in the global circumstances surrounding prices and the effects on the global economy through financial markets, for example, a rise in long - term interest rates. in china, strong economic growth is continuing supported by firm domestic and external demand. however, it is pointed out that fixed asset investment continues relatively high growth and there is the risk of an infrastructural bottleneck arising, for example from the shortage of electricity. china has structural problems, including the large income gap between metropolitan and rural areas. the chinese economy should be watched carefully from the viewpoint of whether it can continue to achieve sustainable growth. iii. characteristics of corporate behavior and future prospects one of the characteristics of japan's current economic recovery is that the economy is growing at a moderate pace. as i have already mentioned, this is against the background of cautious corporate behavior. in other words, if corporate behavior becomes more active, it could cause the outlook for economic activity and prices, which i have just explained, to deviate upward. one might wonder why firms continue to be cautious even in a situation of continued economic recovery with improved profitability. i will present some possible explanations for their cautious behavior. first, it is rational of firms to want to repay interest - bearing liabilities and increase capital as appropriate, because they have become more conscious of business risk and financial risk after experiencing the severe downturn in the business cycle after the bursting of the bubble and instability in the financial system. firms have been strongly aware of the necessity of strengthening their resilience to unexpected shocks by squeezing inventories and fixed costs. they have also been making efforts to reduce their debt - to - capital ratios in light of the heightened awareness of credit ratings and financial markets'evaluation with the progress of globalization of financial markets. second, the intensified global competition accompanying emerging economies'transition to market economy, which i mentioned earlier, is likely another factor. cautious corporate behavior can be seen in most advanced nations, including the united states, though to a varying degree. the yield spread derived by subtracting the expected earnings on stocks from long - term interest rates has been on a declining trend in these countries. this means that the stock markets'expectations for economic growth have been declining. while corporate scandals in the united states related to accounting rules and delayed structural reforms in europe may also have had some effect on investors'sentiment, intensified global competition seems to have contributed to the cautiousness of corporate behavior. it is quite natural for japanese firms to feel that they are most

and this alleviates the negative effect of high crude oil prices on the economy. in addition, the yen's appreciation in the past two years has partially restrained the rise in crude oil prices denominated in yen. however, closer monitoring is required of the risk of downward deviation of the economy, due to possible emergence of a profit squeeze and decline in real purchasing power, as the price of middle eastern crude oil, which accounts for a significant proportion of japan's imports, has risen in the current situation unlike during the price hike last year. in addition, as evident from continuing high price levels in the futures market, the possibility cannot be ruled out that expectations that crude oil prices will remain high may become more widespread. if the high price is actually sustained, the trajectory of global economic growth might deviate downward, and we need to be aware of the indirect effects of any deceleration of the global economy on the japanese economy through the resulting reduction in exports. the second point i would like to discuss as downside risk is the outlook for the world economy. the world economy continues steady expansion, occurring mainly in the united states and china, and it is thought very likely that it will continue expanding at a rate roughly equivalent to the potential growth rate. at the meeting in april, the g - 7 countries concurred that global expansion remained robust and economic growth in 2005 is likely to be solid. the imf forecast of real gdp growth for 2005 and 2006 is 4 to 5 percent. regarding price developments, the rise in energy and materials prices, including crude oil, has so far been absorbed by the corporate sector partly through productivity increases, and as a result, inflation has been contained. however, with the possibility of high materials prices continuing for a considerable period, awareness of a risk of inflation on a global basis has begun to increase. in the u. s. economy, although inflationary pressures are most likely to be contained, due consideration has been given to a possible increase in inflation expectations, since productivity growth has been decelerating and unit labor cost has been increasing in a situation where domestic supply - demand conditions are already tight. the u. s. federal reserve indicated its judgment on prices in the press release issued after the policy change in may as follows : " pressures on inflation have picked up in recent months and pricing power is more evident. longer - term inflation expectations remain well contained. " the bank will closely monitor, with consideration of their implications for the japanese economy, changes