bank of japan ’ s annual review of monetary and economic developments bank of japan communication, the bank of japan annual review 1998. annual review of monetary and economic developments in fiscal 1997 summary japan ’ s economic growth slowed during fiscal 1997. 1 the economy, which had been on a recovery path, began to decelerate with the turn of the new fiscal year in april 1997, and became increasingly sluggish toward the end of the fiscal year. final demand deteriorated toward the end of fiscal 1997. until recently, net exports generally followed an upward trend and underpinned japanese economic activities. in detail, real exports expanded, reflecting firm business conditions overseas - particularly in europe and the united states - and also by the depreciation of the yen, while real imports remained virtually unchanged. however, net exports peaked out toward the end of fiscal 1997, owing to a decrease in exports to other asian countries against the background of the ongoing economic adjustments in the region. meanwhile, public - sector investment basically trended downward because of tight budgets at both the central and the local government levels. business fixed investment maintained a gradual increase during the first half of fiscal 1997, particularly in the manufacturing industry. however, in the second half of the fiscal year, it seemed to have peaked out reflecting factors such as deterioration in corporate profits. private consumption and housing investment were depressed from april 1997 mainly in reaction to the surge in demand ahead of the rise in the consumption tax rate from 3 to 5 percent. 2 the stagnation became evident from autumn 1997 partly against the background of the deterioration in household confidence despite a moderate recovery temporarily observed around summer 1997. the stagnation in final demand adversely affected production, corporate profits, and employment condition. accumulation of inventories was followed by an adjustment in production, resulting in a decrease in output in the last two quarters of fiscal 1997. inventories in final - demand goods, including construction goods and consumer durables, began to accumulate in spring 1997, and this development expanded to producer goods in autumn 1997. corporate profits plunged in the second half of fiscal 1997 resulting in a turn to decline for the fiscal year as a whole. profits declined even at large manufacturing firms that had maintained steady growth up until that time. under these circumstances, corporate sentiment worsened rapidly across a wide range of firms especially during the second half of the fiscal year, as indicated by the bank ’ s tankan - short - term economic survey of enterprises in japan and other statistics. labor market conditions deteriorated in fiscal 1997

and the positive lending attitude of financial institutions, which facilitated corporate financing and business fixed investment especially in nonmanufacturing industry. however, after autumn 1997, business conditions became severe due to the economic turmoil in other asian economies, especially in korea and the asean nations, and the cautious lending attitude of financial institutions, due in part to weak stock prices and market concerns regarding credit risk. 3 in addition to the weak household expenditures, various strong and persistent structural adjustment pressures on the economy can be cited as another fundamental factor in the economic stagnation. with such pressures, the economy, unable to resume a self - sustained recovery which started in fiscal 1996, stagnated, a result that was triggered directly by factors such as fiscal restraint and cautious household sentiment. the attitude toward expenditure and investment at large manufacturing firms facing so - called “ mega - competition ” remained selective. nonmanufacturing firms were pressed to boost their productivity - which was said to be behind that of the manufacturing sector - amid the ongoing deregulation in addition to the balance - sheet adjustment following the collapse of the “ bubble ” economy. turning to the industrial structure, the japanese economy seemed to be still in the process of transition. there appeared to be no leading industry raising productivity and thereby creating additional employment, while in some industries employment adjustment pressure was intensifying. prices ( excluding the effects from the rise in the consumption tax rate ) remained stable on the whole during fiscal 1997, although they softened slightly during the second half. 4 import prices rose sharply in 1996 but turned to a decline in the first half of 1997 reflecting the fluctuations in crude oil prices and the exchange rate of the yen. the prices remained relatively stable until the end of 1997, but began to trend downward once again reflecting the weakening of international commodity prices due to the economic crisis in asian economies. domestic wholesale prices seemed to be bottoming out during the second half of 1996 and the first half of 1997. prices then softened from summer 1997, reflecting the weakening market conditions in materials - related asean comprises thailand, malaysia, singapore, indonesia, the philippines, brunei, vietnam, cambodia, and laos. price data presented in this report exclude the effects of the rise of the consumption tax rate from 3 to 5 percent effective from april 1, 1997. goods due to stagnant domestic final demand and the accumulation of inventories, in addition to the fall in import prices. corporate service prices in fiscal 1997 narrowed their rate of decline following the ongoing downward trend and have