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

March 14, 2006

Prospects of a Sustained Economic Recovery

The 2nd Preliminary Quarterly Estimates for October-December 2005, released by the Cabinet Office onMarch 13, suggest real GDP growth on the previous quarter equivalent to an annualized rate of +5.4%, a rate virtually identical to that of +5.5% estimated at the time of the 1st Preliminary QE. However, a breakdown by major elements of demand reveals that, reflecting the content of the Financial Statements Statistics of Corporations by Industry, Quarterly, the figures for capital investment have been revised downwards (to a real annualized growth rate on the previous quarter of 1.4%, as against the 7.2% estimated at the time of the 1st Preliminary QE) while figures for inventory investment have been revised upwards (to a real annualized growth rate on the previous quarter of 0.7% as against the 0.1% estimated at the time of the 1st Preliminary QE).

The key points of our revised growth rate forecast are as follows:

As the boost provided by major redevelopment projects in city centers is tailing off and an increasing number of companies have come to regard mergers & acquisitions and overseas direct investment as important options for expanding their business, the pace of capital investment growth is unlikely to be any higher than in past growth phases.
However, given that surveys conducted by a number of institutions at the end of 2005 suggest that the scope of capital investment will broaden during fiscal 2005 and that the growth rate may reach double figures, and as corporate profits in recent months have remained buoyant as sales growth has absorbed the negative impact of the rise in the price of crude oil, among other factors, it would be premature to go so far as to fear a deceleration of capital investment. If anything, it is highly likely that capital investment will see a recovery during the January-March quarter, and the fact that part of the demand for capital investment is set to be carried over into fiscal 2006 may even enhance the sustainability of capital investment growth during fiscal 2006.

On the inventory investment side, it appears that the increase in the value of stocks of raw materials in recent months was underestimated at the time of the 1st Preliminary QE. For this reason, its contribution to the growth rate in fiscal 2005 has undergone a slight upward adjustment.
Although adjustments have been made to the estimates for the major elements of demand on the basis of figures for raw materials, etc., our basic growth forecast and assessment of the general economic outlook are the same as those published after the release of the 1st Preliminary QE*1. The details are given below.

*1: Previous forecast, published on February 21: real growth of +3.3% in fiscal 2005 and +2.3% in fiscal 2006, and nominal growth of +2.0% in fiscal 2005 and +2.1% in fiscal 2006.

For three reasons, it is unlikely that GDP growth will continue at the rapid rate seen in the October-December quarter.

(i) Companies are considering measures such as mergers and acquisitions and overseas investment, as well as domestic capital investment, as means of expanding their business and are increasingly basing their choice on their assessment of which is likely to make the greatest contribution to the "enhancement of capital efficiency". For this reason, the pace of growth ofdomestic capital investment is likely to fluctuate, and the average pace is likely to be somewhat slower than that recorded in past growth phases.

(ii) Amidst ongoing efforts to stabilize the labor share at a low level, the pace of growth of employment and wages will also be slow. As a result, consumer spending is unlikely to see a steady climb.

(iii) In conjunction with the slight deceleration of the US economy, the growth of exports, which has reached double digits on an annualized basis in recent months, is likely to see a gradual deceleration.

However, the virtuous circle of export and capital investment growth -> profit growth -> employment and wages growth and rising share prices -> growth of consumption -> profit growth continues to function, and the economy is becoming more robust.
If anything, the fact that companies are maintaining a cautious management stance, and the fact that part of the demand for capital investment is set to be carried over into fiscal 2006 are likely to contribute to a prolongation of the economic recovery.

Moreover, if share prices regain their stability, in reflection of the fundamentals, the benefits of the rise in share prices can even be expected to offset the short-term negative effects of the halving of the fixed rate income tax reduction.

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

Tel: 03-3288-4263
E-mail:ishikawa.makoto@jri.co.jp

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