A Revised Economic Forecast for Fiscal 2006-2007
(Subsequent to Release of 2nd Preliminary QE for January-March)

Real growth of 2.4% in fiscal 2006 and 2.5% in fiscal 2007 forecast

The 2nd Preliminary Quarterly Estimates for January-March 2006, released by the Cabinet Office onJune 12, suggest real GDP growth on the previous quarter equivalent to an annualized rate of +3.1%, an upward revision as compared with the +1.9% estimated at the time of the 1st Preliminary QE.
A breakdown by major elements of demand reveals that substantial upward revisions of capital investment figures (real annualized growth on the previous quarter is revised upwards from +5.8% estimated at the time of the 1st Preliminary QE to +12.9%, to reflect the content of Financial Statements Statistics of Corporations by Industry, Quarterly), and public investment figures (revised upwards from –13.2% to –2.5%, to reflect the content of the March construction statistics) have made a major contribution to the overall upward revision.
As a result, real and nominal GDP growth for fiscal 2005 are both revised upwards by 0.2 points on the levels estimated at the time of the 1st Preliminary QE, respectively to +3.2% and +1.9%.Moreover, the carry-over effect on real economic growth in fiscal 2006 is expected to be 1.3 points, up 0.25 points on the level forecast at the time of the 1st Preliminary QE.

Meanwhile, share prices in Japan and overseas have been soft since mid-May. One major factor is thought to be a worldwide fall in the supply of risk money amidst growing uncertainty over the future course of US monetary policy, but, on the home front, the administrative punishment of auditors and allegations of misconduct by leading investment funds have exerted downward pressures.
Given that the correlation between consumer spending and domestic share prices, and the sensitivity of the former to the latter have been increasing in recent years, one should assume the possibility of a negative impact on consumer spending.
It is also likely that weather anomalies will also depress consumer spending in the short term, to some extent.

In view of these factors, JRI has made a small downward adjustment to its forecast of consumer spending for fiscal 2006 as compared with the May forecast (subsequent to the release of the 1st Preliminary QE), and an upward adjustment to its forecasts of capital investment and public investment. As a result, the forecasts of overall economic growth (both real and nominal) have been revised upward by 0.1 points.
However, as long as domestic share prices gradually recover their stability, on the assumption that corporate activity sees a steady expansion and political disorder is avoided, it is unlikely that our view of the overall economic trend will change.
Accordingly, our growth forecast for fiscal 2007 remains basically the same as that published in May.

• Looking to the future, the economic recovery is basically set to continue on the strength of the continued operation of the virtuous circle of export and capital investment growth leading to growth of production and profits, which leads to employment and wages growth, which in turn brings growth of consumption and further growth of production and profits.
• With various pressures for structural adjustment abating, the corporate sector in particular, is likely to focus on active business development in order to survive global competition and securing fresh human resources in preparation against the retirement of the dankai generation of baby boomers and the full-scale onset of population decline, while working to boost its medium-term potential growth rate.
• However, the following factors suggest that economic growth is unlikely to see another acceleration in the short term:
• Given that the US economy is expected to see a gentle deceleration into the spring of 2007, it is highly likely that the rapid growth of exports (currently recording double-digit annualized rates) will gradually slow.
• Given that attempts are being made to stabilize the labor share at a low level, even if the rising trend in the number of persons in employment strengthens, the adjustment made to wages will keep the growth of employee remuneration on a macro basis to a gentle pace.
• The rise of natural resource prices and long-term interest rates will bring pressure to bear on corporate profits.
• Moreover, although domestic share prices are expected gradually to recover their stability, on the assumption that corporate activity sees a steady expansion and political disorder is avoided, the fact that the supply of risk money is declining worldwide means that there is little hope of a high-paced recovery. Under these conditions, the boost to consumer spending is likely to tail off to some extent, especially during the first half of fiscal 2006.
• In summary, fiscal 2006 is likely to see the economy shift away from the rapid recovery mode it entered after escaping from the "plateau" and gradually settling into sustained growth mode. More specifically, the quarterly growth rate is likely to settle to an average of around 2%.
• In fiscal 2007, besides the positive effects of a recovery of the US economy, it is likely that the mass retirement of dankai generation of baby boomers will have a growing positive effect on the economy, via two routes — the boost to consumption that will be provided by a rise in the payment of lump sum retirement benefits, and the boost to corporate profits that will come from a fall in personnel costs.
  Under these conditions, economic growth is likely to accelerate in the second half of the fiscal year, and it is possible that the growth rate for the fiscal year as a whole will reach the middle of the 2-3% range.
• Consumer prices (excluding fresh food; year-on-year change) are likely to settle into a positive trend as the balance of supply and demand improves. However, a number of factors, including intense market competition fanned by the growth of imports, the low recovery potential of wages and a slowdown in the rate of increase of natural resource prices, mean that there is little scope for an acceleration of the rate of increase.

Inquiries relating to the content of this report, etc. should be addressed to Ishikawa , Economics Department, the Japan Research Institute, Limited.

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