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A Revised Economic Forecast for Fiscal 2005-2006
(Subsequent to Release of 2nd Preliminary QE for July-September)

December 12, 2005

Little Likelihood of Faster Growth, but Economy Set to Remain Firm

This revised forecast of economic growth reflects the content of the annual revision of the Survey of National Accounts GDP estimates for fiscal 2004 (released on December 2) and the 2nd preliminary quarterly estimates (QE) for the July-September quarter (released on December 9). The major points of these two sets of statistics are as follows.

Following revisions in line with the 2000 benchmark revision, the annual revision for fiscal 2004 adjusts real growth rates for fiscal 2000-2004, particularly those for consumer spending, upwards by an average of 0.2 points (see table).

The estimate of real GDP growth for the July-September quarter (2nd Preliminary QE), which has been revised to reflect the fiscal 2004 annual revision time series and newly reflects the content of the Financial Statements Statistics of Corporations by Industries, Quarterly among other publications, is of +0.2% (annualized rate +1.0%) on the previous quarter, a downward adjustment as compared with the figure of +0.4% (annualized rate 1.7%) suggested in the 1st preliminary QE, if change on the previous quarter for the July-September quarter is taken in isolation. However, an important reasons for this downward revision is that the estimated growth rate for the April-June quarter, already high at the time of the 1st preliminary QE, was revised upwards still further at the time of the 2nd preliminary QE, which led to a still greater "reaction" in change on the previous quarter for the July-September quarter*1. The 2nd preliminary QE, which put the real growth rate for the first half of fiscal 2005 at +4.0%, a figure that in fact represents an upward revision of the figure of +3.6% suggested at the time of the 1st preliminary QE, and put real change on the previous year for the July-September quarter at +2.9%, roughly level with the figure of 3.0% suggested at the time of the 1st preliminary QE, we conclude that there is no need to revise our view that the economy has escaped from its "plateau" phase and is exhibiting a growing recovery trend.

*1: Real growth for the April-June quarter is estimated at +1.2% on the previous quarter (annualized rate +5.0%), an upward revision as compared with the figure of +0.3% on the previous quarter (annualized rate +3.3%) suggested at the time of the 1st preliminary QE. In particular, the contribution to growth made by inventory investment (change on previous quarter) has turned positive, going from -0.1 points to +0.3 points. It should be remembered that, following the benchmark revision and seasonal adjustments, major changes have recently taken place in the pattern of fluctuation.

Accordingly, our assessment of the economic outlook is basically unchanged. Our new growth forecasts revise the previous forecasts published subsequent to the release of the 1st preliminary QE (November 15; fiscal 2005: +2.7%, fiscal 2006: +2.0%) upwards by 0.1 points for both fiscal 2005 and fiscal 2006. However, these adjustments should basically be interpreted as reflecting the 2000 benchmark revision.

The outlook as we move into fiscal 2006 is that the Japanese economy will remain on a firm footing, thanks to domestic private demand. The fact that various structural adjustments are being completed and business enterprises are starting to take a more "aggressive" approach to business management and the fact that profits continue to rise in spite of the high price of crude oil and money stocks remain plentiful, suggest that capital investment will continue to grow.

Thanks to improved employment and income conditions and the continued recovery of asset values such as share prices, consumer spending will continue to rise, with increased spending from a wide range of consumer bands.

However, as the following factors will curb the pace of economic recovery, economic growth is unlikely to accelerate:

Although consumer spending is unlikely to see a significant downturn, the halving and eventual abolition of the fixed rate income tax reduction and other scheduled increases in the burden on household finances will inevitably disrupt the recovery pattern.

Although businesses are likely to be able to maintain profit growth, the boost to profits provided by the reduction of fixed costs such as personnel expenses is tailing off and it is likely that the pressure on profits exerted by the rise in the price of crude oil will gradually become apparent, especially in sectors where growing international competition and other factors make it difficult to raise sales prices.

Although export growth is highly likely to continue on the strength of shipments to newly developing economies and natural resource producing countries, the deceleration of the US economy as the second half of 2006 approaches is likely to slow the rate of growth. Moreover, as the growth of imports will accelerate in tandem with exports to newly developing economies, the contribution of "net exports" to economic growth will diminish.

The growth of capital investment is also likely to slow to some extent during fiscal 2006, relative to fiscal 2005, as a number of major projects are completed.

Consequently, fiscal 2005 will see real economic growth of +2.8%, the fastest rate recorded since fiscal 2000. Notwithstanding some deceleration during the second half of the year, fiscal 2006 will see overall growth of +2.1%.

The three major risks to the main scenario described above are (i) delays to inventory adjustments or the necessity of greater adjustments in the general-purpose materials sector (ii) a loss of momentum in the US economy and (iii) a further rise in the price of crude oil and other natural resources.

*2: For details of forecasts, see "Revised Economic Outlook for Fiscal 2006-2015: Population Trends and the Japanese Economy 10 Years From Now -What Must be Done in the Forthcoming Growth Phase-" (update of article published on December 7 to reflect content of latest QE to be posted on the JRI website in the near future).

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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