japan, growth by default

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    Feb 25, 2004

    Japan: Revival of the Cycle

    Osamu Tanaka (Tokyo)

    Real GDP rose by an annualized 7.0% QoQ for October-December 2003, the first high growth figure recorded in 13 1/2 years. Based on this result, we have revised our economic forecasts for 2004-05. The GDP data for October-December confirm two developments:

    (1) the revival of leadership by overseas demand is now causing private-sector domestic demand to expand and

    (2) the pace of the decline in the deflator is accelerating even as the percentages of decline are easing in the various price indexes.

    Prospects for future economic growth will likely depend on two points as well:

    (1) whether the groundwork has been set for a self-sustaining recovery in domestic demand and

    (2) if the pace of decline in the deflator contracts.

    To state our conclusion up front, we do not think any full-fledged rebound in personal consumption can be expected, because corporations continue to restrain personnel spending and households’ need to restore depleted savings both will weigh heavily on consumption. In this environment, manufacturing and capex activity cannot escape from their dependence on external demand — the economy will remain quintessentially "reptilian," needing the warming sunlight of external demand to maintain its temperature and activity, and therefore subject to the vagaries of global cycles. Accordingly, our economic scenario is as follows.

    (a) We expect recovery in production and capex sparked by exports, improvement in labor and income conditions providing support for personal consumption, brisk demand for digital home appliances in the run-up to the Olympics, and government and BoJ industrial policies that focus on avoiding a hard landing ahead of the Upper House elections and the total elimination of payoff. Hence, the recovery trend should continue through 2004, in our view.

    (b) With the deceleration in Chinese and US economic conditions, the impact of the strong yen has begun to appear. When demand for digital home appliances eases, there should be a mini-inventory adjustment. As commodity prices remain at high levels, the terms of trade are worsening. The commitment of the government and the BoJ to strengthening the corporate safety net might well change after the elections for the Upper House. So we expect a temporary contraction in the first half of 2005.

    (c) Overseas economic expansion is likely to continue, despite a moderation in its pace, and with more progress in the elimination of bubble era legacies (i.e., balance sheet restructuring), mainly at large manufacturing companies, we should see a return to growth after a short and mild recession.

    (d) However, given depleted household savings and psychological uncertainty about the future, we do not expect a full-fledged rebound in personal consumption. Lacking an engine of growth after digital home appliances, the recovery will likely be quite tepid.

    The acceleration in the pace of decline in the deflator occurs as mainstay price indexes such as the consumer and corporate goods price indexes are showing a slower pace of decline than previously. It is highly likely that this shift in the deflator is caused by the workings of the downward bias caused by the way a Paasche index is compiled. This downward bias is particularly evident in capex, and appears striking during periods of recovery, when production expands for IT-related products that are subject to sharp price declines.

    Therefore, we expect relatively strong real GDP growth in 2004, supported by both improvement in nominal growth and the decline in the deflator. On the other hand, for 2005, the opposite mechanism is likely to be at work during a period of stagnation, making it difficult for the downward bias in a Paasche index to have its effect. For 2005, real GDP growth is likely to be crimped by both sluggish growth in nominal terms and an easing in the pace of decline in the deflator.

    Our revised figures are as follows: We have substantially raised our real GDP growth forecasts to +3.2% for F2004 and +3.7% for C2004 (previous: +1.7%, +1.9%), but lowered them to +0.9% for F2005 and +1.1% for C2005 (previous: +1.8%, +1.5%).

    For 2004, there are three main reasons for the forecast increase. The base effect of the high growth of October-December 2003 raises our forecasts, the inventory cycle for digital home appliances should push up production, and the sharp decline in the deflator is likely to continue.

    For 2005 conditions will likely reverse in important ways, and we have trimmed our estimates for two main reasons. The digital home appliance inventory cycle should act to lower production, and export deceleration should lead to deceleration in production and capex.

    In nominal GDP terms, while we are looking for positive growth for 2004 (+0.9% for the fiscal year, and +1.3% for the calendar year), for 2005 we now anticipate another downturn (-0.7% for the fiscal year, and -0.6% for the calendar year).

    In effect, we are looking for two straight years of real GDP growth of roughly 3% for 2003-04. But these figures are supported by the large decline in the deflator, and so differ greatly in quality from growth of more than 3% achieved in 1996 and earlier. These estimates are nothing like forecasts for a genuine full-fledged recovery.

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