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back to index backASIAtalk February,  2006


Japanese Economy Remains Strong After Record 2005 Performance

Japan's economic recovery continued throughout 2005, delivering strong improvements in retail sales growth, industrial output, trade performance, and bank lending. Even more noteworthy, consumer and wholesale price statistics suggest Japan is finally emerging from the deflation that has troubled its economy. As a result, rising investor interest caused Japanese stock indices to rise dramatically -- 40% for the Nikkei 225 in 2005 alone.

This has caused some investors to wonder if Japan's potential has been realized and whether it will remain as compelling an investment story in 2006. While the emergence of the Livedoor financial scandal served recently to unnerve investors, a period of consolidation is not altogether unhealthy, and should be expected after a period of such strong performance. It is important, however, to keep in mind the trends that underlie the progress Japan has achieved. One of the most important developments is the restructuring of the corporate sector, which has created leaner, more competitive, and more profitable firms. Other important trends include an improved banking sector and increased consumer spending.

As Japan transitions to a more market-oriented economy under the continuous structural reform by the Japanese government, there is every reason to believe the momentum seen over the past few years will accelerate and build over time. Indeed, enhanced business profitability and confidence is helping to create a virtuous cycle of business investment, hiring and wage increases. This is resulting in higher consumer spending, increased domestic investment into Japanese equities and profit growth that should continue over the coming year.

Japan's Economy Ended 2005 on a Strong Note

One extremely important theme that emerged in 2005 and which continued throughout the year was the stabilization or slowing of deflation. After small declines in the previous four months, the government reported that core” consumer prices ended their fall in October. Specifically, wholesale prices rose at an annual rate of 1.9% in November. Moreover, prices of final goods increased for the first time in almost five years. Beyond this, consumer prices rose 0.1% yearon-year in November, the first rise in more than two years. This accumulated data led Japanese Finance Minister Sadakazu Tanigaki to tell a recent Japan Society gathering in New York that Japan was likely to overcome deflation within this year.” An end to deflation would be extremely beneficial as it would bolster profits, the hiring of workers, consumer spending, bank lending, and investment.

On the banking front, end-of-the year data was also positive. First, non-performing loans at leading banks fell from 8.4% in March 2002 to 2.4% as of September 2005. Second, in December, lending by Japanese banks, after special adjustments, grew by 1.3% to ¥390.08 trillion from the previous year. This represented the fifth straight monthly increase. Quoted in the Japan Times, a Bank of Japan official stated the December data confirmed that demand for loans is improving on the back of the economic recovery and diminishing excess debts in the corporate sector.” Finally, when looking at the year as a whole, after adjustments for special factors such as securitization, lending by Japanese banks fell by 0.1% in 2005. This is the smallest drop since the Bank of Japan starting gathering such data in October 1998.

Another bright area has been industrial activity. In November, Japanese industrial output grew by 1.4% month-on-month. This represented the fourth consecutive monthly increase. It was more than twice the increase seen in October and represented the fastest growth in manufacturing in two years. Commenting on this data, Akiyoshi Takumori, Chief Economist at Sumitomo Mitsui Asset Management stated, We can say that the economy has finally emerged from a soft patch.” The October data also led Japan's Ministry of Economy, Trade and Industry (METI) to label Japanese industrial output as being on a moderately upward trend”. Additionally, private-sector machinery orders in October grew by 4.8% over the preceding month and 8.5% over the previous year.

While the industrial sector is significant, people assessing Japan's prospects should also pay attention to its non-industrial sector as well. That is because the performance of Japanese business in 2006 will have a strong influence on the country's growth prospects, affecting hiring and wage increases, and the continuation of productivity and innovation beyond that already seen. It is important to note that Japanese businesses are increasingly confident about their future. A Bank of Japan Tankan survey of sentiment among big manufacturers released in December showed a positive balance of 21 for the October to December period. This was the highest level of business confidence in a year.

Source: JETRO Focus Newsletter - GAI


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