Corporate confidence in Japan has dropped for the first time in seven quarters, the Bank of Japan revealed this week in the tankan survey covering the period September to December 2004. Although the fall was widely expected, the survey showed that sentiment among the manufacturing sector is pessimistic about the prospects of growth in the first quarter of 2005.

 

A slowing of production and exports, especially in the IT sector, caused business confidence among large manufacturers to fall to 22 points in December from 26 in September. The index for large manufactures had improved for six straight quarters. In September, it reached the highest level since the collapse of the bubble economy in 1990. In relative terms, it still remains high despite the quarterly decline. Moreover, the indexes for large non-manufacturers and small-to-midsize firms either held steady or grew modestly.

 

Owing to slow exports, the index for electronics makers registered at 11 points, a 17-point sequential decline. It marked the first drop for the IT sector since December 2002; the IT industry has figured prominently in Japan's economic recovery. Although demand was high leading up to the Summer Olympics, Japanese electronics makers are now cutting back on output as domestic demand subsides. Consumer spending for the third quarter grew by only 0.2%, after previous estimates called for 0.9% growth.

 

The diffusion index for the next quarter's business outlook declined by seven points for large manufacturers, but held steady for large non-manufacturers. Sentiment among smaller non-manufacturing companies strengthened for the seventh quarter in a row. The index also improved for retailers and was remarkably high for information and service providers. The results seem to suggest that the IT sector has entered a correction phase while non-manufacturers and smaller firms are possibly picking up steam.

 

A fall in capital spending had been forecast for the third quarter, but revised official GDP data showed that capital spending actually rose by 1.1%. In a potentially positive sign, the latest tankan report indicates that capital spending is likely to increase by an estimated 23.4% in fiscal 2004 for large manufacturers and by about 1.1% for non-manufacturers. However, concerns related to the value of the yen vis-a-vis the US dollar and slowing exports to China could dampen investor sentiment. Export growth to China has fallen to 10% for the year from a peak of 40%.

 

Predicting how soon the economy will pull out of the present deflationary cycle is not easy, as manufacturers are having difficulties passing on higher materials costs to the consumer due to weak demand. The Bank of Japan believes that the next stage of recovery could begin by summer 2005 if economic conditions in the US and China improve. The bank has said that it will maintain its two-year policy of holding interest rates near zero while injecting cash into the economy until consumer prices stop falling for at least a few months in succession. The current slide in prices has been ongoing for more than six years.