Forecast for the Japanese Economy in Fiscal 2016 and 2017

Transcription

1 February 2016 Forecast for the Japanese Economy in Fiscal 2016 and The Economy Is Improving Gradually, but There Is a Risk It Will Remain Virtually Flat for a Prolonged Period --- Economic Research Department

2 (1) Current State of the Economy: The Economy Is Basically Flat The real growth rate for the October-December period of 2015, which was announced on February 15, 2016 was 0.4% ( 1.4% at an annualized rate). This followed growth of +% in the July-September quarter (representing a +% upward revision of the previously announced figure) and was the first negative figure in two quarters. Since the beginning of 2015, quarterly growth rates have alternated between positive and negative, but, on average, the economy remains virtually flat. Examination of the real GDP data in greater detail shows personal consumption experienced a pronounced decline in the October-December quarter (Chart 1). Consumption was down 0.8% from the previous quarter and made a negative contribution to real GDP growth over the previous quarter of 0.5 percentage point. The unseasonably warm winter weather was a contributing factor, as demand for winter apparel dropped, bringing a decline of 3.7% quarter to quarter in semi-durable goods, but demand for durable goods, nondurable goods, and services also declined by 3.1%, 0.8%, and 0.1%, respectively. Even after excluding the effects of unseasonable weather conditions, trends in consumer spending are judged to be weak. Judging from the fact that real worker compensation showed a firm increase of % for the quarter (+1.8% year on year), it appears that consumption was restrained by a combination of the growing propensity toward frugality and a deterioration in consumer confidence accompanying the decline in stock prices and other factors. (Qr/Qr, %) 3.0 Chart 1. Real GDP growth rate by demand (Quarterly) Imports Exports Inventory Investment Government Expenditure Private Capital Investment Private Consumption Real GDP Source: Cabinet Office "Quarterly Estimates of GDP" 1

3 The recovery in residential housing investment from the slump that followed the earlier surge in demand preceding the increase in Japan s consumption tax rate (in April 2014) appears to have paused. New housing starts, which are a leading indicator, decreased, and housing investment decreased 1.2% quarter to quarter, the first decline in four quarters. In the corporate sector, private capital investment was up 1.4%, the second consecutive quarter-to-quarter increase and a higher percentage rise than in the previous quarter. The cautious stance of corporations regarding capital investment is believed likely not to have changed, but, with the continuing improvement in corporate performance especially among large companies, it would not be surprising for capital investment to show some improvement. However, there is a possibility that the figure for the quarter may be revised downward after the data of the Financial Statements Statistics of Corporations by Industry, which reflect trends on the demand side, are released. It is also possible that the cautious attitude of corporations toward investments may worsen going forward due to a decline in confidence among corporations. Turning to inventory investment, the contribution of inventory investment to real GDP growth for the quarter was 0.1 percentage point, which was the second consecutive quarterly decline, partly because inventory adjustments were still in progress in the corporate sector. As a result of the developments mentioned, the contribution of the private sector as a whole to GDP for the quarter was 0.5 percentage point. On the other hand, the contribution of the public sector was slightly negative, standing at 0.0% percentage point. The contribution of government consumption was +0.5 percentage point, mainly because of increases in medical and other costs; however, since the positive effects of allocations in the supplementary budget for fiscal 2014 are now running their course, public works investment continued to decline during the quarter, decreasing 2.7% from the previous quarter. Exports declined 0.9% from the previous quarter. Service exports are on a rising trend, reflecting favorable trends in consumption by foreign tourists in Japan, but exports of goods are weak because of the slowdown in overseas economies. On the other hand, imports decreased 1.4% for the quarter, reflecting weak domestic demand. Since this 2

4 was slightly more than the decline in exports, the contribution of the external sector was a marginal +0.1 percentage point, and, while small, contributed positively to GDP growth. The GDP in nominal terms decreased % from the previous quarter (a decrease of 1.2% at an annualized rate), thus slipping into the negative range. In addition, the GDP deflator, which reflects price movements in the overall economy, stood at +1.5%, slightly lower than the +1.8% in the July-September quarter. As a result of the decreases in crude oil and other resource prices, import prices have dropped substantially, thus raising the overall level of the deflator, which was also reflected in the lower rate of increase in domestic prices (+0.1% over the previous quarter on a seasonally adjusted basis). In considering economic trends going forward, it is important to assess the impact of the turmoil in global financial markets since the beginning of the year and effects of the introduction of negative interest rates by the Bank of Japan (BOJ). The decline in stock prices that began in December 2015 has continued in The Nikkei Stock Average that exceeded 20,000 in early December had fallen below 15,000 on February 12. Thereafter, the average rose 1,000 compared with the previous month on February 15 and has continued to fluctuate wildly. The decline in stock prices has occurred not only in Japan but also simultaneously in markets around the world, and, in foreign currency markets, funds have moved from riskier assets into yen, which is viewed as a safer asset. For this reason, the yen has appreciated, and while the yen stood at 123 against one U.S. dollar in mid-december, it had increased in value temporarily to about 110 in mid-february. On the other hand, the price of crude oil, which recently has shown signs of finally reaching bottom, remains at a low level. There is a possibility that this turmoil in financial markets will continue for the time being. However, compared with actual conditions in economies around the world, to some extent there is a tendency toward excessive pessimism. If the view that the pace of interest rate increases in the United States will be moderate is now widely shared, and if expectations rise that the brakes have been applied to the deceleration in the Chinese economy, there is a possibility that conditions could reverse themselves quickly. In 3

5 addition, although the declines in crude oil and other resource prices are having a negative effect on resource-producing economies, the reverse side of this is that lower resource prices are having a positive impact on Japan and other resource-importing economies. The increase in the value of the yen is a factor that lowers the profitability of exporting companies. However, since a stronger yen lowers the amounts spent on imports when expressed in yen, the declines in raw material, energy, and other prices reduce corporate costs, and, through the declines in gasoline and electric power costs, the real purchasing power of households is increased. Accordingly, yen appreciation improves Japan s terms of trade and has a positive effect on the economy; therefore, there is no reason to be excessively pessimistic if the yen increases in value. The recent appreciation of the yen has been at a very rapid pace, and, for this reason, the responses of exporting companies have been delayed, and there is a possibility that their performance may deteriorate rapidly. Nevertheless, if the yen appreciates to the 110 level to the U.S. dollar, companies can still show sufficient profit. Let us turn next to the effects of the BOJ s quantitative and qualitative monetary easing policies, including the introduction of negative interest rates. After the BOJ announced its policies, unexpectedly, stock prices rose, the yen weakened, and interest rates decreased. However, even though the BOJ s policy led to negative yields on 10-year government bonds and contributed to a decline in interest rates, deeply rooted concerns about the slowdown in overseas economies, the decline in crude oil prices, and concerns about the detrimental impact on bank performance after the application of negative interest rates brought a reverse wave of sudden declines in stock prices and an increase in the value of the yen. If market interest rates decline, in general, this should lead to increases in corporate borrowings and purchases of homes by the household sector. However, interest rates are already at a sufficiently low level, and a rise in demand for funds cannot be expected. In addition, there is a possibility that expanding the margin of negative interest rates will result in greater monetary easing, but there is a risk this will increase costs for banks and create turmoil in financial markets. There is also a risk that additional monetary easing will have a negative impact on the economy. For these reasons, we should not expect significant positive effects on the economy. 4

6 (2) Outlook for the Japanese Economy in Fiscal 2016 and Fiscal 2017: The Risk of the Economy Remaining Virtually Flat for a Prolonged Period Is Rising We have prepared this outlook based on the assumption that the consumption tax will be increased as scheduled to 10% in April 2017 and that lower tax rates will apply to certain items, including food and newspapers. We have also assumed that, in advance of the increase in the consumption tax, economic measures will be formulated, including an additional allocation for public investments, amounting to 0.5 trillion, in the supplementary budget for fiscal In fiscal 2015, the growth rate during the January-March quarter of 2016 is expected to move into the positive range, but will be only +0.1% over the previous quarter, thus leaving the economy virtually flat. The supply/demand balance for labor will remain tight, and household income conditions will continue to improve. In addition, the negative impact of unseasonable weather conditions will subside, and we are looking for a positive boost from the leap year effect. Accordingly, we are ing that personal consumption in the January-March quarter will expand over the previous quarter. However, there will be limits on the extent of the improvement because of factors that will restrain consumption. These will include the deterioration in consumer confidence along with the sharp decline in stock prices since the beginning of the year and the growing concerns about future directions in the world economy. Therefore, real consumption will not fully recover from the decline in the October-December quarter. In addition, judging from the trends in the world economy since the beginning of 2016, exports of smartphone-related components are expected to weaken, and, because of this and other factors, rapid growth in exports is not expected. Also, as a result of the decline in stock prices and the rise in the value of the yen, there is a possibility that confidence in the corporate sector, principally in manufacturing, will cool off suddenly, and steady expansion in corporate capital investment in the January-March quarter may be difficult. Moreover, there is a strong possibility that private residential investment and public investment, which have already peaked out, may continue to decline. Growth in real GDP for fiscal 2015 is expected to be +%, only a marginal improvement over the 1.0% negative growth in fiscal However, after the 5

7 exclusion of the carryover effect (+0.9%), growth during the fiscal year as a whole is to be %. The principal reason for stagnation in the growth rate in fiscal 2014 was the substantial decline in consumer spending after the increase in the consumption tax rate in that year, which was followed by a continuing downward trend in consumer spending. This resulted in negative growth of % compared with the previous fiscal year, the second consecutive year of negative growth. On the other hand, the improving trend in corporate performance is continuing, and, although shrinkage in the margin of improvement in profits is for the second half, corporations are expected to report record high profits for the third consecutive year. However, since corporations are expected to maintain their cautious stance toward capital investment, investment in real terms for the fiscal year is expected to rise 2.1%, which will be relatively small in comparison with the increase in corporate profits. The contribution of the external sector for the fiscal year is expected to be +0.1 percentage point, as exports expand by only a small margin of % and imports decline by a slight 0.1%, reflecting the weakness of domestic demand. Note that growth in nominal GDP is to be +2.2%, a relatively high rate of expansion compared with +1.5% growth in fiscal However, the reason for this will be a relatively high 1.5% rise in the GDP deflator. This rapid pace of expansion will be due to the decline in import prices, and the domestic demand deflator will remain virtually level with the previous fiscal year. (Yr/Yr.%) Chart 2. Real GDP growth rate by demand (Fiscal year) Forecast Exports Imports Inventory Investment 0.0 Government Expenditure -1.0 Private Capital Investment -2.0 Private Consumption -3.0 Real GDP Source: Cabinet Office "Quarterly Estimates of GDP" 6

8 In fiscal 2016, the pace of increase in the growth rate is expected to rise as we approach the fiscal year-end, and the outlook is for the continuation of positive growth of 1.0% in real GDP. However, during the first half of the fiscal year, the pace of improvement will only be moderate, and there may be periods when concerns about a possible downturn in the economy increase. The period when the pace of improvement will begin to quicken will be when the rate of increase in exports rises somewhat against a background of improvement in overseas economies and the surge in demand, prior to the next increase in the consumption tax, begins to emerge in the latter half of the fiscal year. There is a possibility that turmoil in financial markets, including declines in stock prices, will continue after the beginning of fiscal 2016, as concerns about the negative impact on the economy arise owing to the deterioration in consumer and corporate confidence. Even so, the outlook is for the economy to avert a downturn. For this reason, first, the drop in raw materials prices, including crude oil, is expected to give a boost to household incomes and corporate profits throughout the fiscal year. There is a possibility that the price of crude oil may rise gradually during the fiscal year, but, even so, the outlook is for crude oil prices in yen terms to decline about 30% year on year. In addition, along with the improvement in income conditions accompanying the tightening of labor markets, the maintenance of the rising trend in consumer spending will provide support for the economy. It is believed likely that labor conditions will continue to be favorable, and, along with the increase in the number of employed persons, wages in nominal terms are expected to continue to rise. Near the end of the fiscal year, a surge in demand will emerge in advance of the hike in the consumption tax rate, and the rate of expansion in consumer spending is expected to temporarily rise significantly. Moreover, the continuing improvement in corporate performance is another plus factor for the economy. Although raising sales prices is difficult and growth in sales is weak, corporations are continuing to experience improvement in marginal profits as a result of the drops in crude oil and other resource prices. Similarly, the positive effects of corporate restructuring thus far are enabling companies to maintain profitable operations. 7

9 In addition, due to the expected surge in demand preceding the upcoming rise in the consumption tax rate, corporations are expected to report a fourth year of record high ordinary income. Since corporations have high levels of cash flow and cash on hand, even if they maintain their cautious stance toward capital investment, increases in investments are likely to continue. There is a possibility that borrowing rates may decrease further along with the introduction of negative interest rates, but the level of interest rates is already low, and the introduction of negative interest rates is not expected to boost demand for borrowings. Public investment is expected to rise temporarily at the beginning of the fiscal year, owing to the impact of allocations in the supplementary budget for fiscal 2015, but after this rise runs its course, public investment will continue its decline. There is a possibility that demand related to the 2020 Tokyo Olympics will emerge, but, on a fiscal year comparison basis, the boosting effect will be marginal. As adjustments in financial markets pause, the world economy is likely to show stronger trends toward improvement in summer 2016 and thereafter. For this reason, the momentum of growth in exports is expected to grow gradually stronger in the latter half of the fiscal year, and this will be a factor providing support for the economy. On the other hand, since imports will rise more rapidly near the end of the fiscal year in tandem with the surge in demand prior to the increase in the consumption tax rate, the contribution of the external sector for the fiscal year is expected to be a small negative figure of 0.0 percentage point. Over the course of the fiscal year, the principal risk factor will be the possibility of a further deceleration in overseas economies. If the emerging economies, including China, and the resource-producing countries show further deceleration in growth, and Japan s exports shift to a decreasing trend, the risk of the Japanese economy remaining virtually flat for a prolonged period will increase. Turning to prices, it will be difficult for corporations to raise sales prices in the current economic environment, and, as the impact of the decline in energy prices grows gradually stronger, the consumer price index (CPI) (comprehensive index, excluding fresh foods) may again slip below the level of the previous year. Factors accounting for this will also include the subsiding of upward price pressures coming from higher 8

10 import prices accompanying the depreciation of the yen, and, as a result, the margin of the year-on-year decline may increase moderately from the middle of fiscal 2016 onward. Since even the comprehensive CPI, excluding food products (other than alcoholic beverages) and energy, will show a diminishing rate of increase, the BOJ will have to postpone the attainment of its inflation target beyond the currently scheduled first half of fiscal In fiscal 2017, real GDP growth is to drop to %, because of the impact of the consumption tax rate hike. However, since the increase in the consumption tax rate will be smaller than the previous increase in April 2014 and lower tax rates will be imposed on certain items, the surge in demand prior to the tax increase and slump afterwards are expected to be smaller. Even so, the impact of the decrease in real incomes of households is expected to be significant, and negative growth will continue, mainly in the household sector in the first half of the fiscal year. However, an increase in demand linked to the 2020 Tokyo Olympics will emerge in the latter half of the fiscal year, and the economy is expected to begin to show signs of improvement. Since growth in real wages is expected to be negative as a result of the tax hike, consumer spending will drop substantially in the April-June quarter in reaction to the surge in demand prior to the tax increase, and, thereafter, growth in the July-September quarter is to be marginal. In the corporate sector, there is a strong possibility that corporate profitability will begin to decline as the cost-reducing impact of the drops in crude oil and other prices recedes and the slump in demand following the consumption tax rate hike takes hold. This will likely restrain growth in private capital investment. Public investments may temporarily show positive rates of change compared with the previous year at the beginning of fiscal This will be because of the implementation of measures in the supplementary budget for fiscal 2016 aimed at responding to the slump in demand following the consumption tax rate increase and the accelerated usage of budgetary allocations. However, approaching the end of fiscal 2017, the effects of these measures are likely to gradually subside. Nevertheless, demand related to infrastructure improvement in advance of the 2020 Tokyo Olympics will gradually increase, and the outlook is for public investment to bottom out in the latter 9

11 half of the fiscal year. Exports will continue to improve gradually as the pace of improvement in overseas economies rises slightly. On the other hand, reflecting stagnation in domestic demand after the consumption tax hike, imports are to decline significantly, but, thereafter, improve at a moderate pace. However, since the growth in imports will be slower than the growth in exports for the fiscal year as a whole, the contribution of the external sector will expand to +%. There is a possibility that growth rates in real GDP on a quarterly basis will show a decline to negative growth in the April-June quarter, followed by marginal negative growth in the April-June quarter, implying that the economy is likely to continue to be stagnant in the first half of the fiscal year. However, drawing on the lessons learned at the time of the previous consumption tax rate hike, corporations are believed likely to take strong measures to avoid inventory accumulation, and households that purchased large durable goods before the previous tax rate hike are unlikely to accelerate their expenditures sufficiently to cause a surge in demand. Due to these and other factors, the magnitude of the reactionary slump is expected to be less serious. Positive growth will return, as we approach the end of the fiscal year, in part because of the gradual emergence of demand related to the 2020 Tokyo Olympics, and the pace of improvement in the economy is expected to increase gradually. 10

12 The outlook for principal sectors and other economic indicators is as follows. (1) Households As structural demographic change occurs, with the productive-age population (15 to 64 years) decreasing, the supply and demand balance for labor during the period is expected to remain tight. The unemployment ratio is to continue to be low and stable: 3.2% in fiscal 2016 (compared with 3.3% in fiscal 2015) and 3.2% in fiscal 2017, when the economy will show negative growth. Reflecting the increasing participation of women and seniors in the workforce, the number of employed persons is expected to increase gradually. This improvement in employment conditions will tend to bring an increase in wages. During the 2015 spring wage offensive, base wages were increased over the previous year, and regularly scheduled wages are on an increasing trend. However, summer bonus payments were below the level of the previous year, and payments of the winter bonus are expected to continue to decline, albeit by a small margin. In fiscal 2015, total worker cash compensation will remain level with the previous year. The outlook is for a further increase in base wages in the 2016 spring labor offensive, but there is a possibility that the rate of increase will be smaller than in fiscal 2015, in part because of the difficult management environment. For this reason, although worker cash compensation in fiscal 2016 is expected to increase, the percentage rise will be only +0.5%. On the one hand, although growth in per capita wages will be stagnant, the number of employed persons is continuing to rise. In fiscal 2015, nominal worker compensation rose 1.4% over the previous fiscal year, and the outlook is for increases of 1.6% in fiscal 2016 and 1.0% in fiscal Real worker compensation in fiscal 2015 increased 1.3%, but, in part because of moderate increases in prices, the outlook is for a continued rise in fiscal 2016 of 1.9%. However, accompanying the increase in the price level following the consumption tax rate hike, in fiscal 2017, real worker compensation will decrease 0.5%, the first decline in three years. In fiscal 2016, the outlook is for consumer spending to continue to increase against a background of rising real incomes, but several factors are viewed as likely to restrain growth in consumption, and the pace of expansion will continue to be moderate. First, 11

13 since consumers have increased their expenditures thus far, even though incomes have increased relatively little, the average propensity to consume of households is still high compared with previous average levels. Since expenditures are too high compared with incomes, a movement toward adjustment is expected to continue for the time being, and it is likely that the increase in real consumption will not be as large as the increase in incomes. In addition, one of the factors accounting for the absence of an increase in the pace of consumer spending is that the increases in wages and bonuses are mainly confined to large companies, and the trend to increase wages is not spreading among small and medium-sized enterprises and other companies as a whole. Another factor is that the increase in the number of people in the workforce has consisted mainly of non-regular employees. Also, in the first half of fiscal 2016, there is a possibility that there will be a decline in consumer confidence because of the turmoil in financial markets and the growing trend toward frugality among consumers. During fiscal 2016, real consumption, which decreased % in fiscal 2015, will change direction and increase by 1.3% as the surge in demand prior to the increase in the consumption tax rate approaches. When the planned tax rate is increased in April 2017, there will be a surge in demand before the increase, followed by a decline thereafter; however, the margin of the tax increase will be small, and lower tax rates will apply to certain items. Since it is likely that consumers satisfied their demand for consumption prior to the time of the tax increase, the sizes of the demand surge and reactionary decline will be smaller this time, compared with the previous tax increase. In fiscal 2017, due to the reactionary decline in demand, conditions will be stagnant in the first half of the fiscal year, and growth for the full fiscal year is expected to decline to 1.6%. In housing investment, at present, the reactionary decline in demand that followed the previous consumption tax hike has about run its course, and housing starts were continuing to show improvement, but recently the pace of improvement has paused. In fiscal 2016, under a special tax relief measure, the previous consumption tax rate will be applicable, even for houses that are transferred to the new owners after the planned April 2017 consumption tax rate increase. Therefore, through the end of September 2016 and onward toward the end of 2016 (which will be the final effective date for the special tax relief measure), a surge in demand for housing is believed likely, mainly for owner-built and rental housing. For this reason, the level of housing starts in fiscal 2016 is expected to rise to about 948,000 (an increase of 4.5% over the previous fiscal year), 12

14 compared with 908,000 starts in fiscal 2015, which represented a year-on-year rise of 3.1%. However, thereafter, as a consequence of the reactionary decline following the surge in housing starts, starts in fiscal 2017 are expected to decline by a large margin to about 884,000 ( 6.8% year on year). (2) Corporations The improvement in corporate performance is to continue. The recovery in domestic and overseas demand has paused, and the impact of the weaker yen in raising sales of exporting companies has weakened, while fixed costs, including personnel expenses, are rising. However, prices of crude oil and other resources have decreased further, and, because of the appreciation of the yen to the middle of the 110 to 120 yen to the U.S. dollar range, Japan s terms of trade are improving significantly, and this is contributing to the rise in profit ratios. For this reason, even though sales are showing little growth, the rise in corporate profits is continuing, and the outlook is for companies to attain higher levels of ordinary income in both fiscal 2015 and fiscal 2016 and set new record highs for earnings. In view of these trends, capital investments are expected to remain on an upward trend. With ample cash on hand, companies are expected to resume some investments and this will provide support for the economy. These investments will include those they have been postponing, investments for coping with labor shortages, investments for maintaining competitiveness, investments for the maintenance and replacement of existing equipment, and investments in IT systems and software. It is also possible that demand for investments that may have little to do with the economy, such as expenditures related to the introduction of the My Number social security number system and investments to improve security systems, may increase. Investments in areas where supply shortages exist, including the construction of hotels, office buildings, warehouses, and logistics systems are expected to remain firm. However, companies are expected to continue to refrain from aggressive investments to increase capacity in Japan, and this will preclude any major increases in investment. Although some companies and industries are seen as likely to move production facilities they had previously located overseas back to Japan, this trend is not widespread across industries, and, as a result of the sudden appreciation of the yen after the beginning of 2016, there is a possibility that exporting companies have become warier about possible 13

15 yen appreciation. In addition, although lending interest rates are declining following the introduction of negative interest rates, corporations have ample cash reserves, and the level of rates is already low, it seems unlikely that this will kindle the desire to invest among corporations. Instead, if custody fees are introduced for deposit accounts, this will represent an increase in costs for corporations. For these reasons, real private capital investment is to rise only 2.1% over the previous year in fiscal 2015 and then continue to rise by virtually the same margin, of 2.4%, in fiscal Reflecting the cautious stance of corporations regarding new investments in Japan, the degree of improvement in investment spending will be moderate in comparison with the improvement in corporate performance. In fiscal 2017, corporate performance is expected to deteriorate by a small margin owing to the weakness in domestic demand accompanying the increase in the consumption tax rate and the diminishing positive impact of the improvement in Japan s terms of trade. (3) Government Public investment has already peaked out, and the outlook is for a decrease of 1.6% year on year in fiscal 2015, the second consecutive year of decline. In fiscal 2016, the positive effects of the supplementary budget for fiscal 2015 will come into full force, and there is a possibility of a temporary increase in public investment. However, thereafter, it will continue its decline, and the outlook is for a continued drop of 1.6% for the fiscal year. In fiscal 2017, the government is expected to include economic measures in the supplementary budget for fiscal 2016 to counter the deterioration in the economy following the increase in the consumption tax rate. In addition, the use of government budgetary allocations will be accelerated. The effects of these measures are expected to emerge early in fiscal 2017 and provide support for the economy. Although the impact of these measures will diminish in a short time, demand for infrastructure investment in connection with the 2020 Tokyo Olympics will begin to strengthen, and the outlook is for public investment to bottom out in the latter half of fiscal Regarding government consumption expenditures, there is a strong likelihood that the rising trend will continue, mainly in medical expenditures, accompanying the demographic aging of the population. 14

16 (4) External Sector Owing to the deceleration in overseas economies, there is a possibility that exports will show weakness for the time being, but with improvement in the world economy, the rate of increase in exports is expected to rise moderately from summer onward. However, a sharp rise in export growth should not be expected because of the impact of the relocation of many production bases overseas. The movement seen in some manufacturing industries of bringing production facilities back to Japan to avert increases in import costs will be on a small scale, and it is unlikely there will be a major movement toward resuming exports from Japan. Regarding overseas economies, concerns will remain for the time being about the trend toward the deceleration of economic growth. However, they may show movements toward recovery in the summer and later, provided a number of conditions prevail. These include a pause in adjustments in financial markets, a rise in the value of the U.S. dollar, as the United States increases interest rates marginally and cautiously, a braking of the downward movements in the currencies of the emerging and certain other countries, and the emergence of more leeway for reducing interest rates in a broader range of countries. In China, the downward trend in growth rates will continue, but factors providing support for the economy will include further decreases in interest rates by the Bank of China and lowering of bank deposit reserve ratios. Additional support will also come from the implementation of the Silk Road Economic Belt and the 21st Century Maritime Silk Road concepts as well as China s 13th five-year plan. Note that the most-significant risk factor for the Japanese economy continues to be deterioration in overseas conditions as economies of the emerging countries, principally China, and the resource-producing nations experience deceleration. On the other hand, since growth in imports will be moderate, reflecting only marginal improvement in Japan s domestic demand, the contribution of external demand to GDP growth is expected to remain about the same as in the previous year, or +0.1 percentage point. Turning to imports, the impact of the increase in energy fuel imports for generating electric power, including the rise in LNG imports following the Great East Japan Earthquake, has run its course, and, henceforth, the rise in imports is expected to continue to be in line with domestic electric power demand. In fiscal 2016, exports will 15

17 show improvement on the one hand, and the temporary surge in demand in advance of the increase in the consumption tax rate will bring an increase in imports. Therefore, the contribution of the external sector is to be 0.0 percentage point. In fiscal 2017, domestic demand will be stagnant, and imports will decrease. As a result, the contribution of the external sector is to rise to + percentage point. (5) Production The index of industrial production in the October-December period of 2015 reversed its downward trend and rose for the first time in three quarters. However, in view of the outlook for declines in demand for electronic components and devices in overseas markets, the outlook is for a decline in the January-March quarter of For fiscal 2015 as a whole, industrial production is expected to show a decline of 0.9%, the second consecutive year-to-year drop. Inventories, which had risen temporarily to a high level, are now gradually decreasing, but, even so, they are still high in some industries, and companies may restrain production in such industries. In fiscal 2016, as a consequence of the improvement in exports, the completion of inventory adjustments, the need to prepare for a surge in demand prior to the scheduled consumption tax increase, and other factors, the outlook is for the pace of increase in production to rise. Even so, however, the rate of expansion in production for the fiscal year will be a relatively small 1.9%. In fiscal 2017, the growth rate of production is to become negative again, slipping % year on year because of the impact of the slump in demand following the consumption tax increase. (6) Commodity Markets, Foreign Exchange, and Prices The price of oil continues to be weak because of various factors. These have included predictions of a decline in demand caused by uncertainty regarding the future course of the world economy and a sense of excessive supply worldwide caused by the decision by OPEC not to decrease production, the plateauing of shale oil production at a high level, and resumption of oil exports from Iran. In addition, prices of other raw materials have also declined. In the current circumstances, there will be a tendency to think oversupply conditions will persist, and there is a possibility of further market weaknesses. Nevertheless, the crude oil market may bottom out before summer if demand strengthens accompanying recovery in the world economy and if s 16

18 indicate that the supply and demand balance for crude oil in the United States may tighten moderately. However, the pace of increase will most likely be gradual, in part because oil-producing countries, including members of OPEC, may take a cautious stance toward reducing production. Regarding the yen/dollar exchange rate, if the worldwide tendency is to avoid risk-taking subsides, it is expected that eventually there will be a correction of the high value of the yen. However, if the pace of interest rate increases in the United States, remains moderate, there will be limits on how much the yen will weaken because of differences in direction of monetary policies in Japan and the United States and it will be difficult for the yen to stabilize at over 120 to the dollar. During fiscal 2016, the yen is expected to fluctuate mainly in the 115 to 120 range. However, in fiscal 2017, because of the decline in resource prices, Japan s trade balance has moved toward a surplus, and, since the surplus is likely to expand, there is a possibility that the yen may begin to strengthen again. As a result of the influence of the decline in crude oil prices and other factors, energy prices in Japan have declined, and the CPI (excluding fresh foods) is fluctuating at about the same level as in the same months of the previous year. Reflecting increases in wages, the prices of services are rising, and this is a factor pushing the index upward. As a result, minus figures will not take hold, and there is little concern about the return of deflation. However, near the middle of fiscal 2016 onward, negative figures may reappear and grow larger because the upward pressures on import prices due to the weakening of the yen will run their course and the margin of decline in energy prices due to the decline in crude oil prices may expand. As consumers tend to become more frugal, it will also be difficult for companies to pass on their cost increases to consumers, and this will be a factor moderating upward price pressures. The rate of increase in the CPI (excluding fresh foods) in fiscal 2015 will be +0.0% year on year, but, in fiscal 2016, this is to decline to 0.1%. Note that in fiscal 2017, as a result of the increase in the consumption tax rate, the CPI will be pushed upward by about 1.0 percentage point, and the rate of increase will likely rise to +1.7%. Excluding the impact of the tax hike, the underlying increase is viewed to be about %. As a result, the BOJ will be obliged to set the timing for reaching its inflation target beyond the first half of fiscal

19 (7) Financial Policy and Interest Rates Since the rate of inflation in the CPI has not risen to the target level, during the period, the BOJ is likely to continue its qualitative and quantitative easing policy with negative interest rates. However, because it will not be possible for the BOJ to continue to buy Japanese government bonds indefinitely, gradually the continuation of the policy will become more difficult. For this reason, at that time, it seems likely that the principal policy tool will shift from quantitative easing to interest rate adjustments, and, as a result, the negative margins will gradually increase. When the judgement is made, around the end of fiscal 2016, that reaching the current inflation target in the first half of fiscal 2017 will not be possible, there is a possibility that it will be difficult to continue purchasing Japanese government bonds, and changes in monetary policy will become necessary. At that time, it seems likely that the current monetary easing framework can be continued, but it is likely that modifications will be made, such as shifting to a policy of reducing the current pace of asset purchases and maintaining the current balance, expanding the margin of negative interest rates, and broadening the types of assets that the BOJ will purchase. Following the introduction of the negative interest rate policy, there is a possibility that short-term interest rates, such as the unsecured overnight interbank call rate, will become negative, but the margin will be less than for BOJ s negative interest rate. In addition, for long-term interest rates, if the BOJ changes its monetary policy, there is a possibility that upward pressures will rise temporarily, but, until then, since tight supply and demand conditions will persist, there is a possibility that rates, including those on long-term Japanese government bonds, will continue to be negative. 18

20 GDP demand Economic Outlook for fiscal Yr/Yr % FY 2014 FY 2015 FY 2016 FY 2017 (actual) () () () Nominal GDP Real GDP Contribution of domestic demand Private consumption Housing investment Private capital investment Contribution of inventory investment Government expenditure - Government final consumption expenditure Public investment Contribution of external demand Export of goods and services Import of goods and services GDP deflator Overseas economy and market data Yr/Yr % 19 FY 2014 FY 2015 FY 2016 FY 2017 (actual) () () () Real GDP (US) (CY) Real GDP (Euro zone) (CY) Real GDP (Asia) Real GDP (China) Yen/U.S.Dollar Uncollateralized call rates (O/N) (%)* TIBOR (3months) Newly issued government bond yields (10years) (%) WTI future price (near month contract, US dollar/barrel) Dubai crude oil prices (US dollar/barrel) * actual=average, =end of period

21 External demand (export and import) Yr/Yr % FY 2014 FY 2015 FY 2016 FY 2017 (actual) () () () Value of exports (Yen base) Ammount (Yr/Yr,%) Value of imports (Yen base) Ammount (Yr/Yr,%) Balance (trillion yen) Current account balance (trillion yen) balance on goods (trillion yen) balance on service (trillion yen) balance on income (trillion yen) Corporations Yr/Yr % FY 2014 FY 2015 FY 2016 FY 2017 (actual) () () () Industrial production Inventory index Sales Ordinary Profits Income and emploiment Yr/Yr % FY 2014 FY 2015 FY 2016 FY 2017 (actual) () () () Income per capita Scheduled - Non-scheduled Wage increase rate (%) Employee Nominal compensation of employees* Unemployment rate (%) *GDP base 20

22 Goods prices Yr/Yr % FY 2014 FY 2015 FY 2016 FY 2017 (actual) () () () Domestic corporate goods prices excluding tax effects Consumer prices excluding tax effects 1.0 excluding freshfood excluding tax effects excluding food (excluding alcoholic beverages) and energy New housing starts annualized, ten thousand units New housing starts Owned Rented Built for Sale Yr/Yr % FY 2014 FY 2015 FY 2016 FY 2017 (actual) () () ()

23 Economic Outlook (Quarterly) Qr/Qr,% Yr/Yr,% FY 2014 FY 2015 FY 2016 FY (Qr/Qr,%) Nominal GDP Annualized rate (Yr/Yr,%) (Qr/Qr,%) Real GDP Annualized rate (Yr/Yr,%) Contribution of domestic demand (Qr/Qr,%) Private consumption Housing investment Private capital investment Contribution of inventory investment (Qr/Qr,%) Government expenditure Government final consumption expenditure Public investment Contribution of external demand (Qr/Qr,%) Export of goods and services Import of goods and services GDP deflator (Yr/Yr,%) Overseas economy and market data FY 2014 FY 2015 FY 2016 FY Real GDP (US) (Annualized rate Qr/Qr,%) Real GDP (Euro zone) (Annualized rate Qr/Qr,%) Real GDP (Asia) (Yr/Yr, %) Real GDP (China) (Yr/Yr, %) Yen/U.S.Dollar Uncollateralized call rates (O/N) (%)* TIBOR (3months) Newly issued government bond yields (10years) (%) WTI future price (near month contract, US dollar/barrel) Dubai crude oil prices (US dollar/barrel) * actual=average, =end of period 22

24 External demand (export and import) Yr/Yr % FY 2014 FY 2015 FY 2016 FY Value of exports (Yen base) Ammount (Yr/Yr,%) Ammount (Qr/Qr,%) Value of imports (Yen base Ammount (Yr/Yr,%) Ammount (Qr/Qr,%) Balance (trillion yen) Current account balance (trillion yen)* Balance on goods (trillion yen)* Balance on service (trillion yen)* Balance on income (trillion yen)* *seasonally adjusted Corporations Yr/Yr % FY 2014 FY 2015 FY 2016 FY Industrial production Inventory index (Qr/Qr, %) (Qr/Qr, %) (Yr/Yr, %) (Yr/Yr, %) Sales Ordinary profits Income and emploiment Yr/Yr % FY 2014 FY 2015 FY 2016 FY Income per capita Scheduled Non-scheduled Real wage indices Employee Nominal compensation of employees* Unemployment rate (%) GDP base 23