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

December 9, 2009

Business sentiment DI: treading water largely due to adjustment in speed of expansion of production and stagnation of sales prices

The Business Sentiment Diffusion Index (DI) in the Bank of Japan's Short-Term Economic Survey ("Tankan") for March is expected to reflect a slowing of the pace of economic growth since the beginning of the year.
Japan is enjoying strong capital investment, a recovery in consumer spending and a pause in the upward trend of crude oil prices, but the deceleration of overseas economies, the rise in inventory ratios of IT devices sector and the persistent preference for low prices shown by the household sector have led to a slowing of the rate of expansion of production activities in recent months and made it even more difficult for small and medium companies in particular to raise their sales prices.
Moreover, the volatility of exchange rates and share prices since late February have slowed the pace of business development in recent months and may have a negative impact on corporate confidence.

Under these conditions, it is highly likely that the upward trend observed in every sector of industry up to December 2006 will pause, and that the DI will remain at the same level or record a small fall.
On an all industries/all sizes of company basis, the Institute expects the DI to fall by 2 points on its December level, to +8. Even among small and medium enterprises in all industries, where the DI saw its first rise in 15 years in December 2006, the DI is set to move into the negative once again, albeit only a short way.

Meanwhile, the "Forecast" DI for the period to June this year is highly likely to reflect a general mood of caution, owing to the risk that the US economy will suffer a "delayed landing" and the attendant risk that markets will become destabilized.
On an all industries/all sizes of company basis, the "Forecast" DI is likely to be 2 points point lower than in March, at +6.

Thus, the March Tankan is highly likely to show corporate confidence "treading water", but, owing among other factors to the low general level of inventory ratios in sectors other than IT devices, the alleviation of various pressures for structural adjustment and the availability of abundant money stocks (in contrast to the situation at the time of the collapse of the IT bubble or during the "plateau" phase of 2004), Japan's corporate sector retains a considerable ability to absorb shocks.
If the adjustments in the US economy look like being completed by about the middle of 2007, the DI for the June Tankan is likely to show a further improvement in corporate confidence (as compared with the "Forecast" DI in March) and is unlikely to suggest that the economy is peaking out.

Capital investment plans: possibility of 2-digit growth in FY 2006;
"launch-pad" for FY 2007 likely to be cautious

Although it is possible that the pace of growth among small and medium enterprises has slowed in recent months, the gentle improvement in capital investment efficiency (ratio of ordinary profit to fixed assets) and the availability of plentiful money stocks suggest that the overall level of capital investment in fiscal 2006 is not likely to be very far off the planned level recorded in December 2006.
At the March forecast stage, Year-on-year growth of capital investment on an all industries/all sizes of company basis is likely to be +10.2% (including investment in land but excluding investment in software). The final real growth rate is also likely to reach somewhere between +9% and +10%.

Because (i) companies are adopting a cautious stance as they wait to see how far the domestic and overseas economies have decelerated in recent months, (ii) the impetus provided by large-scale projects in certain industries (materials, railways, etc.) is tailing off and (iii) an increasing number of companies making active use of mergers & acquisitions as a way of expanding their businesses, among other reasons, capital investment plans for fiscal 2007, as compiled from the March survey, are likely to start from a low "launch pad" as compared with fiscal 2005 and fiscal 2006 (plans are forecast to fall by −2.8% year-on-year on an all industries/all sizes of company basis), especially among small and medium enterprises.

Owing to (ii) and (iii) above, the pace of capital investment in fiscal 2007 is likely to be a little slower than the rapid expansion recorded up to and into fiscal 2006.
However, owing to (i) the strength of business profits and the availability of plentiful money stocks, and (ii) management concerns in the corporate sector shifting from the "adjustment of excessive levels of employment, capital equipment and debt" to "active business development with a view to survival against global competition", among other reasons, it is likely that the upward trend of capital investment in the medium term itself can be maintained.
If, under these conditions, the grounds for uncertainty over outlined in (i) above are gradually eliminated, it is highly likely that the level of capital investment will be adjusted upwards, as in the average year, and that capital investment will, in the end, rise for a fifth consecutive year.

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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