A Revised Economic Forecast for Fiscal 2004-2005:
Issues to be Resolved if Japan is to Escape From Deflation
and Achieve Sustained Growth
July 06, 2004
The Japanese economy is maintaining a fairly rapid rate of recovery and there are signs that the recovery is becoming self-supporting, including a rise in the pulling power of domestic private demand and a slowdown in the pace of deflation. However, negative factors such as fears of economic deceleration overseas and a rise in the price of materials and interest rates in Japan have also emerged.
Under these conditions, any economic forecast must rest on four points: (i) the impact of the trend of foreign economies, especially that of China, on the Japanese economy, (ii) the impact of the rise in the price of materials on corporate profitability and the trend of capital investment, (iii) structural changes in employment and wages and the sustainability of the recovery of consumer spending, and (iv) the prospects and impact of Japan escaping deflation.
In China, financial stringency has begun to take effect, investment in fixed capital is slowing, government policy controllability is high, and the economy is expected to achieve a soft landing towards the end of 2004. A survey of shipments to China, which have been providing the momentum for Japanese exports, suggests that, as the ratio of products relating to fixed capital (which are directly affected by financial stringency) is not particularly high, the overall impact on exports to China is likely to be limited.
In the corporate sector, current conditions make it difficult to pass cost increases on to the price of final goods. The rise in the price of materials is boosting costs and is likely to exert downward pressure on profits, especially in the manufacturing industries. However, given the accelerating profit growth due to sales growth in the context of economic recovery, corporate profits should be able to maintain growth. In addition to this recovery in corporate profits, many industries, especially the electrical machinery sector, are beginning to bring their production operations back from overseas to domestic bases, and capital investment is likely to continue to recover at a rapid pace. Nevertheless, if Japan is to achieve full-scale economic recovery, it is vital that there be recovery in the service industries, as well as in the manufacturing sector, which has provided the pulling power for the economy in recent months. The polarization between strong and weak performance according to size of company is also a persistent problem.
Although unemployment is expected to continue to fall at a gentle pace, (i) the fact that no major growth in the number of people in employment can be expected due to the mismatch between workers skills and job demands, and (ii) the fact that an increasing number of companies are converting personnel expenses to variable costs with a view to reducing their ratio of fixed costs, mean that the recovery of income conditions in the household sector is likely to be slow. Even under these stagnant income conditions, the recovery in consumer confidence and the growth of the market for digital consumer electronics suggest that consumer spending is likely to continue to recover for the time being. However, the deterioration in working conditions for the younger generations and the increase in the household burden from the second half of fiscal 2004, among other factors, mean that there is little chance of consumer spending growing any faster.
In conjunction with the recovery of the real economy, the supply-demand gap has rapidly narrowed and as the surge in imports of cheap manufactured goods from China has slowed, the fall in consumer prices has slowed sharply. The supply-demand gap is expected to close in the early part of 2005, and although conditions will then be right for Japan to escape deflation, the continued growth of productivity and stagnation of nominal wages, among other factors, mean that, basically, a state of dis-inflation is likely to persist. Although the likelihood of acceleration in inflation is small, the problem of polarization in the corporate sector persists and as the side effects of suspending the policy of quantitative monetary easing at an early date would be considerable, the policy should be continued for the time being. Meanwhile, it is important that a consensus be achieved regarding a financial policy framework.
Looking to the future, the above analysis, suggests that, against a background of (i) export growth, (ii) rapid growth of capital investment and (iii) steady consumer spending, the recovery is likely to continue during fiscal 2004. In 2005, capital investment will enter a cyclical adjustment phase, the household burden will rise in conjunction with systemic changes and the economy is likely to slow in the second half of the fiscal year. However, given the continued growth of the Chinese economy and the improving health of the corporate sector, the adjustment is likely to be a small one.
The Japanese economy has emerged from the long period of stagnation that followed the collapse of the bubble economy and has finally started on a "return to normality". However, many problems, including the growing dependence on China, the continued adjustment of employment and wages and the polarization in performance between industries and sizes of company, have to be resolved before it will be possible to claim that the economy is reborn. The resolution of these problems will require strategic use of free trade agreements, the fostering of new service industries, the deployment of a proactive labor market policy, encouraging the transformation of industrial and employment structures under regional leadership, the formation of a consensus on the normalization of financial policy, and the formulation of a plan for the reform of social security and the restoration of soundness to public finance.
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Hideki Matsumura / Hisashi Yamada