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A Revised Economic Forecast for Fiscal 2005-2006
(Subsequent to Release of Preliminary QE for April-June)

December 9, 2009

Annualized Growth of 1.1% in the April-June Quarterw

In the April-June quarter of 2005, Japan's real GDP (1st preliminary figures) rose by 0.3% on the previous quarter (equivalent to annualized growth of 1.1%). Although inventory investment fell sharply, consumer spending and capital investment, two major elements of domestic demand, saw continued relatively strong growth and exports, exports, which recorded a quarter-on-quarter dip in the January-March quarter, also began to recover centering on shipments to the United States, Middle East and Central and South America, resulting in positive growth for a third quarter in succession.

The movements of the major elements of demand were as follows.

(1) Consumer Spending (Real: +0.7% on Previous Quarter, +3.0% Annualized)

Following on from the sharp rise recorded in the January-March quarter (equivalent to annualized growth of 5.0%), consumer spending continued to grow in the April-June quarter. This is largely due to the recovery of spending by consumers in the mid-range income brackets as fears over employment and incomes have eased. A survey of expenditure by item reveals promising developments in areas such as (i) demand for leisure during the long stretch of consecutive public holidays, (ii) digital consumer electronics and personal computers (iii) seasonal goods (air conditioners, summer clothing, including "Cool Biz" clothing). Thanks to the introduction of many new models and sales promotion campaigns, car sales have also held firm. However, although the growth recorded during the first half of the calendar year (January-June) on the second half of 2004 (equivalent to annualized growth of 2.9%) includes the reaction to the rather slow growth recorded in the second half of 2004, it is rather suggestive of overheating given the recovery potential of wages for the same period (equivalent to an annualized recovery of 0.7%).

(2) Housing Investment (Real: -2.3% on Previous Quarter, -8.9% Annualized)

Housing investment figures were down for a second quarter. In the wake of the cut in the tax reduction on housing loans from January 2005, investment is peaking out, especially in the area of owner-occupied housing.

(3) Capital Investment (Real: +2.2% on Previous Quarter, +9.0% Annualized)

Capital investment saw relatively strong growth, following on from the annualized increase of 11.2% recorded in the January-March quarter. A number of major projects generated by (i) pent-up demand in the electric power industry (in fiscal 2005, capital investment by the industry is set to rise for the first time in 12 years), and (ii) capital investment in the media industry (TV studios, printing factories), are boosting investment figures but, basically, there is a growing shift of emphasis towards channeling part of the plentiful stock of money into investment with a view to increasing the sophistication of industry. The depth of demand for investment is steadily growing.

(4) Private Inventory Investment (Real: Contribution to Growth on Previous Quarter, -0.5 points)

Real growth of private inventory investment fell sharply, declining quarter-on-quarter for the first time in three quarters. Among other factors, this was due to the fact that stocks of cars and other manufactured goods, which had accumulated during the January-March quarter while waiting to be laded owing to the bottleneck in marine transportation, began to fall. Against a backdrop of relatively strong growth of domestic private sector demand, it is also possible that "unintentional inventory reduction" occurred in the areas of capital goods and non-durable consumer goods.

However, because (i) inventories of production goods have been growing in the general goods sector due to the growth of production capacity in China, among other factors, overall inventory investment, once the "lading factor" is discounted, saw a slight increase (the average for January-June was slightly higher than that for July-December 2004). Taking industry as a whole, the conclusion is that pressure for inventory adjustments remains.

(5) Public Investment (Real: -1.3% on Previous Quarter, -5.2% Annualized) The boost to demand provided by the fiscal 2004 supplementary budget (relating to recovery work after natural disasters, approved in February) began to emerge but, overall, the decline in public investment continued.

(6) Exports (Real: +2.8% on Previous Quarter, +11.6% Annualized)

Shipments of cars and capital goods to the United States, the Middle East and Central and South America played an important role in a recovery from the fall in exports recorded in the January-March quarter. However, the peaking of shipments to China and the EU countries that was the principal reason for the fall in exports recorded in the January-March quarter continues. Moreover, if figures are analyzed on the basis of the January-June period with a view to offsetting the impact of delays in shipping, the annualized growth rate works out at 4.2%. Given the annualized rates of 19.9% and 6.0% achieved in the first and second halves of 2004, it appears that exports are slowing.

(7) Imports (Real: +1.6% on Previous Quarter, +6.7% Annualized)

Although imports of crude oil are weakening, import figures recorded a quarter-on-quarter rise for an eighth consecutive quarter, thanks to (i) solid demand from the domestic private sector and (ii) the international division of labor coming into operation in earnest.

The movements of the growth rate during the April-June quarter confirm that domestic demand has become firmer, moving towards sustained growth. However, the nominal growth rate, which is closer to the true picture, saw little change, suggesting that the "growth plateau" continued.

Moreover industrial indicators remain weak, with slight delays occurring in the final stages of inventory adjustments in the electronic devices sector, and inventories of production goods accumulating in the general goods sector. Given that the rate of income growth suggests that consumer spending is unlikely to continue growing at the rate recorded in the first half of the year and that exports are weakening due to slower demand from China and the EU, it is highly likely that the economic growth rate will slow temporarily during the July-September quarter.

Economy set for gentle recovery after escaping the "growth plateau"

Looking ahead, owing to the weakening of export shipments to China and the EU, the mixed state of production activity (which is now advancing and now retreating amidst delays in completing inventory adjustments in some sectors) and the likelihood of a slackening of consumer spending following the relatively rapid growth recorded in the first half of the year, among other factors, it is likely that the July-September quarter will see a growth rate somewhat lower than that recorded in the April-June quarter. However, given that substantial growth of capital investment, an improvement in employment conditions and a recovery of the US economy are expected, a sharp fall of the growth rate should be avoidable. From early autumn, when the completion of inventory adjustments is likely to be in sight and production activity is likely to begin recovering, it is likely that economic growth will gather momentum and that the Japanese economy will show clearer signs of escaping from its present "growth plateau".

From the second half of fiscal 2005 into fiscal 2006, as the pressure for structural adjustments recedes still further and the pressure for inventory adjustments diminishes, the economy is set to move towards recovery. However, for the following three reasons, the growth pattern on a quarter-by-quarter basis is likely to remain unstable: (i) As the recovery potential of wages is lower than in the past, and further increases in the burden on household sector, including the scaling back of the fixed-rate tax reduction, are scheduled, it is unlikely that the growth of consumer spending will accelerate.
(ii) With a slight adjustment of the US economy expected as the effects of the raising of interest rates spread, exports to the United States are unlikely to accelerate in fiscal 2006. (Two-digit growth of the kind seen in fiscal 2002-2004 is unlikely to be achieved.)
(iii) Although capital investment will continue to grow, the rising prices of natural resources will continue to exert pressure on corporate profits and the backswing that will follow the boost provided by large-scale projects implemented in fiscal 2005 mean that growth is likely to slow to some extent in fiscal 2006.

In conclusion, although the real economic growth rate will see no clear acceleration in fiscal 2005 and 2006, at 2.0% in fiscal 2005 and 2.2% in fiscal 2006, in both years, it is likely to remain at a level comparable to that recorded in fiscal 2003-2004.

The dissolution of the House of Representatives and general election this summer will have little short-term impact on the economy. Nor are they likely to have any severe medium-to-long term, as long as the election results do not lead to a reversal of the structural reform policy. Even if the election leads to a change of administration, as long as the current of reform "from public to private" and "from savings to investment", symbolized by the privatization of the postal businesses, continues, it is likely that Japan will avoid any sharp decline in economic vitality.

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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