# Japanese Economy in 2006 and Beyond: Despite Slow Growth, Record Postwar Expansion Achieved

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## Japanese Economy in 2006 and Beyond: Despite Slow Growth, Record Postwar Expansion Achieved

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The Japanese economy achieved high growth rates in 2006, particularly in the corporate sector in the first half of the year. The middle of 2006 brought a slowdown, especially in consumer spending. In general, however, corporate performance held steady, labor supply was tight and the economy overall did not slow significantly. The economic growth phase that began in January 2002 is virtually certain to be statistically verified as having marked its 58th consecutive month in November 2006, making it the longest period of growth in postwar Japan. Although favorable results have been seen in the corporate sector, there was only mild improvement in wages and consumer......

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## Nội dung Text: Japanese Economy in 2006 and Beyond: Despite Slow Growth, Record Postwar Expansion Achieved

1. 06-ERC 70L-001AA 17 Japanese Economy in 2006 and Beyond: Despite Slow Growth, Record Postwar Expansion Achieved February 2007 Japanese Economy Division, Economic Research Department JETRO
2. Contents Overview .....................................................................................................................................................i 1. General Indicators: Longest Economic Expansion in Postwar Japan ............................................. 1 A. Corporate Activity Robust, Although Growth Slows in 2006 Second Half ....................................... 1 B. Characteristics of Current Economic Growth .................................................................................... 4 C. Issues and Outlook for Japanese Economy ........................................................................................ 5 2. Trade and Direct Investment: Ties with Emerging Markets Deepen............................................. 13 A. Exports and Imports Reach High Levels.......................................................................................... 13 B. Trade Trends by Geographic Area (Jan.–Nov.) ................................................................................ 13 C. Trade by Product .............................................................................................................................. 16 D. International Trade Balance ............................................................................................................. 20 E. Expectations for 2007....................................................................................................................... 20 F. Foreign Direct Investment ................................................................................................................ 21 3. Production: Mining and Manufacturing Output Remain High ..................................................... 27 A. Expansion Continues Despite Uneven Pace..................................................................................... 27 B. Rising Inventories in Electronic Components and Devices ............................................................. 31 C. Mild Growth to Continue in 2007 .................................................................................................... 32 4. Corporate Sector: Capital Expenditure Plans Still Solid ................................................................ 33 A. Corporate Earnings Continue Growing............................................................................................ 33 B. Capital Expenditure Maintains Steady Growth ................................................................................ 35 C. Slower but Sustained Growth in 2007.............................................................................................. 38 5. Employment: Wages Stagnant but Employment Improves ............................................................ 42 A. Employment and Wage Trends in 2006 ........................................................................................... 42 B. Gearing Up For Mass Retirements by Baby Boomers ..................................................................... 45 C. Outlook for 2007 .............................................................................................................................. 47 6. Personal Consumption: Spending Remains at a Standstill ............................................................. 50 A. Trends in 2006.................................................................................................................................. 50 B. Growing Expectations for Spending by Baby Boomers................................................................... 53 C. Outlook for 2007 .............................................................................................................................. 54
3. 7. Prices: End to Deflation Put on Hold ................................................................................................ 57 A. Consumer Prices Maintain Slight Upward Movement .................................................................... 57 B. Corporate Goods Prices Peak ........................................................................................................... 58 C. Outlook for 2007: End of Deflation ................................................................................................. 59 8. Finance: Financial Environment Returns to Normality.................................................................. 62 A. BOJ Tightens Money Policy ............................................................................................................ 62 B. Demand for Funds Recovers, albeit Slowly ..................................................................................... 64 C. Banking Industry Trends .................................................................................................................. 68 D. Stock, Securities and Foreign Exchange .......................................................................................... 70 E. Increased Polarization of Real Estate Market................................................................................... 73 F. Key Points to Watch.......................................................................................................................... 74 Columns Column 1 .................................................................................................................................................. 11 Column 2 .................................................................................................................................................. 17 Column 3 .................................................................................................................................................. 26 Column 4 .................................................................................................................................................. 40 Column 5 .................................................................................................................................................. 49 Column 6 .................................................................................................................................................. 56 Column 7 .................................................................................................................................................. 61 Column 8 .................................................................................................................................................. 67 Column 9 .................................................................................................................................................. 75
4. Overview 1. General Indicators: Japan's Longest Economic Expansion in the Postwar Period The Japanese economy achieved high growth rates in 2006, particularly in the corporate sector in the first half of the year. The middle of 2006 brought a slowdown, especially in consumer spending. In general, however, corporate performance held steady, labor supply was tight and the economy overall did not slow significantly. The economic growth phase that began in January 2002 is virtually certain to be statistically verified as having marked its 58th consecutive month in November 2006, making it the longest period of growth in postwar Japan. Although favorable results have been seen in the corporate sector, there was only mild improvement in wages and consumer spending, so the pace of recovery was slower than in previous phases of growth. The United States economy is forecast to slow down in 2007. Meanwhile, Japanese companies remain reluctant to increase wages, so the Japanese economy is also expected to lose momentum. The labor supply will tighten as baby boomers retire en masse. It is unlikely that the economic recovery will stall due to slowed consumer spending. Stable economic growth is expected, although actual results could be hurt by a potential downturn in the United States economy, crude oil prices rising again, an increase in the fiscal deficit or political events that could negatively affect consumer confidence. 2. Trade and Direct Investment: Deeper Ties with Emerging Markets Exports increased thanks to a weaker yen and favorable conditions in the global economy. Imports also expanded as the Japanese economy recovered and crude oil import prices stayed high. Despite potential risks, conditions remain favorable in China and the rest of East Asia, which together accounted for 45.7% of total Japanese exports. Exports to this region should remain brisk in 2007. Crude oil prices appear to have stabilized since October 2006, so import growth is expected to decline. Foreign direct investment in January to September 2006 confirmed that investment in China continued to slow down, as in 2005. Japanese corporations, aware of the risks of intellectual property rights violations in China, partly shifted operations to the emerging markets of India, Russia and Vietnam. Outward M&A included several megadeals as Japanese corporations sought to expand their core businesses. Inbound FDI was boosted by major increases in funding, resulting in the largest net outflow since such statistics were first complied in 1996. 3. Production: Mining and Manufacturing Production Sustains High Levels Mining and manufacturing output maintained an overall upward trend in 2006, sustained by a steady recovery in the materials industries. Robust increases in both internal and external demand for products such as transport equipment and electronic components and devices led to high growth in shipments overall, although trends varied among industries. Stock buildups of certain key products, such as mobile phones and game equipment in the electronic components and devices industry, put sporadic pressure on the mining and manufacturing sector to reduce inventories. But the buildups were considered transitory, so mining and manufacturing is forecast to enjoy moderate growth sustained by brisk internal and external demand in 2007. i
5. 4. Corporate Sector: Appetite for Capital Investment Remains Healthy Corporate profits continued growing, buoyed by an economic climate of high production and stabilized oil prices. Increased profits were seen across a wide range of industries and firms (in terms of company size), which helped to boost capital investment. The scope of capital investment expanded due to efforts to raise global competitiveness, centering on processing industries, and the elimination of perceived overcapacity among even small and midsized enterprises. Capital investment could see a reactionary decline in 2007, but it is still expected to continue growing because of new overseas demand being developed by Japanese companies seeking to reinforce their revenue bases. 5. Employment: Wages Stagnant but Employment Improves Employment improved in 2006 as the labor supply tightened due to the start of mass retirements by baby boomers and corporate performance rose steadily. Corporate performance is forecast to remain firm, which would help to fuel a moderate improvement in employment. However, with non-regular workers now accounting for 30% of all employees, this could lead to new problems in the labor market, including broader inequalities in incomes. Wages tended to remain static in 2006. Earnings were not passed along to employees due to corporate reluctance to increase wages. A tightening labor supply, however, is exerting upward pressure on wages, which are expected to increase moderately in 2007. 6. Personal Consumption: Spending Remains at a Standstill Personal consumption (consumer spending) was stagnant in 2006, influenced by factors such as a long rainy season and sluggish sales of winter clothing due to unusually warm weather. Spending was hampered by sluggish wage increases. Although consumers remain uncertain about prospects due to the scheduled elimination of tax breaks and increases in their social security burden, wages are expected to rise as the labor supply continues to tighten. This, along with retirement payments to baby boomers retiring en masse, should stimulate a moderate increase in personal consumption in 2007. 7. Prices: Move out of Deflation Comes to Standstill Consumer prices turned moderately upward in 2006. However, statistical revisions to key indices and increasingly severe price competition in digital products negated any clear upward trend in prices, so the government did not officially declare an end to Japan’s chronic deflation. But these special factors notwithstanding, the elimination of domestic oversupply and, on the demand side, personal consumption will be pushed upward by moderate wage increases. As a result, the demand/supply gap is expected to tighten and prices are likely to experience upward pressure in 2007. 8. Finance: Financial Environment Improves The Bank of Japan lifted its easy money policy for the first time in five years in March 2006, and then ended Japan’s era of ultra-low interest rates by raising its bank lending rate in July. Although further increases were expected during the year, they were postponed until January 2007. The impact of the BoJ’s tightened money policy was limited to commercial and home loans. Going forward, however, intensified upward pressure on rates should affect households and companies, and beyond them government finances. The financial climate moved steadily toward normality, particularly in banking where non-performing loans were largely eliminated. The BoJ’s timing for additional rate increases must ii
6. be watched, as a distinctly tighter stance is envisioned in the latter half of 2007, when the Japanese and U.S. economies are expected to show clear signs of stable growth and rising prices. iii
7. 1. General Indicators: Longest Economic Expansion in Postwar Japan A. Corporate Activity Robust, Although Growth Slows in 2006 Second Half The Japanese economy enjoyed stable growth led by capital expenditure in 2006. The underlying positive tone of 2005 extended into first half of the year, with high growth primarily in the corporate sector. From midyear, however, the economy began to slow, particularly in consumer spending. The GDP rose more than two percent in the first quarter, propelled by consumer spending, capital expenditure and other segments of the private sector. In the second quarter, growth slowed to 0.3% over the previous quarter (1.1% annualized) due to weakened demand from the public sector and efforts to cut inventories. Although the GDP in the third quarter was up just 0.2% (0.8% annualized), it was the seventh consecutive quarter of positive growth, so the economy continued to avoid any significant decline (figs. 1-1 & 1-2). Consumer spending turned pessimistic and declined 0.9% from the second quarter. The decline, although due to temporary factors such as inclement weather, also reflected the fact that improved jobs and stronger corporate results had not translated into increased incomes because companies kept a lid on personnel costs. Capital expenditure grew 1.5%. The third-quarter GDP was also supported by external demand as exports to the U.S. and East Asia rose. Imports were sluggish. After years of chronic deflation, the consumer price index (excluding fresh foods, 2000 [pre-revision] baseline) rose 0.5% year on year in January, which followed 0.1% growth in each of the two previous months. Thereafter, the index grew throughout much of the year, but the GDP deflator and special factors influencing CPI growth remained negative, so the government did not officially announce the end of deflation (Fig. 1-3). Fig. 1-1 Contributions to GDP Growth by Calendar Year and Quarter Calendar Year (% YoY) Quarter 8.0 6.8 Other (annual rate, % QoQ) Public sector demand 6.0 5.1 5.3 5.2 Net exports Private sector capital investments 3.4 3.2 3.8 Private sector final consumption expenditure 3.0 3.4 GDP 2.8 2.1 2.7 4.0 1.10.8 1.0 2.7 1.6 2.9 2.7 0.21.1 2.0 1.9 2.0 0.3 1.4 0.2 0.0 -2.0 -0.1 -2.0 -4.0 06 -12 85 86 87 88 89 90 91 92 93 94 95 96 97 98 20 9 01 02 03 04 05 6 10 -9 6 9 00 3 -3 9 4- 4- 7- 1- 7 /1 / 05 Real values, derived from a fixed-base estimates formula up to 1994, and a chain-weighted index formula from 1995. “Other” includes private-sector inventory growth (decrease) and private housing. Sources: Economic and Social Research Institute, Cabinet Office and Government of Japan 1
8. Fig. 1-2 GDP Growth Trends (%) Real GDP Public Private Private Nominal GDP Private Housing Private sector sector (annual rate) sector Net exports GDP deflator sector final investment corporate demand demand inventories Exports Imports Calendar year (YoY) 2000 2.9 - 0.7 0.9 7.5 0.9 0.5 12.7 9.2 0.1 3.2 1.1 -1.7 2001 0.2 - 1.6 -5.3 1.3 -0.2 -0.8 -6.9 0.6 1.1 1.0 -1.0 -1.2 2002 0.3 - 1.1 -4.0 -5.2 -0.3 0.7 7.5 0.9 0.4 -0.7 -1.3 -1.5 2003 1.4 - 0.4 -1.0 4.4 0.2 0.7 9.2 3.9 -1.1 1.4 -0.2 -1.6 2004 2.7 - 1.6 1.9 5.6 0.3 0.8 13.9 8.1 -0.6 2.8 1.6 -1.1 2005 1.9 - 1.6 -1.3 6.6 -0.1 0.3 7.0 5.8 0.1 2.2 0.6 -1.3 Fiscal year (YoY) 2000 2.6 - 0.7 -0.1 7.2 0.8 0.1 9.5 9.7 0.7 3.0 0.9 -1.6 2001 -0.8 - 1.4 -7.7 -2.4 -0.5 -0.5 -7.9 -3.4 0.6 -0.5 -2.1 -1.3 2002 1.1 - 1.2 -2.2 -2.9 0.1 0.7 11.5 4.8 0.1 0.4 -0.8 -1.8 2003 2.1 - 0.6 -0.2 6.1 0.3 0.8 9.8 3.0 -0.5 1.9 0.8 -1.3 2004 2.0 - 1.3 1.7 6.2 0.1 0.5 11.4 8.4 -1.5 2.4 0.9 -1.0 2005 2.4 - 1.9 -1.0 5.8 -0.1 0.5 9.0 6.0 0.4 2.4 1.0 -1.3 Quarter (QoQ) 2005/1-3 0.8 3.4 0.8 -1.5 2.5 -0.1 0.0 -0.3 -0.3 0.8 0.9 0.1 -1.0 4-6 0.8 3.2 0.9 -1.6 1.6 0.1 0.3 3.4 1.2 -1.0 1.0 0.4 -1.0 7-9 0.7 2.8 0.6 1.0 0.9 -0.2 0.0 3.0 3.5 1.9 0.4 0.1 -1.4 10-12 0.5 2.1 0.5 1.5 -0.8 0.0 0.6 3.8 -0.2 -1.3 0.3 0.4 -1.6 2006/1-3 0.7 2.7 -0.1 0.9 3.6 0.2 0.1 2.3 1.9 -0.6 0.9 0.4 -1.3 4-6 0.3 1.1 0.5 -2.1 3.2 -0.2 -0.1 0.7 1.3 -0.9 0.7 0.0 -1.1 7-9 0.2 0.8 -0.9 -0.3 1.5 0.2 0.4 2.5 -0.5 -0.4 -0.2 0.0 -0.7 Levels of contribution to overall GDP by private-sector inventories and net exports. Quarterly GDP deflator figures show annual change. Sources: Economic and Social Research Institute, Cabinet Office and Government of Japan Fig. 1-3 Consumer and Wholesale Price Trends The current economic expansion, which began in January (% Y oY ) (% Y oY ) 2002 and reached 58 months as of 8.0 C orp orate goods (sem i-finished, right ax is) 40.0 November 2006, almost certainly C orp orate goods (finished goods) 6.0 C onsum er Price Index (ex cep t fresh foods) 30.0 will be declared the longest postwar G D P deflator 1 growth period , surpassing the 4.0 C orp orate goods (raw m aterials, right ax is) 20.0 57-month Izanagi boom in 1965–1970. The economic 2.0 10.0 sentiment diffusion index (DI, 0.0 0.0 coincident indicators), which shows the economy’s current direction, fell -2.0 -10.0 below the 50 midpoint in both February and March, but then -4.0 -20.0 trended above 50 for the rest of the year. The coincident indicators, -6.0 -30.0 95/01 96/01 97/01 98/01 99/01 00/01 01/01 02/01 03/01 04/01 05/01 06/01 which indicate the value of the economy, rose to 113.0 in October and thereby bested the previous Impact of sales tax increase not reflected in corporate goods index or CPI. record of 112.2 set in October 1990. Sources: Statistics Bureau, Ministry of Internal Affairs and Communications; Bank of Nevertheless, the leading indicator Japan; Economic and Social Research Institute; Cabinet Office and Government of Japan 1 It has not yet been precisely determined that a new record has been set because the Cabinet Office council that researches economic indicators issues its analysis of business cycles (economic peaks and troughs) retroactively. The current cycle’s trough, for example, which occurred in January 2001, was tentatively proclaimed in June 2003 and officially confirmed in November 2004. 2
9. DI was below 50 from July to September, and the coincident indicators also fell after peaking in May, so the data2 could be taken as suggesting an impending economic correction. Fig. 1-4 D.I. Trends 100 50 Leading Coincident 0 Lagging 88 -3 89 -3 90 -3 91 -3 92 -3 93 -3 94 -3 95 -3 96 -3 97 -3 98 -3 99 -3 00 -3 01 -3 02 -3 03 -3 04 -3 05 -3 06 -3 -3 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 87 Fig. 1-5 C.I. Trends 130 120 110 100 90 80 Leading 70 Coincident 60 Lagging 50 74 4 76 0 77 4 79 0 80 4 82 0 83 4 85 0 86 4 88 0 89 4 91 0 92 4 94 0 95 4 97 0 98 4 00 0 01 4 03 0 04 4 06 0 4 /0 /1 /0 /1 /0 /1 /0 /1 /0 /1 /0 /1 /0 /1 /0 /1 /0 /1 /0 /1 /0 /1 /0 73 Shaded areas indicate recession. D.I. plots average quarterly values, but data for October 2005 is monthly value. Source: Cabinet Office Fig. 1-6 Business Cycles in Japanese Economy Period Trough Peak Trough Expansion Recession Entire cycle 1st cycle - 1951/06 1951/10 - 4 months - 2nd cycle 1951/10 1954/01 1954/11 27 months 10 months 37 months 3rd cycle 1954/11 1957/06 1958/06 31 months 12 months 43 months 4th cycle 1958/06 1961/12 1962/10 42 months 10 months 52 months 5th cycle 1962/10 1964/10 1965/10 24 months 12 months 36 months 6th cycle 1965/10 1970/07 1971/12 57 months 17 months 74 months 7th cycle 1971/12 1973/11 1975/03 23 months 16 months 39 months 8th cycle 1975/03 1977/01 1977/10 22 months 9 months 31 months 9th cycle 1977/10 1980/02 1983/02 28 months 36 months 64 months 10th cycle 1983/02 1985/06 1986/11 28 months 17 months 45 months 11th cycle 1986/11 1991/02 1993/10 51 months 32 months 83 months 12th cycle 1993/10 1997/05 1999/01 43 months 20 months 63 months 13th cycle 1999/01 2000/11 2002/01 22 months 14 months 36 months Average 33.2 17.1 50.3 Current cycle continued for 60 months as of January 2007. Source: Cabinet Office 2 Seen by past patterns, leading (coincident) indicators peak around a half year ahead of the economy’s peak. 3
10. B. Characteristics of Current Economic Growth In the current economic growth Fig. 1-7 C.I. Trends for Previous and Current Business Cycles phase, as well as in the period from the collapse of the economic bubble to 135 around 2001, external demand in the (Business cycle trough = 0 corporate sector has led the way. The 130 months) current phase has also benefited from a virtuous cycle of corporate profits 125 boosting employment and consumer sentiment, which in turn spurred 120 consumer spending. But companies 115 have yet to raise wages, especially contractually obligated payments, so 110 consumer spending has remained fragile March 1975~January 1977 and the recovery has been relatively 105 September 1977~February 1980 sluggish compared to previous periods February 1983~June 1985 of economic growth (Fig. 1-7). The 100 November 1986~March 1991 October 1993~May 1975 private sector has worked to eliminate 95 January 1999~October 2000 the so-called “three excesses,” i.e., January 2002~ excess debt, employment and facilities, m hs m s m hs m hs m hs m hs m hs m hs m hs m hs m hs m hs m hs m hs s 8 th th t 12 ont 20 ont 16 ont 24 ont 28 ont 32 ont 36 ont 40 ont 44 ont 48 ont 52 ont 56 ont on on on so perceptions of oversupply in m 0 4 employment and facilities have been mostly eliminated (Fig. 1-8), while Source: Cabinet Office banks nationwide have reduced bad debts by more than 60% from the peak. With the three excesses now behind Japan, deflation also has nearly been eliminated. Foreign countries also had a hand in the elimination of the three excesses. In the 1990s, following the collapse of the Soviet bloc, China and other former socialist countries leveraged their low-cost labor to rapidly increase their presence on the supply side, which at first increased the breadth of direct and Fig. 1-8 Sentiment on Three Excesses Fig. 1-9 Growth in Exports, Imports and Industrial (Points) (%) Production Index from 1990 30.0 50.0 35.0 48.0 (%) 20.0 30.0 46.0 10.0 25.0 44.0 0.0 20.0 42.0 15.0 -10.0 40.0 38.0 10.0 -20.0 Recession 36.0 5.0 -30.0 Over-staffing sentiment (excess – shortage) Excess facilities sentiment (excess – shortage) 34.0 0.0 Interest-bearing debt to total assets ratio (right axis) 1991 - 1995 -40.0 32.0 -5.0 1996 - 2000 2001 - November 2006 -50.0 30.0 -10.0 Export volume Import volume Industrial 06 1-3 -3 / 3 /1 3 / 3 / 3 /1 3 / 3 / 3 / 3 /1 3 / 3 / 3 /1 3 05 - 3 / 3 94 1- 97 1- 00 1- 01 1- 92 1- 93 1- 95 - 96 1- 98 - 99 1- 02 - 03 1- 04 1- index index production index /1 / / 91 Sources: Ministry of Economy, Trade and Industry, and Ministry BoJ Tankan survey’s employment D.I. is used for employment of Finance and manufacturing plant D.I. is used for facilities. Sources: Bank of Japan and Ministry of Finance 4
11. indirect supply-side pressure on Japan. But as some of these countries developed their consumer markets and other demand-side economies in the 2000s, they then eased supply-side pressures on the Japanese economy by ameliorating their exports to Japan while purchasing increased exports from Japan (Fig. 1-9). Another characteristic of the recovery has been sustained growth despite substantial cuts in government expenditure. Public demand (total government expenditure, public fixed-capital formation and increased public inventories) as a share of GDP reached more than 24% between 2001 and 2002, but fell to 21% in the second quarter of 2006 and contributed negatively to economic growth (figs. 1-10 & 1-11). Following the inauguration of the Koizumi administration in April 2001, the government designated the following three years to fiscal 2004 as a period of structural reform. Measures included stepped-up efforts to eliminate non-performing assets, resolution of bad debts through the Financial Revitalization Program and economic stimulation through regulatory reform, such as specially deregulated zones and reduced taxation of R&D and capital expenditure. The effect was reduced downward pressure on the economy and stronger stimulation of the private sector. On the other hand, rapidly retrenched employment and declining government expenditure, as well as changes in industrial structure, led to widening disparities in income, consumer spending and household assets. Moreover, reduced public works led to widening regional disparities (see Column 1). The Abe administration, after taking in September 2006, has made the promotion of new opportunities one of its main policies. Specifically, it has encouraged steady employment for job-hopping “freeters,” offered assistance to families headed by single mothers to help them become more independent, banned multiple consumer loans, and provided support for entrepreneurs and people restarting their careers. Fig. 1-10 Public Demand’s Share of GDP Fig. 1-11 Increase/Decrease in Contribution to GDP by Demand Line Item 25 1.8 2.0 (Annual rate, %) (%) 1.5 0.0 0.7 24 1.5 1.0 0.9 23 0.5 1.2 0.5 0.2 22 0.6 0.2 0.0 0.1 External demand -0.2 Public demand 21 -0.5 Private demand 95 - 3 96 - 3 97 - 3 98 - 3 99 - 3 00 - 3 01 - 3 02 - 3 03 - 3 04 - 3 05 - 3 06 - 3 -3 1991-1995 1996-2001 2002-2006/3Q /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 94 Real values, derived from a fixed-base estimates formula up to Sources: Economic and Social Research Institute, 1995, and a chain-weighted index formula from 1996. Cabinet Office and Government of Japan Source: Economic and Social Research Institute, Cabinet Office and Government of Japan C. Issues and Outlook for Japanese Economy 1) Population decline and need for higher productivity in services The Japanese population decreased by 21,266 to mark its first postwar decline in 2005, according to 5
12. official statistics released on November 30, Fig. 1-12 Japanese Population Estimates 2006. The forecast is for the population to fall below 100 million by 2046 and 90 million by 140 2055, a faster decline than previously (million people) anticipated (Fig. 1-12). This will have an adverse effect on the economy owing to the Population peak in 2005 (127,768,000) diminishing stock of capital due to declining 100 labor inputs, while aging will put downward pressure on the overall economy due to Population growth (actual) Old estimate (January 02) reduced levels of personal savings. An aging New estimate (January 07) population will also have an impact on social 60 guarantees such as pensions and medical care, 19 0 19 5 19 0 19 5 19 0 19 5 19 0 19 5 19 0 20 5 20 0 20 5 20 0 20 5 20 0 20 5 20 0 20 5 20 0 20 5 20 0 55 leading to pressure to revise the entire social 5 5 6 6 7 7 8 8 9 9 0 0 1 1 2 2 3 3 4 4 5 19 security system. To ease such pressures and Source: National Institute of Population and Social achieve sustainable economic growth, Security Research measures will be needed to halt declining births, and bring women and older citizens Fig. 1-13 TFP Growth Rate more fully into the labor force. Although Japan experienced a lengthy economic downturn from the mid-90s to 2001, overall productivity 1.2 was not impaired and growth was at levels not 1.0 (%) substantially lower than those of other major 0.8 developed nations (figs. 1-13 & 1-14). But 0.6 while manufacturing maintained high 0.4 productivity compared to other nations, the services sector was weak (Fig. 1-15). Since the 0.2 service sector’s share of the economy is 0.0 increasing, improved productivity is vital. The 95 96 97 98 99 00 01 02 03 04 05 new economic growth strategies announced in May 2006 contain specific measures to boost Source: Council on Economic and Fiscal Policy competitiveness and productivity, such as promoting new business models, deregulation, training, IT and foreign direct investment entering Japan. Fig. 1-14 Breakdown of Economic Growth in Major Fig. 1-15 Productivity Contributions in Major Nations Nations, by Industry 3.5 2.8 3.2 2.5 3.2 (%) 3.0 Manufacturing 0.7 1.2 2.5 1.0 0.5 2.0 Enterprise services 2.1 Other services 2.0 0.9 0.9 0.2 Other industries 1.5 0.7 1.0 1.3 1.5 0.6 1.0 0.3 1.5 1.4 0.5 1.1 1.0 1.0 1.1 1.0 0.0 -0.5 -0.8 -0.2 0.5 -1.0 TFP Capital input volume Labor input volume -1.5 0.0 Japan U.S. Canada U.K. Germany France -0.5 (95-04) (95-05) (95-05) (95-03) (95-05) (95-05) U.K. Japan U.S. Germany Canada France Source: OECD Source: OECD 6
13. 2) Fiscal restructuring Japan’s government finances are the worst among developed nations, so fiscal restructuring is required (Fig 1-16). In the January 2002 Structural Reform and Medium-Term Economic and Fiscal Perspectives, the government announced it would turn the deficit into a surplus by the early 2010s by reducing spending through structural reforms. In fact, some anticipate that a surplus might be possible even sooner, due to increased corporate tax revenues in conjunction with the economic upswing. In fact, improvements proceeded faster than expected at the start of 2006, with the primary balance for FY2006 estimated at ¥11.2 trillion (2.2% of GDP) and ¥4.4 trillion (0.8% of GDP) for FY2007 under the proposed budget (Fig. 1-17). Government debt issued under the draft FY2007 budget would be reduced to ¥25.4 trillion, down from ¥29.97 trillion in FY2006, with the aim of further reductions for the next three years. Assuming steady progress in fiscal restructuring, dependence on government bonds would drop to 30.7%, down from a peak of 41.8% (real) in FY2003. Fig. 1-16 Government Debt as % of GDP in Major Fig. 1-17 Government Basic Expenditure as % Nations of GDP (%) 200 0.0 Japan U.S. Actual 180 U.K. Germany -0.5 Outlook as of January 06 France Italy 160 -1.0 Canada 140 ％ -1.5 120 -2.0 100 -2.5 80 -3.0 60 -3.5 40 -4.0 20 -4.5 0 03 04 05 06 07 08 09 10 11 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 (e) (e) (e) (Annual rate) Source: OECD Sources: Ministry of Finance and Council on Economic and Fiscal Policy 3) Robust economic growth, but weak consumer spending Ensuring that Japan’s economic expansion continues in 2007 will require prudent action. Although companies have steadily improved their finances and profits, they have remained cautious about raising wages, especially contractually obligated payments (figs. 1-18 & 1-19). Companies still believe that in light of intense international competition, stronger earnings should be passed along to employees only as bonuses or one-time payments3. Consumer spending through 2006 did not exhibit a clear growth trend due to the lag in wages, and it is unlikely that improved employment will boost consumer spending in 2007. However, it is also difficult to conceive this might lead to a correction in the economy. Manufacturers and other leading corporations have nearly completed their financial restructuring by putting lean financial structures into place. In employment, baby boomers born between 1947 and 1949 will begin to retire in 2007, so the real issue will be how to ensure sufficient staffing. In fact, perceptions of a tighter labor supply in light of increasing demand are expected to grow. Despite low expectations of wage increases, substantially lower wages are very unlikely. 3 In the Nihon Keizai Shimbun’s Survey of 100 Company Presidents, just 26% said they would increase wage levels in 2007. 7
14. Fig. 1-18 Labor Share Trends Fig. 1-19 Real Growth in Capital Expenditure and Wages 56 (%) 20.0 4.0 55 (% YoY) 3.0 54 10.0 2.0 53 1.0 52 0.0 0.0 51 50 -1.0 49 -10.0 -2.0 48 Capital expenditure -3.0 Wages (right axis) -20.0 -4.0 /1 3 96 - 3 /1 3 / 3 99 1- 3 /1 3 01 - 3 / 3 / 3 04 1- 3 /1 3 06 - 3 -3 95 1- 97 1- 98 - 00 1- 02 1- 03 1- 05 1- /1 / / / / / 94 96 - 3 97 - 3 98 - 3 99 - 3 00 - 3 01 - 3 02 - 3 03 - 3 04 - 3 05 - 3 06 - 3 -3 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 /1 95 Labor share = wages/GDP Sources: Economic and Social Research Institute, Sources: Economic and Social Research Institute, Cabinet Cabinet Office and Government of Japan Office and Government of Japan The corporate sector, after supporting the Fig. 1-20 IMF Country/Region Forecasts economy in 2006, should again enjoy strong profits in the first half, especially among 11.0 10.0 10.1 10.2 10.0 10.0 (% YoY) exporters, given that the yen weakened 9.1 unexpectedly to ¥119 to the U.S. dollar as of the 9.0 8.3 U.S. Japan 4 2006 yearend . While a temporary lull in capital Euro zone Asia NIEs ASEAN 4 China expenditure is expected, if only as a backlash to 7.0 5.9 5.6 aggressive expenditure through 2006, the 5.3 4.9 5.1 possibility of a large downturn is limited because 5.0 5.5 5.8 3.9 4.4 producers don’t yet feel they have excess 4.7 3.2 4.5 5.0 2.9 3.2 3.4 capacity. Corporate profitability will remain 3.0 2.5 2.5 2.3 2.7 1.6 1.8 strong. 1.9 1.1 2.6 2.4 2.0 2.1 In external demand, the U.S. economy 1.0 0.8 0.9 2.1 1.3 0.4 0.8 should slow until around mid-2007 and Asian 0.1 NIEs also appear headed for a slight downturn. -1.0 Exports to these countries and regions will be 2001 2002 2003 2004 2005 2006 2007 (forecast) (forecast) affected, but the breadth of decelerated exports will remain limited due to high growth in China and the ASEAN region (Fig. 1-20). Forecasts for 2006 and 2007 Since domestic oversupply has nearly been Source: IMF resolved, demand is expected to remain generally firm, except for somewhat fragile consumer spending, and will exert upward pressure on consumer prices. Crude oil prices (West Texas Intermediate) continued to fall nearly across the board after hitting an all-time high of $77 in July 2006. Falling petrol prices will affect consumer prices. Aside from such market factors, however, prices are forecast to remain stable and deflation will be virtually eliminated in 2007. 4 According to the BoJ’s December 2006 Tankan quarterly survey, manufacturers and leading corporations had expected a rate of ¥113.40 to the dollar in the latter half of 2006. 8 15. To sum up, capital expenditure, consumer spending and external demand are all expected to grow at slowed rates in the first half of 2007, but the economy should grow stably, underpinned by solid corporate earnings. External demand and the corporate sector will steadily pick up speed from midyear, when signs of a recovery will begin to appear in the U.S. economy. But the pace of the recovery in consumer spending will be sluggish, so economic growth will lack strength overall. There is a slight possibility of the economy faltering due to stalled consumer spending resulting from a tightened labor supply. Nevertheless, stable growth is forecast, although it will lack the strength of economic activity from 2005 to mid-2006. Of 19 private think tanks, nine have predicted a slowdown in fiscal 2007, although the forecasts vary widely from 1.2% to 2.5%. All but one predict the deflator will revert to positive, anticipating an end to the trend of nominal growth exceeding real growth (figs. 1-21 & 1-22). Fig. 1-21 Private and Government Growth-Rate Fig. 1-22 Real/Nominal Growth Rates (Fiscal Years) Forecasts (%) Real GDP Nominal GDP Company FY 2006FY 2007FY 2006FY 2007 (% YoY) Goldman Sachs Japan 1.9 2.5 1.3 2.6 4.0 Nikko Citigroup 1.8 2.4 1.3 2.6 2.9 Real growth rate Nominal growth rate The Japan Research Institute 1.8 2.3 1.2 2.5 3.0 2.5 Deflator Nomura Securities Financial & Economic Research Cente 1.8 2.2 1.4 2.5 2.4 2.6 2.1 2.0 2.4 1.9 2.02.2 Morgan Stanley 2.0 2.2 1.3 2.8 1.9 2.0 1.5 Meiji Yasuda Life Insurance 1.9 2.1 1.1 2.4 1.0 1.1 1.0 Daiwa Institute of Research 1.9 2.0 1.2 2.3 1.0 0.7 0.9 0.8 0.9 Mitsubishi Research Institute 2.0 1.9 1.4 2.2 Dai-Ichi Life Research Institute 1.9 1.9 1.3 2.2 0.0 Shinko Research Institute 1.8 1.9 1.3 2.1 0.0 Mizuho Research Institute 1.9 1.8 1.6 2.5 Norinchukin Research Institute 2.0 1.7 1.2 2.1 -1.0 -0.7 -0.8 -0.8 Japan Center for Economic Research 1.8 1.7 1.2 1.8 BNP Paribas 1.7 1.6 1.0 1.5 -2.0 -1.5 NLI Research Institute 1.8 1.6 1.3 1.9 -1.9 -2.1 Mitsubishi UFJ Securities 1.8 1.6 1.3 1.8 Daiwa Securities SMBC 1.8 1.4 1.0 1.6 -3.0 Mitsubishi UFJ Research & Consulting 2.0 1.2 1.4 1.4 95 96 97 98 99 00 01 02 03 04 05 06 07 Bank of Tokyo-Mitsubishi UFJ 1.9 1.2 1.8 2.0 Average 1.9 1.8 1.3 2.1 (f) (f) Median 1.9 1.9 1.3 2.2 Government forecast 1.9 2.0 1.5 2.2 Source: Cabinet Office Sources: Above companies and Cabinet Office 4) Main risk factors are overseas economies and impaired sentiment A potential risk in 2007 is the possibility of the U.S. economy growing slowly. Many anticipate it difficult to hope for the U.S. to achieve more than its potential growth rate of around 3% (annualized) basis in the first half, particularly if consumer spending were curbed by falling home prices and rising costs of mortgages. If the U.S. economy were to come under even stronger downward pressure, the effect would be felt in Japan after a lag of around half a year. Under this scenario, the Japanese economy would be more turbulent in the second half of 2007. Energy prices rose until midyear 2006, but by the end of the year crude prices (WTI) had fallen more than 20% from their peak, diminishing anxieties. But in the future, if high prices were coupled with a weaker yen (which began declining in December 2006), corporate profits would be hurt and fears of rising consumer prices would increase. Even in this case, however, damage to the overall economy would be limited so long as energy prices did not match previous highs5. Domestic factors that may affect consumer sentiment include increased burdens on households and fears 5 Kyoto University Professor Akira Maeda, a research fellow with the Cabinet Office’s Economic and Social Research Institute, estimates that an effect equal to the 1973 oil shock are inconceivable unless the price of crude were to exceed$125 per barrel. 9
16. of future tax increases due to the abolition of uniform tax breaks and increases in national pension premiums, along with local elections in April and upper house elections in July. Many believe that the long-term political stability of the Koizumi administration contributed significantly to stabile consumer sentiment, so political developments under the Abe administration bear watching. 10
19. 2. Trade and Direct Investment: Ties with Emerging Markets Deepen A. Exports and Imports Reach High Levels Fig. 2-1 Japanese Exports and Imports Japanese exports during (US$billions, %) January to November 2006 rose 2006 2006 2005 7.8% over the same period in (Jan-Nov) I II III 2005 to$587.7 billion (Fig. Exports 598.3 587.7 151.2 158.2 166.3 YoY change 5.9 7.8 4.8 7.3 10.4 2-1). The yen’s depreciation Imports 518.0 527.6 137.9 142.0 148.5 and a buoyant world economy YoY change 13.9 11.5 13.5 11.0 11.4 helped exports achieve Trade with Balance of payments 80.3 60.1 133.6 161.6 177.6 quarterly year-on-year World YoY change -27.3 -11.8 -9.5 -3.3 0.4 increases of 4.8%, 7.3% and Export volume index 114.3 122.6 119.2 122.5 125.7 YoY change 0.8 8.1 11.2 8.7 8.4 10.4% in the first three quarters, Import volume undex 117.6 122.8 121.0 121.9 122.5 respectively. YoY change 2.7 4.5 5.4 4.5 2.9 Imports rose 11.5% to Exchange Average 110.2 116.2 116.9 114.4 116.2 $527.6 billion, maintaining Rate (yen/$) YoY change -1.8 -5.9 -10.6 -5.9 -4.3 double-digit growth since 2003. Oil Import $/barrel 51.1 64.6 59.5 64.9 70.7 Price YoY change 40.5 27.5 46.1 30.5 26.0 The trade balance over the Volume compared with 2000. Exchange rates are Interbank averages. Data as of December 28, 2006. same period was$60.1 billion, Sources: Ministry of Finance and Bank of Japan down $11.8 billion from 2005. Import value rose as the Fig. 2-2 Trade Trends by Geographic Area Japanese economy recovered (US$ billions, %) 2006 2006 and crude oil prices soared. 2005 (Jan-Nov) Q1 Q2 Q3 By volume, exports Exports 134.9 132.9 34.4 35.5 37.3 increased 11.2%, 8.7% and YoY change 6.3 8.1 5.0 6.7 12.5 Imports 64.5 62.6 16.4 17.0 17.4 8.4% in the first three quarters, U.S. YoY change 3.3 6.2 7.1 2.1 5.3 respectively. Yet export growth Export volume YoY change 2.1 9.1 9.3 8.4 9.7 Import volume YoY change 1.6 1.5 0.2 -3.7 0.9 for all of 2005 was just 0.8%. Exports 88.0 84.7 22.6 23.1 23.1 Export volume was solid for all YoY change 0.7 5.7 0.0 7.0 9.1 regions except the ASEAN4 EU25 Imports 59.1 54.5 14.9 14.6 14.8 YoY change 3.0 0.0 -1.8 -2.1 2.1 nations. Import volume grew Export volume increase -5.2 3.9 3.8 5.4 5.0 4.5%, exceeding the 2.9% rate Import volume increase 0.2 0.3 1.8 -1.1 0.8 of 2005. Exports 279.4 268.3 67.9 72.9 76.6 YoY change 5.5 5.3 2.7 4.9 7.0 East Asia 9 Imports 219.3 218.1 56.8 58.3 60.4 YoY change 11.9 8.7 7.2 7.0 9.2 B. Trade Trends by Exports 145.5 136.8 35.3 37.6 38.6 YoY change 4.3 3.0 0.4 3.5 4.5 Geographic Area Imports 51.0 51.6 13.9 13.9 14.1 Asia NIEs YoY change 9.5 10.6 13.3 9.3 10.3 (Jan.–Nov.) Export volume increase -5.5 8.0 5.1 12.2 8.9 Import volume increase 5.8 20.9 28.8 32.9 15.8 Exports 53.6 47.8 12.3 12.7 13.9 YoY change 4.2 -2.8 -5.5 -8.7 2.3 The largest contributions to ASEAN 4 Imports 59.2 58.7 15.3 15.7 16.5 export growth were China (2.0 YoY change 7.4 8.2 4.5 6.3 9.9 Export volume increase 1.4 0.3 3.4 -1.0 0.3 points), the U.S. (1.8 points) Import volume increase -1.6 3.8 -1.9 5.5 5.0 and South Korea (0.5 point). Exports 80.3 83.7 20.3 22.5 24.0 YoY change 8.8 15.1 13.0 17.4 14.3 Imports 109.1 107.8 27.6 28.7 29.8 1) Double-Digit Exports to China YoY change 15.8 8.0 5.9 6.2 8.3 China Export volume increase 2.4 14.8 19.0 18.4 11.7 Import volume increase 11.2 7.9 8.8 6.4 6.5 Asia NIEs are South Korea, Taiwan, Hong Kong and Singapore. ASEAN 4 are Indonesia, Thailand, Philippines and Malaysia. ASEAN 10 export/import volume increases cover ASEAN 4 only. Data as of December 28, 2006. Source: Ministry of Finance 13
20. Exports to China Fig. 2-3 Changes in Exports to China by Product climbed 15.1% to (% QoQ) $83.7 billion, 70 following growth of Others 60 8.8% in 2005. Metal products Chemical products Precision equipment Double-digit growth 50 Electrical equipment General machinery was maintained in each 40 Transport equipment Total export volume Total export value of the first three quarters: 19.0%, 18.4% 30 and 11.7%, 20 respectively. Electrical machinery, including 10 semiconductors and 0 electronic components, jumped 19.8% to$22.5 -10 billion (Fig. 2-3). The -20 main factor was -3 2 -3 -3 -3 2 -3 2 2 2 -3 6 9 6 9 6 9 6 9 6 9 6 9 -1 -1 -1 -1 -1 4- 7- 4- 7- 4- 7- 4- 7- 4- 7- 4- 7- /1 /1 /1 /1 /1 /1 10 10 10 10 10 electrical machinery 01 02 03 04 05 06 Source: Ministry of Finance exports, which continued to rise as companies in Japan increasingly supplied parts to Japanese-owned companies in China, which then assembled and exported finished products back to Japan. Exports of machinery, such as engines, grew 12.2% to $17.3 billion. Local orders grew nicely as China’s increased needs for energy drove up demand for plant construction. 2) Automobiles Boost Exports to U.S. Exports to the United States rose Fig. 2-4 Contributions to Changes in Exports to the U.S., by Commodity 8.1% to$132.9 billion. (% QoQ) Volume climbed 9.3%, 15 8.4% and 9.7% in the 10 first three quarters, respectively. 5 Transport equipment exports 0 were strong, rising -5 18.2% to $53.4 billion, Others which included -10 Precision equipment automobiles growing Electrical equipment General machinery -15 25% to$41.2 billion Transport equipment Total export volume (Fig. 2-4). The U.S. -20 Total export value accounted for 1.8 points of the increase -25 in Japan’s total exports, -3 6 9 -3 6 9 -3 6 9 -3 6 9 -3 6 9 -3 6 9 2 2 2 2 2 4- 7- 4- 7- 4- 7- 4- 7- 4- 7- 4- 7- -1 -1 -1 -1 -1 /1 /1 /1 /1 /1 /1 10 10 10 10 10 01 02 03 04 05 06 with 1.5 points coming Source: Ministry of Finance from automobiles. In addition to increased demand for smaller vehicles due to soaring gasoline prices, Japanese exports benefited from a lag in the U.S. production of popular Japanese compact cars, hybrids and diesel vehicles. The depreciation of the yen also drove up export value as models from Japan enjoyed strong demand (Fig. 2-5). After growing 7.3% to 1.93 million vehicles in 2005, exports skyrocketed 29.9% to 2.28 million vehicles during January to November 2006. 14