Japan - Developments in Individual OECD Countries

OECD Economic Outlook, June, 1993

Having contracted in the second half of 1992, activity has continued to be weak, as businesses cut back further on their capital expenditure and consumer spending stagnated. Despite further losses in Japanese export market shares, due to worsening competitiveness, the trade surplus continued to rise because of terms-of-trade effects and weak import demand. Against the background of sluggish economic activity and low inflation, the official discount rate has been brought down to 2 1/2 per cent, matching its 1987-88 low, and a second large fiscal package was announced in April. Monetary and fiscal easing has been accompanied by a surge in the stock market and higher bond yields, which may reflect more optimistic expectations for domestic growth. Indeed, there are signs that the recession has bottomed out and activity should pick up in the second half of 1993. As yet, however, the signs of recovery are rather fragile, with the sharp yen appreciation adding to uncertainties over business prospects.

Recent developments

GDP fell by 1 1/2 per cent (s.a.a.r) in the second half of 1992, the third and fourth quarters both registering TABULAR DATA OMITTED declines. Private sector demand was especially weak: non-residential investment declined, while consumption and housing investment were flat. The most buoyant elements were public investment and exports. For 1992 as a whole, real GDP increased by 1.3 per cent, with almost equal contributions from the public sector and net exports.

Private sector activity continued to be weak in the first quarter of 1993. Investment remained on a downward trend, reflecting overcapacity in industry and excess stocks. Personal income growth was held back by sharply lower overtime hours and sluggish gains in employment. In addition, weak corporate profits have not allowed for much increase in bonus payments, which ordinarily comprise about a quarter of cash earnings. Although the unemployment rate has risen only marginally, and real income growth has been boosted to some extent by a fall in inflation to around 1 1/2 per cent, consumer sentiment remained very weak.

With the commercial real estate sector suffering from overbuilding, the main sources of domestic demand strength so far in 1993 have been residential construction and public works, the latter reflecting the delayed impact of the August 1992 fiscal package. Export growth, by contrast, seems to have slowed, reflecting weaker overseas TABULAR DATA OMITTED markets and the appreciation of the yen, which is leading to further losses in Japanese export market shares.

There are, nevertheless, signs that the first quarter of 1993 may have marked a cyclical low: new car registrations rose, the inventory overhang shrank, industrial production increased and capacity utilisation steadied. Share prices recovered strongly, probably reflecting, in part, the fact that corporate restructuring has begun to be effective in halting the two-year deterioration in operating profits. The composite indexes of coincident and leading indicators both began to give more positive readings, not just from the financial and construction sectors, but also from the investment goods sector, where new orders for machinery rose.

Policies and other forces acting

Monetary policy has been conducted against the background of demand weakness, declining inflation and a rising yen. In February, the Bank of Japan cut the official discount rate (ODR) by a further 75 basis points, taking the rate down to the historical low of 2 1/2 per cent that prevailed from February 1987 to May 1989. Short-term rates (three to six-month CDs) have subsequently traded at around 3 1/4 per cent. Bond yields also declined to below 4 per cent initially, but the rally was short-lived; by late May the average ten-year government bond yield had risen to around 5 per cent, as signs of strengthening activity emerged. At the same time, monetary easing has at last been accompanied by a recovery in the money stock (M2 CDs), after six months of decline.

Concern has remained about the surge in problem loans at financial institutions, as a result of continued weakness in real-estate prices, especially for commercial property. Land prices are estimated to have fallen by 8 per cent on average in 1992, with residential prices declining slightly less than commercial ones. To boost their operating income and strengthen their capital base in the face of mounting loan losses, the banks have adopted a cautious credit stance, tightening previously lenient credit standards and not offering lower lending rates to higher-risk customers. Despite this, overall bank profits fell substantially in FY 1992 due largely to write-offs of bad loans. Nevertheless, helped by increases in subordinated debts and the recovery in the stock market, all the city banks and long-term credit banks easily achieved the BIS target capital/asset ratio of 8 per cent at the end of March 1993.

Japan's growing external surplus and the increasing foreign demand for Japanese securities, especially stocks, have been associated with a strong rise in the yen. The yen has risen in effective (trade-weighted) terms by almost 11 per cent compared with late 1992, reaching Y 107 to the dollar in May, compared with Y 124 at end-December.