Bank of Japan's monthly report of recent economic and financial developments1
BANK OF JAPAN, COMMUNICATION, October 1998.
The Bank's View2
Japan's economic conditions still continue to deteriorate.
With respect to final demand, public investment has bottomed out. Net exports
(exports minus imports) are basically increasing mainly due to a decline in imports. Business fixed
investment, however, has been decreasing significantly partly because of financial constraints, and
housing investment has declined further. Private consumption has not yet shown a recovery despite
the special income tax reduction. Against this background of weak final demand, production has
been reduced substantially. As a result, some industries have shown improvements in inventory
adjustments, but the level of inventories is still high as a whole. With the decline in expenditure and
production, corporate profits are worsening rapidly. Furthermore, the employment and income
conditions have deteriorated further as the unemployment rate marked a historical high and the
decline in employee income has accelerated. In these circumstances, corporate perceptions of
business conditions have worsened substantially and consumer sentiment has become cautious.
As the above indicates, there remain continued negative interactions of production,
income, and expenditure. With the effects of the comprehensive economic stimulus package and the
recent monetary easing, the deterioration of the economy is expected to moderate gradually toward
the second half of fiscal 1998. Nevertheless, the economy is hardly expected to recover immediately,
judged from the strong negative interactions mentioned above and the financial constraints such as
financial institutions' cautious lending stance due to the nonperforming-loan problem. In these
circumstances, there is an immediate need to rebuild the stability of the financial system. In this
regard, bills related to financial revitalization have been legislated, and a bill related to bank
recapitalization, including policy measures to strengthen banks' capital base through injecting public
funds, has passed the House of Representatives of the Diet. It is desirable that functions of and
confidence in Japan's financial system be restored based on these schemes. Furthermore, the
government is devising plans for economic recovery, including reduction in personal income taxes
and corporate taxes as well as additional public investment. It is important to materialize these
measures promptly, in such a way that they not only have sizable direct effects on the economy but
also contribute to restore corporate and household confidence.
With regard to prices, wholesale prices are on a downtrend reflecting the expanding
output gap, and consumer prices have fallen below the previous year's level. With respect to the
outlook, given the persistently strong negative interactions of production, income, and expenditure,
the expansion in the output gap seems unlikely to cease despite the expected effects of the
comprehensive economic stimulus package. Furthermore, the continued decline in wages and the
recent appreciation of the yen may exert downward pressure on prices. Hence, prices are likely to be
on a downtrend for some time.
In the financial markets, responding to the further monetary easing by the Bank of
Japan on September 9, short-term interest rates declined as a whole after mid-September. However,
since the end of September, the Japan premium has expanded and interest rates on Euro-yen deposits
have rebounded slightly reflecting intensified market concern toward Japanese financial institutions'
funding in foreign currencies over the year-end. In the meantime, due to heightened uncertainty over
the economic outlook, long-term interest rates declined considerably.
Stock prices continued a downtrend reflecting the concern over the worldwide stock
market plunge, the further deterioration in economic indicators, and the persistent uncertainty over
the resolution of the problems with Japan's financial system. In October, stock prices recorded
historically low levels since the bursting of the economic "bubble". Meanwhile, in early October, the
yen surged against the dollar with the emerged uncertainty over the outlook of the US economy.
With regard to corporate finance, while funding needs for real economic activities
seem to be decreasing, some firms, especially large ones, are seeking to secure ample on-hand
liquidity to prepare for unexpected situations. Reflecting such increase in credit demand, the growth
rate in has slightly recovered since the summer of 1998.
M2+CD
However, Japanese financial institutions have become more cautious in extending
loans, facing up severe fund-raising environments and deteriorating business conditions of borrower
companies. While especially large firms are steadily increasing the issuance of commercial paper
and corporate bonds, small and medium-sized firms and relatively low-rated ones continue to face
difficult conditions for fund-raising in capital markets. The influence of these severe financial
conditions on business activities and on the economy continues to warrant careful monitoring.