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Outlook for the Fiscal Year 2008-2009 Intensification of the Mood of Adjustment in the Japanese Economy Downturn in Domestic Demand Due to Soaring Cost of Natural Resources

DJune 16, 2008

Overview

Despite the weak recovery in domestic demand, the Japanese economy is showing sustained growth due primarily to foreign demand. Most economic indicators point to a slowdown and there is little sign of real “solid” growth. Looking toward the future, there are fears of a slowdown in the global economy due to the prolonged subprime mortgage crisis and the soaring cost of natural resources and its knock-on effects, and the risk of a downturn in the economy is growing.

Firstly, looking at the overseas economic situation, long-term stagnation is expected in Europe and the US against the backdrop of the prolonged subprime mortgage crisis and rising prices due to the soaring cost of natural resources. In the US, in particular, growth is likely to remain “fractional” for the foreseeable future. In the developing countries, on the other hand, growth is expected to remain basically high, driven by domestic demand for fixed capital investment, etc. Japanese exports are forecast to grow, albeit at a slow pace, underpinned by exports to developing countries and resource-producing countries.

Next, the upward trend in resource prices is expected to continue amid the likelihood of further decline in the value of the dollar due to the uncertain outlook for the US economy as well as factors such as increased demand in developing countries, supply constraints and the influx of speculative money. This is expected to have the following effects on the Japanese economy.

1) Macro effects
Rising resource prices will generate a transfer of income from Japan to resource-producing countries through increased import payments. Estimates of the amount of revenue outflow in fiscal 2008 run to 17 trillion yen. This will lead to a dramatic reduction in the trade surplus and the possibility of plunging into deficit after 2010. The difficulty of shifting costs onto the price of final goods and services will drive a drop in the GDP deflator.

2) Effect on corporate sector
Amid the slowdown in sales growth, ordinary profits will decline due to the increased cost of raw materials. Reduced cash flows will boost downward pressure on capital investment, and an increasing number of small and medium-sized enterprises will face bankruptcy due to the acute contraction of profit margins.

3) Effect on consumer prices
Consumer prices (excluding fresh foods) will rise at a faster pace, increasing by 1.6% in fiscal 2008. With companies reaching the limit of their ability to absorb costs, food prices as well as gasoline and utilities prices will start to rise. The decline in corporate profits will increase pressure on wages, so there will be little risk of inflation accelerating synergistically with wages.

4) Effect on individual consumption
As downward pressure on corporate profits increases, there will be a growing tendency to curb personnel costs, particularly bonuses. The added burden of rising costs will reach 4.3 trillion yen in fiscal 2008. As a result, household purchasing power is expected to decline by 1% or more. The adverse effect will be felt especially by low-income and rural families.

Looking at the Japanese economy in fiscal 2008 on the basis of the above, the mood of adjustment will intensify against the backdrop of pressure on corporate profits due to the slowdown in export growth and rising resource prices. To maintain steady exports to resource-producing countries and developing countries, recession must be avoided. With the continuing fall in corporate profits pushing down capital investment, the growing burden on households due to suppression of employees’ incomes and rising prices is expected to further dampen the pace of demand-led recovery after fiscal 2009. Furthermore, the GDP deflator will drop and zero nominal growth is likely. It will be harder for people to “feel real recovery.”

As for the Japanese economy in the foreseeable future, in the business cycle mechanism of “production→income→expenditure”, despite a healthy “production” first stage underpinned by external demand, the rising cost of natural resources will lead to a downturn in the next stage, “income,” creating a state that could be described as “thriving, but poor”. In view of the fact that the scale of income outflow is greater than during the oil crisis and far greater than other countries against the backdrop of high reliance on imported natural resources, trends in the price of natural resources will be a major factor in the outlook for the Japanese economy.

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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