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A Revised Economic Forecast for Fiscal 2004-2005:

September 14, 2004

Economy Set to Decelerate Into 2005

(This forecast is a recent revision, reflecting the figures in the second preliminary report for the April-June quarter, released on September 10. Although the forecasts of real GDP for fiscal 2004 and nominal GDP for fiscal 2004 and 2005 have undergone a slight downward revision as compared with our previous forecast, issued on August 18, the scenario for the future is basically unchanged.)

For the remainder of 2004, given the two following points, although the economy will decelerate slightly, towards cruising speed, the recovery trend is likely to continue.

The recovery in capital investment will continue. Although growth slowed in the first half of 2004, machinery orders and capital investment plans herald substantial growth, led by the manufacturing sector, and the pace of growth is likely to accelerate once more in the second half of the year.

Thanks to a slowing of the deterioration in income conditions and a gentle recovery in consumer confidence, consumer spending is likely to see a general rise and, as there are signs of a growing willingness to purchase relatively expensive items especially among the older generations, is likely to remain firm.

Looking ahead to early 2005, the following three points suggest that the economy will slow.
1) Export growth will slow, especially those destined for the United States and Europe. The OECD leading indicator of export volume has already peaked, suggesting that export growth will slow.

2) The rise in the price of crude oil will place an additional burden on household finances through a rise in the price of gasoline, as current conditions make it difficult to pass increased costs on to the price of final goods, those increased costs will contribute to a slowing of the recovery in business profits.

3) The growth of capital investment is also expected to slow considerably towards the end of 2005. In the manufacturing sector, the slowdown will lag behind the fall in exports and industrial output by around six months, while in the non-manufacturing sector, recovery potential is highly likely to remain weak owing due to the tailing off of the momentum provided by urban regeneration projects in the Tokyo area, among other factors.

However, given the following three points, it is likely that a major slump can be avoided and that the economy will continue to grow at a pace of 1.5-2%.

1) The continued growth of the Chinese economy suggests that there is little risk of a fall in exports.
Stringency measures in China target only a few specific areas, such as excessive capital investment by traditional local industries, and do not aim to restrain production activities as a whole, so that their negative impact on Japan's exports is likely to be limited.

2) Production adjustments in electronic components and devices are unlikely to be as severe as in 2001, as (i) the range of final products is diversifying from computers and telecommunications equipment to consumer electronics, (ii) in addition to the United States, the Asian region is gaining importance as a source of final demand, and (iii) the range of products itself is shifting from general-purpose to higher value-added products.

Consumer spending will remain firm. As Japan's population ages, propensity to consume is remaining high and disposable income has begun to rise at a gentle pace: (i) social security benefits will continue to rise, (ii) the completion of personnel cost adjustments are completed and the slowing of the fall in the number of self-employed persons means that the fall in employee remuneration and mixed income is beginning to slow, and (iii) the fall in asset income due to falling interest rates and share prices has stopped.

This forecast does not take account of the impact of the discontinuation/cut in the fixed-rate tax reduction. If the fixed-rate tax reduction were to be cut by half, consumer spending would be likely to fall by 0.45%, exerting a considerable downward pressure on consumer spending and the economy at large in fiscal 2005.

For more information on the content of this report, please contact
Hideki Matsumura / Hisashi Yamada
Economics Department

Tel: 03-3288-4245 / 03-3288-4245
E-mail:matsumura.hideki@jri.co.jp / yamada.hisashi@jri.co.jp

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