Focus: Consumer Demand

While investors began to turn more positive on Japan in April of last year after the Nikkei 225 index hit a multi-decade low, many observers remain doubtful -- pointing to the hesitant stance of Japanese consumers since the collapse of Japan’s bubble economy in the early 1990s. An announcement on May 28th, however, that spending by Japanese wage earners surged 7.2 percent in April -- the biggest increase in more than 20 years – further demonstrates the progress that has been achieved and that Japanese consumers may have finally begun to regain the confidence needed to sustain an economic recovery.

Further reinforcing this optimistic view is recent data showing that Japan’s GDP grew at an annual rate exceeding 5% during the first quarter of 2004. Industrial output in April was also up a record 8.5% from the same month in 2003. Unemployment remained unchanged, yet far below the record high of 5.5% set in January 2003. The efforts of banks and corporations to improve profitability and the efficiency of their operations are also proceeding along and during the fiscal year that ended March 31st, three of Japan's four biggest banks reported solid profits.

Further action is certainly necessary to maintain and build upon the restructuring, reform and deregulation initiatives that have helped to introduce economic, social and commercial change and to reinvigorate Japan’s business environment. However, it should be noted that foreign firms who have invested in Japan in recent years are increasingly being rewarded for their efforts. One of the more notable recent examples of success includes Ripplewood’s pending sale of Japan Telecom Co. to Softbank for an appreciable profit following its acquisition of this firm in Japan’s largest leveraged buyout less than a year ago.

The Japan External Trade Organization (JETRO provides the following information, which examines these issues, as well as specific opportunities and developments that may be of interest to the corporate and portfolio investor.


Focus: Consumer Demand
JETRO, 1221 Avenue of the Americas, NYC, NY 10020June 8, 2004
Rising Confidence Provides Further Evidence of an Economic Recovery in Japan
While investors began to turn more positive on Japan in April of last year after the Nikkei 225 index hit a multi-decade low, many observers remain doubtful -- pointing to the hesitant stance of Japanese consumers since the collapse of Japan’s bubble economy in the early 1990s. An announcement on May 28th, however, that spending by Japanese wage earners surged 7.2 percent in April -- the biggest increase in more than 20 years – further demonstrates the progress that has been achieved and that Japanese consumers may have finally begun to regain the confidence needed to sustain an economic recovery. Further reinforcing this optimistic view is recent data showing that Japan’s GDP grew at an annual rate exceeding 5% during the first quarter of 2004. Industrial output in April was also up a record 8.5% from the same month in 2003. Unemployment remained unchanged, yet far below the record high of 5.5% set in January 2003. The efforts of banks and corporations to improve profitability and the efficiency of their operations are also proceeding along and during the fiscal year that ended March 31st, three of Japan's four biggest banks reported solid profits. Further action is certainly necessary to maintain and build upon the restructuring, reform and deregulation initiatives that have helped to introduce economic, social and commercial change and to reinvigorate Japan’s business environment. However, it should be noted that foreign firms who have invested in Japan in recent years are increasingly being rewarded for their efforts. One of the more notable recent examples of success includes Ripplewood’s pending sale of Japan Telecom Co. to Softbank for an appreciable profit following its acquisition of this firm in Japan’s largest leveraged buyout less than a year ago. The Japan External Trade Organization (JETRO provides the following information, which examines these issues, as well as specific opportunities and developments that may be of interest to the corporate and portfolio investor.
Consumer Demand Declined With the Collapse of Japan’s Bubble Economy
	During the late 1980s consumer spending in Japan grew at an annualized real rate of 5.5 percent. Following the collapse of Japan’s bubble economy in fiscal 1991-2001, however, it declined to an annualized rate of 1.0 percent. Most experts believe this slowdown in consumer spending, which accounts for 60 percent of gross domestic expenditures in Japan, was one of the primary factors contributing to Japan’s economic problems over the past decade. The changing dynamics of Japanese real estate provides one example of the forces impacting consumer sentiment in Japan. During the bubble economy, it has been estimated that land prices soared within major metropolitan areas at an annualized rate of 23.2 percent. Valuations grew so high that the land on which the Imperial Palace is located was reported to be worth more than the whole State of California. As a result, people began to aggressively buy homes, lest they be permanently shut out of the housing market. To allow more people to participate and to finance larger purchases, some financial institutions even began to extend mortgage maturities up to 100 years. With the collapse of the bubble, however, land prices started falling in fiscal 1991. Prices in and around these same areas have since fallen by 73 percent -- an annualized rate of 10.2 percent from fiscal 1990. This plunge precipitated expectations of further declines and saddled existing homeowners with mortgages exceeding the value of their homes. As a result, the market for real-estate transactions declined even further, despite interest rates remaining at historic lows. In addition, the forces of deregulation and reform, the gradual outsourcing of production, an inefficient credit market and the introduction of lower priced imports into Japan, all have helped to exacerbate further declines in prices and consumer and business sentiment. This led to a downward spiral in expectations from which the nation is only now beginning to recover.
Recent Data Indicates Consumer Sentiment is Rising in Japan
	As reported in the last Focus Newsletter, global macro trends have begun to turn more favorable to Japan. This is helping to restore growth through reinvigorated demand from emerging export markets such as China as well as sales to traditional customers such as the United States. In fact, exports climbed 13.3% in March from the same month in 2003, rising to ¥5.4 trillion ($49.8 billion). This marked the fourth straight monthly increase. To keep up with demand, companies have been investing in capital equipment. Core machinery orders, a key indicator of capital spending, rose 4.9% in February over January. In addition, industrial production rose 3.3 percent in April from a month earlier due to demand for machinery and digital-electronics products, such as cellphones, DVD players and flat-panel displays. It should be emphasized, however, while positive, export demand in and of itself is not sufficient to insure a sustainable recovery. As one reporter recently noted in the New York Times, “In the past decade, Japan has seen two fledgling export-driven recoveries die as consumption at home failed to take hold.” Government data released during the last week in May, however, demonstrated that consumer sentiment is starting to rise. Spending by Japanese wage earners jumped substantially. In addition industrial output continued to grow and pressures eased on unemployment. The 7.2 percent surge in spending by wage owners in April over the same month in 2003 was the biggest increase since October 1982. It exceeded the 0.9 percent average rise forecast by economists surveyed by the Dow Jones Newswire. Private consumption accounts for 60 percent of gross domestic expenditures in Japan, and wage earner spending is a key measure of consumption. Another indicator, household spending, has also increased for five consecutive months, creeping up 0.2 percent in March from a year earlier following a 5.2 percent jump in February. These figures give further credence to data released by the Japanese Cabinet Office on May 12th, noting that the consumer confidence index for April was up 2.7% on the month to 45.4, the highest level seen since September 1996. Consumers are not only purchasing automobiles, cellphones, appliances and consumer electronics, but also spending more on travel, dining and other services. Since remodeling its Crown sedan last year, Toyota has sold more than 10,000 units a month – double its original forecast. Sales of the Subaru Legacy have also risen by 40% and higher-end models that cost around ¥3 million accounted for almost half of the vehicles sold. Japanese travel giant JTB Corp. has also estimated that people traveling abroad for the recent Golden Week holiday rose for the first time in four years. JTB’s package tour reservations are 36% higher for the year, and Kinki Nippon Tourist Co. and Nippon Travel Agency Co. are up 61% and 53% year-on-year respectively. Hotel occupancy rates are also rising and a Mandarin Oriental, Peninsula, Ritz Carlton and Conrad Hotel are scheduled to open in Tokyo in the near future. Shuji Shirota, an economist at Dresdner Kleinwort Wasserstein in Tokyo commented on improving growth and consumer consumption recently in the New York Times noting "The outlook for the Japanese economy is turning brighter". He went on to state “This is a very good sign for the household sector," and added the increase in spending on travel and other nonessential services indicates consumers are genuinely becoming more optimistic. Over all, for the first quarter, household consumption grew at an annualized rate of 4.1 percent. The unemployment rate also held steady, holding at 4.7 percent in April, an improvement of 0.8 percent from a record high of 5.5 percent hit in January last year. That is the highest level of unemployment ever reached in Japan since the government began tracking this statistic in the 1950s. The only other time the jobless rate reached 5.5 percent was in August of 2002. This amounted to 3.35 million unemployed people in April. That was 500,000 fewer than the same month in 2003 and represented the 11th straight month of year-on-year declines. Service jobs, in particular have shown signs of strength. This is especially true in the medical and welfare sectors, which added 560,000 jobs in April from a year earlier. Other positive signs include announcements that major firms are now stepping up their hiring. One recent survey conducted by the Nihon Keizai Shimbun forecast that major firms plan to hire 18.8% more college graduates in FY2005. Firms in 40 of the 43 sectors surveyed plan to increase hiring, whereas 18 planned reductions last year. Mid-career employment is also reviving with Recruit Ablic, the nation’s largest job placement firm reporting it had been offered 26% more mid-career positions this February than during the same month in 2003. Improvements in consumer sentiment are also reflected in recent residential real estate transactions in Central Tokyo and other prime locations, suggesting the downward spiral in property prices may finally be reversing its course. The rising interest in real estate can be seen in the performance of the 12 real estate investment funds listed on the Tokyo Stock Exchange. The Nikkei Weekly reports that as of March 19th, their combined value exceeded ¥1.25 trillion, as opposed to an initial ¥250 billion.
Restructuring and Reform Helping to Improve Japanese Corporate Performance
	Restructuring and reform initiatives implemented over the past few years have been helping to restore the efficiency of the Japanese economy and to improve the performance of Japanese firms. During the first quarter of 2004, Japan's gross domestic product grew at an impressive annual pace of 5.6 percent. While this is not as robust as the 6.9 percent recorded in the final quarter of 2003, it remains extremely strong compared to the weakness seen in recent years. Corporate profitability is also on the rise. According to figures compiled by the Nihon Keizai Shimbun, a rising stock market, export growth and demand for digital appliances, have all helped net profits of listed companies to rise to a record ¥3.26 trillion ($29.02 billion) for the year ended March 31st. This is up 68% from fiscal 2002. Even more importantly, we are now beginning to see revenue and profitability growth being generated through higher sales as well as corporate rationalization. Asia Pulse highlighted this trend recently in a report stating “After securing profits through restructuring efforts in fiscal 2002, (Japanese) companies have shifted towards generating income through higher sales to set a new high for the first time in three years.” Japanese financial institutions have also been showing signs of strength. Mitsubishi Tokyo Financial Group, regarded by many as the healthiest of the major city banks, reported a net profit of ¥560.8 billion (approximately $4.99 billion), compared with a loss of ¥161.5 billion in fiscal 2003. The bank's costs for writing off bad loans shrunk to ¥165 billion from ¥486 billion in fiscal 2003, indicating progress in dealing with its bad-debt problem. Mizuho Financial Group and Sumitomo Mitsui Financial Group also posted profits for the latest fiscal year. Japan's two largest trading companies, Mitsubishi Corp. and Mitsui Co. also released strong earnings last month. Mitsubishi's net income for the year that ended March 31st rose 85 percent to ¥115 billion, or $1 billion, from a year earlier. Mitsui said profit more than doubled to ¥68.4 billion, from ¥31.1 billion. The environment for small- to mid-sized businesses also seems to be improving. According to one recent survey by the National Conference of the Associations of Small Business Entrepreneurs , the business outlook index for the third quarter is expected to turn positive for the first time in seven and a half years. Furthermore, another survey of approximately 300 companies by the Nihon Keizai Shimbun reported that summer bonuses were up this year for the second straight year. This was said to be largely due to rising exports and healthy global sales of digital gadgets. It has also been reported that 64% of the 42 firms whose labor unions belong to the Japan Council of Metalworkers Unions are expected to pay higher annual bonuses during the current fiscal year. At the same time, the Koizumi Administration moved to lower government investment at an annual rate of 12.8 percent to begin reducing the huge deficits built up over the past decade as previous administrations tried to revive the economy with heavy doses of public spending. Regional economies are also showing signs of strength. One Nikkei Weekly article highlighted recent reports presented at a Bank of Japan branch managers meeting in April. It was shown that economic activity is strengthening in the Tokai region, and industrial production indexes in Aichi, Gifu and Mie prefectures rose to new highs for five straight months through January 2004. The job market has also been rising, with the ratio of job offers to seekers rising to an 11 year high in Aichi Prefecture. Of the 11 reports presented from regional and branch offices, 10 upgraded their assessments of local economies since last January. Hokkaido proved to be the only exception. In the article the manager of the BOJ’s Sapporo branch blamed Hokkaido’s weakness on the regions reliance on public works projects and the fact there are only a small number of exporters located there.
The Positive Outlook that is Emerging Does Not Eliminate the Need for Caution
	While the future does indeed look far more promising for Japan than it has in over a decade, the need to maintain a balanced perspective – evaluating both the positive trends as well as those that necessitate a greater sense of caution -- should not be minimized. Important considerations include: Lack of Income Growth: The trend toward greater consumption should be seen as a positive sign of renewed confidence and optimism on the part of Japanese households. Unfortunately, however, as in the U.S., this rise in spending is being largely generated through expenditures from savings rather than a rise in the incomes of wage-earners. While it is true the performance of Japanese companies is improving, this has not yet translated into higher salaries. The Nihon Keizai Shimbun provided additional analysis on this phenomenon, noting while personal spending grew 4% year on year in real terms during the first three months of 2004 – representing 2.2 percentage points of the 5.6% annualized GDP growth reported during the first quarter -- wages declined 2.8% in nominal terms. They explain this divergence both through improving consumer sentiment as well as through demographic trends in which a younger work force is emerging through the early retirement of the baby-boomer generation. Rising Materials and Commodities Prices: Only a short while ago, one of the greatest concerns of Japanese policymakers was the deflationary bias that seemed to have taken hold of Japan. This constrained consumption as Japanese consumers delayed purchases under the assumption prices would be lower in the future. While deflation still remains a concern, the progress Japan has achieved in restoring growth and momentum, combined with the worldwide economic trends that have led to dramatic rises in commodities and raw materials prices have now introduced price increases on the industrial level. Therefore, the recent news that Japan’s Corporate Goods Price Index rose for the first time since July 2000 can be seen as a mixed blessing. On one hand this can be seen as a sign of more robust corporate activity, removing some of the downward pressures on wholesale prices seen in Japan over recent years. On the other hand, the pricing pressures that are a byproduct of globalization are requiring that companies absorb these price increases rather than being able to pass them on. Ultimately this may affect their potential for future growth and profitability. Export Dependency: Japan’s economic recovery over the past year can be attributed to a range of cyclical and structural factors. One important element is burgeoning demand from China and other markets. While recent data indicates consumers in Japan are beginning to abandon the caution that has constrained their consumption for much of the past decade, this trend is still emerging. Despite the progress that has been achieved, Japan continues to be highly reliant on its export sector. It therefore remains highly correlated to events in foreign business and financial markets. Therefore, any major reduction in demand from China or the U.S. is sure to call into question the sustainability of the progress and momentum that has been achieved. Maintaining Restructuring and Reform: Movement toward restructuring and reform since the introduction of the Japanese government’s “Action Plan for Economic and Structural Reform” in late 1996 has helped to dramatically change the way business is conducted in Japan. While one can debate whether government measures or those of the private sector have been more helpful, both can be seen as necessary to facilitate this transformation. Far more important, however, is the need to maintain the pace of deregulation and reform, the resolution of Japan’s non-performing loan problem, improvements in the efficiency and financial structures of large and small Japanese firms, the creation of value-added industries and additional labor flexibility, cooperation between business and academia and a whole range of measures that will help to strengthen and expand upon Japan’s ability to generate a sustainable economic recovery. In a democratic nation, dramatic change is generally only possible during times of duress when it is clear a break with the past is both important and necessary. With Japan now beginning to realize results from the painful steps initiated in recent years, it can only be hoped it will be able to persevere in its efforts to implement the comprehensive changes, reforms and corporate actions that will be necessary to sustain and build upon the changes that have been made.
Foreign Investors Have Begun to Realize Large Profits on Their Japanese Holdings

	During the late 1990s most internationally-focused investors were enthralled by the U.S. dotcom and seeming productivity miracle. Few were prepared to devote their energies and financial resources on an economy that appeared to be in permanent decline, located in a region struggling to emerge from a major financial crisis. Even most Japanese investors did not have a lot of confidence in Japanese equity holdings. Corporations moved to reduce the cross-shareholdings that had once characterized the Japanese business and financial system and households, who according to Barron’s even today only have about 7% if their assets invested in stocks, also refrained from increasing their exposure. A few brave foreigners, however, foresaw the opportunities that were emerging and moved to realize the potential that could be achieved through new allocations of capital and the introduction of more efficient management styles and methods. One recent example of the success that can be achieved is the example of Ripplewood Holdings, which is realizing a fourfold return on an investment in Japan Telecom in less than a year. That's on top of an even bigger achievement last February, when Ripplewood's four-year investment in the failed Long-Term Credit Bank of Japan culminated in one of the most anticipated initial public offerings in Japan in recent years. Reborn as Shinsei Bank, this financial institution sold for ¥250 billion, or about $2.2 billion, more than double what Ripplewood’s investor group paid in 2000. While it is most well known for the two deals noted above, Ripplewood has a range of other holdings in Japan including the Phoenix Seagaia resort and AlphaPurchase Co., a unique cost-cutting consultancy, designed to improve Japanese procurement and other business practices. The success of Ripplewood and other investors is leading to more activity of this kind. For example, Carlyle Group, the Washington buyout firm, offered in May to purchase a wireless unit from KDDI for $2 billion along with Kyocera. Foreign investors continue to raise their holdings of Japanese securities and the positive benefits of this trend can be seen in the increased valuations accorded to companies such as Nissho Iwai-Nichimen Holdings whose shares rose substantially as reports were released that JP Morgan Chase became its largest shareholder. Another milestone was recently reached, when it was reported that Hoya Corp. became the first publicly listed Japanese firm to be majority held by non-managerial overseas shareholders. Direct investments are also rising and on April 7th, Wal-Mart opened its first supercenter under the Seiyu name in Shizuoka Prefecture. Many observers believe these and other recent deals and purchases are only a harbinger of things to come. They forecast increases in foreign shareholdings and the advent of a global M&A wave in which Japanese companies are subject to the same kinds of corporate finance strategies -- including hostile takeovers -- that are commonplace in the U.S. and other markets. While there has also been concern that demand for Japanese equities has been largely driven by foreigners, with little interest coming from Japan’s domestic market, there are even signs that this is beginning to change. One indicator of rising interest from the retail investor can be seen in new data from six major Japanese securities firms that specialize in online trading. As of the end of the first quarter of 2004, they collectively held 1.15 million brokerage accounts – an increase of 28% year on year. Two firms, Masui and kabu.com even recently launched new systems that charge no brokerage commissions to investors whose trades do not exceed ¥100,000 in a day, in order to encourage novice investors to trade equities. Additionally, during the first week of April it was reported that Japanese retail investors traded the largest portion of stocks on the Tokyo exchange, at 32 percent, overtaking foreign investors, who made 22 percent of the trades. The following week, their share grew to 37 percent, while foreigners traded only 19 percent of stocks.



	Data, statistics and the reference materials presented within this newsletter have been compiled by JETRO from publicly-released media and research accounts. Although these statements are believed to be reliable, JETRO does not guarantee their accuracy, and any such information should be checked independently by the reader before they are used to make any business or investment decision.
	(Final Note: After three exciting years serving as Executive Director of JETRO NY, during which time I had the occasion to meet many of you through publication of this newsletter and other activities, I will be returning to Japan to assume a new position in the Ministry of Economy, Trade and Industry (METI), the Japanese Goverment later this month. I wish all of you the best, thank you for your cooperation and for making my stay in New York a most pleasant one. Please stay in touch and do not hesitate to let my successor know if he can be of help in any way. Best regards, Satoshi Miyamoto - After July 1, 2004: miyamoto-satoshi@meti.go.jp)

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