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A Forecast of the Bank of Japan's
Short-Term Economic Survey ("Tankan")
(December Survey)

December 02, 2005

Business sentiment DI set to show a cautious but steady improvement

Although conditions have not yet improved to the extent of producing a perceptible acceleration in the rate of climb of the business sentiment diffusion index (DI), and negative factors such as inventory adjustments in a number of sectors and uncertainty as to the effects of the halving of the fixed rate income tax reduction continue to impact on business confidence, the continued recovery of the economy and of share prices suggests that, even in the "Forecast" to March 2006, the rising trend of the DI in itself is likely to continue.

In the manufacturing sector, the DI has been boosted by the completion of inventory adjustments in the electronic components and devices sector, steady domestic private sector demand, the recovery of exports, centering on shipments to China, and the rise in domestic share prices, among other factors. The recent decline in the value of the yen has also helped to boost confidence among companies with a high export ratio (exchange rate assumed by manufacturing sector for second half of fiscal 2005, as of September survey: ¥105.62/dollar). However, there are also negative factors, such as residual pressure for inventory adjustments in the general-purpose materials sector. In the electronics sector, although downside risk has diminished, sales prices remain low and it is thought that the recovery has not been sufficient to generate significant pulling power for the manufacturing sector as a whole.
Thus, although there will probably be little sign of acceleration, the manufacturing sector as a whole is likely to see the steady upward trend of the business sentiment DI continue.

In the non-manufacturing sector, too, the DI is basically expected to show a steady improvement against the backdrop of steady domestic private sector demand and a rise in share prices.
However, the "Forecast" is likely to be affected by the following grounds for uncertainty and remain somewhat cautious:
(i) There are fears that the effects of the halving of the fixed rate income tax reduction will begin to appear from early 2006, especially in individual-oriented sectors.
(ii) In the real estate sector, which led the improvement in the DI through September 2005, it is highly unlikely that a conclusion will be reached, during the current survey period, as to the impact on market conditions of the scandals involving a number of firms that emerged in November this year.

The trend of crude oil prices, which appear to have begun to peak, is highly likely to have a positive impact on actual figures for December in the sense that prices have not risen as high as they were expected to at the time of the September survey (actual figures for December are expected to be somewhat higher than the conservative forecast made in September).
However, as the number of companies that would go so far as to say that the upward trend of crude oil prices has begun to collapse is thought to be very small, crude oil prices are once more likely to be incorporated in the "Forecast" as a negative factor.

2005 capital investment plans: strongest growth since 1990

Capital investment plans for fiscal 2005 show strong growth in the form of a rise in demand for investment in (i) the expansion of capacity in the non-manufacturing sector (the building and improvement of optic fiber networks in the telecommunications industry, the expansion of warehouses and distribution centers in the transportation industry, etc.), (ii) the construction of factories with a view to increasing the added value of domestic production and boosting development capability in the manufacturing sector, and (iii) the maintenance and renewal of existing facilities, which has remained pent up until now (the improvement of distribution infrastructure in the electric power industry).

The rate of growth in the amount of capital investment plans recorded by the December survey (on an all industries/all sizes of company basis; including land but excluding software) is likely to be in the region of +9.0%. This will be the highest rate for plans as of September recorded since fiscal 1990. Given that the amount that small and medium enterprises plan to invest tends to be revised upwards with each successive survey, the final increase is highly likely to reach double figures.

There are two reasons for this:
(i) Having completed a range of structural adjustments, enterprises have begun to adopt a more "aggressive" approach to business management, taking a medium-to-long term view.
(ii) Although crude oil prices are high, profits continue to rise and the corporate sector as a whole remains cash-rich.

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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