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Revised Economic Forecast for Fiscal 2005-06

May 20, 2005

Annualized Growth of 5.3% in the January-March Quarter

The first preliminary figures reveal that real GDP saw rapid growth during the January-March quarter of 2005, rising by 1.3% on the October-December quarter of 2004 (equivalent to an annualized rate of 5.3%). A substantial contribution was made by the two major elements of domestic demand, consumer spending and capital investment, emerging from the stagnation into which they had fallen around the end of 2004.

However, it should be noted that (i) exports, which have driven the Japanese economy in recent years, began to fall quarter-on-quarter, and (ii) against this backdrop, the accumulation of inventories of manufactured goods, centering on capital goods, boosted growth figures.

Moreover, the downward trend of the GDP deflator accelerated as compared with the October-December quarter of 2004, and nominal GDP achieved growth of only 0.6% on the previous quarter, and zero growth on the same quarter in 2004.

In summary, the figures confirm that the Japanese economy has held firm, but it would be premature to upgrade the assessment that the economy is in mixed condition, with some strong and some weak sectors, now advancing and now retreating.

(1) Consumer Spending (Real: +1.2% on Previous Quarter, +4.7% Annualized)

Consumer spending rose quarter-on-quarter for the first time in three quarters. The main reasons are that (i) employee remuneration has bottomed out, largely on the strength of winter bonus payments, (ii) the fall in temperature in early January boosted sales of winter goods, and (iii) demand for services (travel, eating out, etc.) has recovered from the impact of poor weather and natural disasters, which caused consumers to hold back on spending in the second half of 2004. Nevertheless, consumer spending was only 0.8% up on the same quarter last year and its movements have stayed within a range that can be termed "largely unchanged".

(2) Capital Investment (Real: 2.0% on Previous Quarter, 8.2% Annualized)

Capital investment rose quarter-on-quarter for the first time in three quarters. It is possible that companies have begun to allocate some of their cashflow, currently running at high levels, to investment in developing greater industrial sophistication. In the manufacturing sector, the drive to rebuild factories and introduce machine tools, industrial robots and metalworking equipment is gathering momentum. In the non-manufacturing sector, investment in the creation of distribution bases, etc. is likewise holding steady.

(3) Exports (Real: -0.2% on Previous Quarter, -0.8% Annualized)

Exports fell quarter-on-quarter for the first time since the October-December quarter of 2001. Although shipments to the United States continued to rise, the downward trend of shipments to Asia, which account for just under 50% of total exports, accelerated and, with local economies sluggish, shipments to the EU countries are also weakening, especially in the area of transportation machinery and electrical machinery for public sector use. The deceleration of exports to Asia is due in large part to (i) the adjustment of inventories of IT-related goods in each country and (ii) the peaking of exports of capital goods to China, reflecting a momentary pause in direct investment boom.

(4) Private-Sector Inventory Investment (Real: 0.4 Point Contribution to Growth on Previous Quarter)

With exports falling on the previous quarter, inventories of manufactured goods piled up, especially in general machinery and information & communications equipment. However, in transportation machinery and other areas, shipments and inventories both rose on the previous quarter and, in some areas, the phenomenon could be interpreted as a "positive accumulation of inventory". Moreover progress was made with inventory adjustments in the electronic devices sector, which had been of concern since last year. From these facts, it is clear that the Japanese economy is in mixed condition, with some strong and some weak sectors.

The real economic growth rate for fiscal 2004 (full year) was +1.9%, on a par with the level of 2.0% achieved in fiscal 2003.

Clear Economic Growth Likely to Come Only in 2006

Looking to the future, it is likely that, in the short term, the Japanese economy will remain in mixed condition, with some strong and some weak sectors, now advancing and now retreating.

With income and employment conditions bottoming out and plentiful cashflow in the corporate sector, consumer spending and capital investment can be expected to hold firm. At the same time, the two following factors are likely to hold up economic recovery.

(i) Given that, in the immediate future, the US and Chinese economies are unlikely to see growth as rapid as that achieved in 2003-04, export growth cannot be expected to see a recovery in the short term. (ii) The high level of resource prices is hampering the growth of corporate profits. It is also unlikely that the growth of domestic demand will accelerate.

As a result, the real economic growth rate for fiscal 2005 is likely to be 1.2%, lower than in fiscal 2003-04. It is even likely to be slightly lower than the latent growth rate, which is expected to be somewhere in the middle of the 1-2% range. It is likely that the Japanese economy will only achieve clear growth after the beginning of 2006, and that this will be prompted by a recovery in exports, following an acceleration of the US economy.

For more information on the content of this report, please contact: Makoto Ishikawa the Japan Research Institute, Limited.

Tel: 03-3288-4263

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