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The Outlook for the Japanese Economy in Fiscal 2008:
a Growing Mood of Adjustment

December 9, 2009

Overview

In spite of continued stagnation in the household sector, the Japanese economy continues to enjoy a gentle recovery led by the corporate sector, against a backdrop of export growth driven by shipments to newly developing economies and natural resource-producing countries and a positive stance on capital investment. However, since about the summer of 2007, the emergence of a number of negative factors, such as the sub-prime crisis in the United States, the rise in the prices of primary products such as crude oil and the sharp slowdown in construction starts due to the revision of the Building Standards Act, has increased the downward pressure on the economy.

Under the impact of the subprime crisis that originated in the United States, foreign economies, on which the Japanese economy relies, are experiencing a gradual deceleration across the globe. In the United States in particular, confidence has begun to fall in both the household and the corporate sector, and the negative impact of the subprime crisis on the real economy looks set to be prolonged. However, the scenario in which newly developing economies and resource-producing nations basically continue to enjoy a high rate of growth and continue to drive the growth of the world economy is set to remain in place. Japan's exports are also supported by shipments to the newly developing economies and resource-producing countries, and are likely to continue to grow, albeit at a slower pace.

Thus, although external demand will remain strong, three negative factors are likely to depress the corporate and household sectors.
(i) The fall in share prices triggered by the subprime crisis will lead to a decline in consumer and corporate confidence and depress the economic growth rate.
(ii) The major part of the rise in the price of crude oil will be absorbed by the corporate sector under the title of costs, and for this reason ordinary income will fall by ¥2.9 trillion. The rise in the price of gasoline and kerosene will increase the burden increase the household burden by ¥1.1 trillion.
(iii) The fall in the number of construction starts will have a negative impact on the economy in the following three ways:
(a) Housing investment will see a sharp fall.
(b) Construction investment in the corporate sector will fall. The fall in the number of factory construction starts may also lead to a fall in orders for machinery
(c) Consumer spending will decline owing to a fall in purchases of durable goods and to the deterioration of income conditions in conjunction with a decline in business performance in construction-related industries.

Until the end of 2008, it is likely that these three factors will disturb Japan's growth rate and force the growth path of the economy downwards, so that it diverges to a considerable degree from the actual trend of the fundamentals. In the second half of fiscal 2007, the economy is likely to see a growing mood of adjustment, owing largely to the downturn in housing investment and in construction investment by enterprises. Corporate profits and employee incomes are also likely to see a year-on-year fall. As a result, the growth rate for fiscal 2007 is likely to fall to 1.0%, well below the Bank of Japan's projection. On the assumption that construction starts begin to recover in early fiscal 2008, the growth of housing investment and construction investment by the corporate sector is likely to accelerate up to and into the summer of 2008 or thereabouts, boosting the economic growth rate. The growth rate for fiscal 2008 is also likely to recover to a robust level of 2.0%. However, this firm performance in fiscal 2008 will be nothing more than a "swing back" from the sharp fall recorded earlier, and should not be interpreted as a positive movement. The growth rate obtained if pent-up demand for construction investment is excluded is likely to remain weak. Moreover, given the rise in the prices of primary products and the lack of progress in passing the rise in costs on to the prices of final products and services, the downward trend of the GDP deflator is set to continue. There is little prospect that the reversal of nominal and real growth will be rectified in the near future.

Thus, given that the Japanese economy is highly likely to go through a difficult time, the government will find it necessary, for the time being, to shift the emphasis of its policy management to take account of the economic downturn. The clarification and acceleration of construction inspection procedures should be a particular priority. The Bank of Japan should also switch to a monetary policy stance based on vigilance against the risk of an economic downturn.

In the medium-to-long term, the issue will be how to enhance the capacity of domestic demand to fuel economic growth. In an era of ongoing globalization, the economy is increasingly likely to suffer external shocks via many different routes, including the deceleration of foreign economies, the fall in overseas share prices, and the spread of the credit crunch. This is largely because, against a background of declining confidence due to anxiety over the future, together with increasing polarization in a variety of areas, Japan's domestic demand is weak and the resistance of the economy as a whole to external shocks is declining. Problems such as income stagnation and gaps will have to be overcome through the pursuit of a robust growth strategy.

For more information on the content of this report, please contact Hideki Matsumura, the Japan Research Institute, Limited.

Tel: 03-3288-4524
E-mail:matsumura.hideki@jri.co.jp

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