Economy Report

(Extracted from 2002 Economic Outlook)

REAL GROSS DOMESTIC PRODUCT : The Japanese economy sustained a gradual recovery from the beginning of 1999, whereupon it weakened again in November 2000. Real GDP growth in 2001 is estimated to be around -0.60.2 percent, whereas those of 1999 and 2000 were 0.7 percent and 2.4 percent, respectively.

The weakness can be ascribed to three main causes. Firstly, exports, and plant and equipment investment, the engine for economic recovery, were both weak, leaving the recovery to depend too heavily on external demand and IT. Secondly, consumption failed to pick up; and thirdly, the economy was under pressure from the non-performing loans (NPLs) problem and excessive debts.

In August 2002, the economy continues to be in a difficult situation, but it shows signs of an incipient recovery, especially with regard to exports and industrial production.

As for short-term prospects, the impact of a large increase in exports and a rally in industrial production are expected to spread throughout the economy, and bring about an incipient economic recovery. On the other hand, developments in the worldwide decline in stock prices and depreciation of the US dollar are further increasing uncertainty surrounding the future of the world economy, and there are concerns over the downward pressure on final demand that may be expected as a result of this development..

It is expected that a recovery of the corporate profits and an increase in business investment will be seen in the second half of the fiscal year (FY1) 2002, the Japanese economy will be broadly flat throughout FY2002, but get out of the stagnation, and begin to move gradually towards a recovery centering on private demand in FY 2003.  

INFLATION : Japan has been in a state of deflation since 1999 in terms of consumer prices and, since the mid-1990s, in terms of the GDP deflator. It is the first experience of this for Japan and other advanced economies since the World War II. In FY2002, it is expected that prices will continue to fall, but the rate of decline will be somewhat reduced by a slight improvement in oversupply conditions.

In 2001, domestic wholesale prices declined slightly (by 0.8 percent) compared to the previous year. This decline has continued since 1992, excluding 2000 (when prices were almost unchanged) and 1997 (when they increase by 0.6 percent due to a rise in the consumption tax). The prices of electrical appliances such as personal computers and ICs dropped by 4.9 percent and vehicles prices dropped by 2.0 percent, whereas the cost of petroleum and coal products increased by 4.6 percent. Recently, prices have been broadly flat. The average Domestic Wholesale Price Index in FY2002 is expected to decline by 0.8 percent.

Consumer prices have been declining slightly since the fall of 2000 (in 2001, they declined 0.8 percent, excluding fresh food), mainly due to a fall in the prices of industrial products such as consumer durable goods and food products. The decline in CPI has continued for the first time since 1971 (the oldest comparable data) and the average Consumer Price Index in FY 2002 is expected to decline by 0.6 percent.

EMPLOYMENT : The unemployment situation remains severe. Although overtime work hours have increased, the unemployment rate has remained at a high level and wages have continued to weaken.

The number of the employed compared to the same month of the previous year has continued to decline since April 2001, and the decline has been especially sharp since September. The percentage of regular employees (excluding agriculture and forestry) has decreased for seven consecutive years since 1995, whereas that of temporary employees and daily employees has increased over the same period.

Unemployment was at record 5.0 percent in July 2001, the highest since 1953. It has moved to around 5.5 percent since then. According to the "Fiscal 2002 Economic Outlook and Basic Stance for Macroeconomic and Fiscal Management" which the Japanese government published in January 2002, the average unemployment rate in FY 2002 is expected to rise to 5.6 percent while the structural reforms needed for job creation proceed.

The number of the new job offers in 2001 increased by 1.5 percent and has fluctuated since the beginning of 2002. Though job offers continue to show weak movement; the number of effective job offers and the effective job offer ratio have remained low.

BALANCE OF PAYMENTS : Exports have dropped sharply, affected by the slowdown of the global economy in 2001. They bottomed out in spring of 2002. Recently they have increased, as exports of electrical devices, mainly electronic components such as semiconductors, and general machinery are on a sharply increasing trend and exports of transportation equipment are steady, reflecting the worldwide recovery.

Imports in the second quarter (April-June), third quarter (July-September) and fourth quarter (October-December) of 2001 also decreased by 2.62.9 percent, 4.23.0 percent and 2.02.2 percent respectively, and remained the same increased sharply (3.8 percent) in the second quarter (April-June) of 2002 after a small decline (0.1 percent) in the first quarter (January-March) in 2002, compared to the previous quarter.

Recently, imports increased slightly, as imports of machinery equipment increased as a result of recovery of production mainly in the electrical appliances industry.

The surplus in the Goods and Services trade balance shrank to 3.2 trillion yen in 2001, the second-lowest level since 1985. Most of the change accounts for the decline of the trade surplus, as imports steadily increased due to structural reasons such as the development-and-import scheme, whereas exports significantly dropped due to the cyclical factors such as the recession of the US economy and the decrease of IT-related demand.

The surplus in the Goods and Services account hit bottom in the second quarter of 2001 and has been increasing recently, as export value increased faster than import value due to the combined effects of the bottoming out in export volume and to the sideways movement of import volume.

The surplus in the merchandise trade balance and the current account balance are expected to increase slightly (the current account balance is 2.32.1 percent of GDP) in FY2002, partly as a result of the mild recovery of the global economy.

GROSS EXTERNAL DEBT : At the end of 2001, net external assets jumped to 179.3 trillion yen, up from 133.0 trillion yen in 2000. The increase is accounted for by several factors such as the increase of the estimated asset value in foreign currency because of the low exchange rate. External liabilities slightly declined to 200.5 trillion yen, partly reflecting the drop in internal equity investment. Total external assets at the end of 2001 were 379.8 trillion yen.

EXCHANGE RATE : The exchange rate of the yen against the U.S. dollar moved broadly, from 116-125 yen during the first half of 2001, rising to 119 yen (in August) and falling to 131 yen (in December). The yen hovered around 133 yen from January to March 2002 and rose to 119 yen in June.

FISCAL POLICY : The government’s basic stance for macro-economic and fiscal management is to steadily implement structural reform and carefully watch the economic situation. In October 2001, the government adopted the "Front-Loaded Reform Program" for accelerating the pace of structural reform and subsequently formulated the first supplementary budget of one trillion yen. It also focused on the creation of new jobs and the formation of a safety net concerning job security and small and medium-sized enterprises.

The serious situation of the economy caused the second supplementary budget of 2.5 trillion yen to be passed in February 2002, based on the "Immediate Action Program for Structural Reform" formulated in December, to accelerate structural reform while avoiding a deflationary spiral.

At the beginning of December 2001, the cabinet decided on the "Guidelines for Formulation of the FY2002 Budget" (hereafter referred to as "the Guidelines"). This shows a strategy to formulate next year’s budget as the first step of fiscal reform. Based on the Guidelines, the FY2002 budget of 81 trillion yen was formulated, reducing the amount of general account expenditures by 1.7 percent from the FY2001 initial budget. The budget prioritizes spending by allocating greater funds to the seven priority areas including measures for Japan’s aging society, and the promotion of science, technology, and education. On the other hand, public works expenditures were reduced by more than 10 percent, and budget allocation were prioritized towards the designated seven areas.

The Second Supplemental budget for FY2001 and the FY2002 budget are being implemented in an integrated and seamless manner, in order to prevent the Japanese economy from falling into a "deflationary spiral", while at the same time accelerating structural reforms. In June 2002, the Cabinet presented several points for the FY2003 budget compilation as follows; (i) to overhaul the mandatory budget, (ii) to establish a small, efficient government through promotion of public corporations reform, administrative reform of central and local governments, a budget squeeze and organization curtailment, (iii) to change budgetary formulation procedures in order to strengthen the government’s decision-making system under the Prime Minister’s leadership, and (iv) to ensure the consistency of finance with economy, and revenue with expenditure.

MONETARY POLICY : Looking at short-term interest rates, the overnight call rate moved at a low level in 2001 reflecting the monetary easing policy conducted by Bank of Japan’s (BOJ) several times during the year. It fell slightly to 0.001 percent in July, after slight rose to 0.012 percent in March 2002. Interest rates for two- and three- month contracts have continued to move at low levels since April 2001. Long-term interest rates, which had moved downward since August/September 2000, rose from July to the beginning of August 2001; they have moved sideways since mid-August. After a slight rise in January 2002, they fell from March to July.

The balance of the current account at the BOJ increased significantly, to 14.6 trillion yen in July 2002 from 4.5 trillion yen in March 2001, due to the introduction of quantitative guidelines on money market operations. In addition, the amount of long-term government bonds purchased increased to 12 trillion yen per year in 2001 from 4.8 trillion in 2000.

The BOJ also extended the maximum period for using the Lombard-type lending facility in September to secure smooth fund settlement and the proper functioning of financial markets. In addition, the BOJ decided to purchase commercial paper more actively under repurchase agreements and collateral uses to include asset-backed commercial paper in December 2001, aiming at making of the effect of the monetary easing to corporate banking more pervasive.

MEDIUM-TERM OUTLOOK : On January 2002, the Japanese government decided to adopt a document entitled "Structural Reform and Medium-Term Economic and Fiscal Perspectives", which addressed the government’s medium-term macro-economic and fiscal policies, which are centered on structural reform. It also included a scenario for economic growth over the next five years. The period of intensive adjustment over the next few years will be an important preparation for achieving private-demand-driven economic growth. It is expected that economic growth will stay low for the next two years or so, but subsequently the economy will pick up and achieve 1.5 percent growth or over in real terms and 2.5 percent or over in nominal terms. As for fiscal policy, the ratio of general government expenditures to GDP will be kept at or below its present level during FY2002 and 2006. As a result of positive growth led by private demand and fiscal structural reform, the ratio of the primary balance deficit of central and local governments to GDP is expected to decline from 4.3 percent in FY2000 to approximately half that level by about FY2006, and a primary balance surplus is expected to be achieved in the early 2010s.

OTHER PERTINENT INFORMATION (e.g., structural changes and reforms, foreign direct investments, interest rates, capital markets, etc.)

Since April 2001, the government has fundamentally overhauled and strengthened its programs for structural reform, based on the belief of "no growth without reform." In June, the government formalized its "Basic Policies for Economic and Fiscal Policy Management and Structural Reform of the Japanese Economy" (hereafter referred to as "Basic Policies"). This was followed by the formulation of the "Reform Schedule" in September, providing a road map for the process of structural reform. Furthermore, the government set out the medium-term prospects for the economy and public finance for the next five years, and introduced the budget in FY2002, which tightly prioritized government spending in ways unseen in previous budgets.

Since FY 2002, the government has a implemented fundamental reform of existing social and economic structures through measures such as the expeditious disposal of NPLs, the resolution of excess indebtedness, regulatory reform and reform of giant public corporations, with a view to developing an environment conducive to rigorous activities of the private sector, and advancing fiscal consolidation through budgetary reform.

Overcoming deflation is the most important task during about two years of the intensive adjustment period necessary for the economic revitalization. On 13 February, the government formulated "Emergency Countermeasures to Deflation", including the promotion of the disposal of NPLs and stabilization of the financial system, based on the understanding that a resolution of the financial problems is crucial to overcoming deflation. In addition, in June 2002, the government and the ruling parties agreed to implement the structural reform focusing on the magnification of private demand and employment. They also agreed that the measures, such as promotion of a strategy for economic activation including regulatory reform, tax reform and the establishment of a dynamic and secure financial system including the promotion of the disposal of NPLs, should be implemented as soon as possible.

On 25 June 2002, the government formulated the second phase of the Basic Policies, i.e. "Basic Policies for Economic and Fiscal Policy Management and Structural Reform of the Japanese Economy 2002" (hereafter referred to as "Basic Policies 2002"). It sets out a strategy for economic activation by improving industrial competitiveness through "selection and concentration", and by creating demand through creating "specific areas for structure reform". It also presents ideas for tax reform aiming at the recovery of economic viability, removing impediments to individual lifestyles. In parallel, the restraint on budgetary expenditure will be strictly implemented through setting priorities for social infrastructure development, promoting the reform of social security system, and an authority shift from central government to local governments. In July, Prime Minister Koizumi instructed ministers concerned to set up concrete proposals for policy and regulatory reforms according to the "Basic Policies 2002". By implementing those measures, it is expected that a gradual and sustainable economic recovery will begin in FY2003.

Annex I

JAPAN: OVERALL ECONOMIC PERFORMANCE

Notes: Figures italicized - A new System of National Accounts (changed in 2002) is applied for the estimation of the figures in 2001. Figures before 2000 are estimated in the conventional method.
** Refers to fiscal year (April to March)
*** The calculation method of the real effective exchange rate was changed in February 2002, and the figures are retroactively revised accordingly.

Annex II

JAPAN: FORCAST SUMMARY (percent change from previous year)

as of 1 August 2002

Notes: The official figure for 2001 refers to FY 2002 (from April 2002 to March 2003).
The IMF forecast is based on the IMF World Economic Outlook (IMF, April 2002).
The OECD forecast is based on the OECD Economic Outlook (OECD, April 2002).

Annex III

JAPAN: MEDIUM-TERM TREND FORECAST (percent)