted to a zero-interest rate policy. This monetary tightening did not cause any confusion in the financial markets; stock prices marked a year-to-date high of 17,563 in early April, and long-term interest rates also trended upward towards the two percent level. The economy continued expanding, and just as interest started growing on whether the current recovery would surpass the Izanagi after surpassing the bubble-period (lasting 51 months) in May, the global economy entered an unexpected adjustment phase. As rising inflationary concerns in the U.S. led to speculation for continued monetary tightening and a strong sense of uncertainty towards the global economy grew emerged in financial markets, domestic and overseas investors curbed their risk assets. The Nikkei average, steadily performing at above 17,000 yen until then, plunged to under 15,000 yen. The yen rapidly rose against the dollar, at one point beyond 110 yen, from its previous range of 115-120 yen per dollar. Renewed attention at the G7 meeting held in late April towards global imbalances also pushed the yen higher. The BoJ, having already taken its first step towards financial policy normalization, made its next move in July when adjustments in the financial markets ran its course. After confirming the resilience of corporate sentiment and robust capital spending of large enterprises showing a double-digit increase first time since the bubble period in the BoJ s Tankan, the bank lifted the zero-interest rate policy which continued for five years and four months (including the quantitative easing phase), and raised the target rate for the uncollateralized overnight rate to 0.25 percent on July 14 th. In September, the Abe administration was inaugurated as a successor to the Koizumi cabinet s structural reform drive, and announced a policy focused on economic growth under the slogan, no fiscal consolidation without growth. It happened, however, it was after this summer that domestic and overseas economies gradually started to show signs of slowing. The U.S. housing market clearly entered an adjustment phase with GDP growth falling under 3 percent considered the lower limit of the potential growth rate, for two consecutive quarters from the April-June period. A slowing trend also became apparent in China reflecting the government s investment restriction policies. Following these developments abroad, exports have been showing signs of slowing and increase in inventory is becoming notable in the IT sector which has significant impact on the overall economy. The household sector also moved slower until early autumn, although this was largely due to temporary factors such as the bad weather (long rainy season) and high gasoline prices reflecting the surge 2
in crude oil prices. By November the current economic expansion reached its 58 th month, and appears to have achieved the long-awaited goal of outliving the Izanagi boom; but as we stand at the beginning of the year, a slight touch of uncertainty seems to remain within the expectation for a brighter year. Uncertainties likely to be cleared towards the year s second half What should be expected of the economy in 2007? To state the conclusion first, it seems that the economy will follow a slowing trend towards early spring, starting out the year in a phase that requires some caution. The primary factor to this slowdown will be the corporate sector. Exports, the starting point for demand, is likely to lack momentum for some time as the impact of the slowdown of overseas economies centering on the U.S. is likely to surface with some lag. Developments in the IT sector will be another major factor that will affect the course of the economy in the 2007 first half. In addition to intentional build-up of inventory, the recent increase in IT sector inventory seems to reflect the global slowdown in IT demand and expansion of the IT sector s production capacity, that we need to keep an close eye on the sector for the time being. In addition, we should also keep in mind that business fixed investments, which had been growing robustly until now, should also slightly slow along with the downturn in exports and production, although it is difficult to expect a major collapse now that excess capacity has been eliminated. On the other hand, private consumption is generally expected to move steadily during this time. As mentioned above, although private consumption had turned weak after last summer, employment and income conditions has remained solid as a whole; private consumption is now gradually picking up as temporary negative factors such as bad weather fades out. Considering the decline in the burden of personnel costs from a long-term perspective, and companies increasing sense of labor shortage indicated in the Tankan s employment conditions DI due to the baby-boomers mass-retirement starting in 2007, employment and income conditions are much likely to continue improving. Private consumption can thus be expected to underpin the economy by following a steady recovery trend along with the growth in compensation of employees. While the economy is likely to follow a slowing trend until the early half of 2007, we expect that the pace of growth will gradually regain momentum towards the second half of the year. If the U.S. economy which is the primary cause of the slowdown manages a soft-landing, and overseas economies gradually pick up from around the spring, 3
Japan s economy should also gradually strengthen its mechanism of recovery in which corporate earnings gradually expand along with a recovery in exports and production, leading to the reacceleration of business fixed investments, sometime into the second half of the year. In the household sector, wages per employee, now weaker in growth compared to number of employees, is likely to follow a moderate upward trend as the economy gradually picks up and unemployment rates drop under four percent in the second half of the year. Compensation of employees is also likely to slowly rise along with this. As the economic expansion spreads into the household sector, the foundation for economic expansion will gradually be strengthened in the latter half of the year. The retirement of the baby-boom generation is expected to increase household receipts of lump-sum retirement payments by around 1.2 trillion yen (equivalent to 0.5% of total compensation for employees) compared to 2006, and is expected to support private consumption from the income side. In the financial markets, while the BoJ is expected to maintain its stance of raising interest rates, the pace of the additional rate hikes are expected to be around once in a half year. This is due to the moderate pace of the economic expansion itself as well as the unlikelihood for the inflation rate to pick up, and the overall pace of increase of short-term interest rates should also remain moderate. 2007 as the starting year of strategies for growth As we have seen, the economy can be expected to continue its expansion in 2007 despite some uncertainties, though this does not mean we can sit back in ease. Looking at the outlook of the economy in a longer term, Japan will face the challenge of reducing staggering amounts of government debts unprecedented in other advanced nations, under the increasing setback of an aging and decreasing population under low birthrates. Japan s population already past its peak and started declining in 2005, and the Population Projection for Japan released by the Ministry of Health, Labor and Welfare in December reported that the fertility rate has been revised downward due to further advance in the trend of later marriage and that the projected pace of population decline is expected to increase ahead of schedule. In order to maintain and further boost the nation s potential for economic growth against these adversities in our population structure, it will be crucial to further improve productivity. The key is in the active utilization of IT and raising the quality of labor. The government s Directions and Strategies for the Japanese Economy also advocates a policy of: i) improving productivity of the overall economy through expansion and 4
deepening of IT utilization in diverse fields and by sophistication of basic infrastructure; and ii) developing human resources and enhancing skills in the labor market that respond to the needs of new technologies, and also promote labor mobility into fields with higher productivity, which will lead to further innovation and thus acceleration of growth. Additionally, no matter how much the potentials were raised, realization of sustainable and stable growth would be dubious if demand, the key element for growth, were to be restrained from anxieties towards the future. While it has already been pointed out repeatedly, the private sector must step up their innovations to develop products and services that will stimulate potential demand; and the public sector must increase areas of free access to the private sector including the opening of government-controlled markets, as well as carry out continuous reforms to structure a more flexible economic system, including the social security system which will be largely affected by demographic ageing. According to the Oriental zodiac, 2007 is the year of hinoto and i (the boar), meaning that the energy of life will reach its peak ( hinoto ) and that plants will bear fruit to condense and accumulate energy ( i ). If this holds true to the Japanese economy, 2007 will be a year in which new seeds of reforms are sowed towards the next stage while the fruit of past structural reforms are reaped. Little time remains to see whether the economy can sustain continuous stable growth even under the forthcoming society of an aging and decreasing population yet to be experienced by any advanced country. It will depend on how much we can accelerate the reforms by making 2007 as the starting year of strategies for growth. 5
Japan's Economic Outlook (y/y,%) FY2005 FY2006 FY2007 Result Forecast Forecast Nominal GDP 1.0 1.2 2.0 GDP Deflator -1.3-0.7 0.2 Real GDP 2.4 1.9 1.8 Private consumption 1.9 0.7 1.7 Housing investment -1.0 0.1 0.8 Private business fixed investment 5.8 7.9 4.3 Business inventories (billion yen) 1200 1510 1769 Government expenditures 0.4-1.7-0.6 Public investment -1.4-12.3-8.2 Exports 9.0 7.7 5.2 Imports 6.0 4.0 4.2 <()Contribution of overseas demand> ( 0.6) ( 0.6) ( 0.3) Industrial production 1.6 3.5 2.3 Domestic corporate goods prices 2.1 2.7 0.8 Consumer prices (excl. fresh food) -0.1 0.2 0.3 Current account (billion yen) 19,123 19,429 20,856 Trade balance (billion yen) 9,563 8,767 9,984 Exchange rate (yen/u.s.dollar) 113 116 114 (January 2007, Toshiki Iwaoka) The Bank of Tokyo-Mitsubishi UFJ, Ltd. Economic Research Office 2-7-1, Marunouchi, Chiyoda-ku, Tokyo 100-8388, Japan This report is intended only for information purposes and shall not be construed as solicitation to take any action. 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. 6