Is Japan’s Economic Recovery in Danger?

Business/Government/Assignment Editors

NEW YORK -- February 28, 2005

The Japan External Trade Organization New York (JETRO NY) released a newsletter today highlighting recent economic trends in Japan. It can be viewed at:

http://www.jetro.go.jp/usa/newyork/focusnewsletter/focus38.html.

A summary is presented below::

• Foreign Investors Dramatically Raised their Exposure to Japan in 2004

Many foreign direct and portfolio investors bypassed Japan during the 1990s and early 2000s believing other markets offered better returns. Recognizing the need for change, Japanese policymakers adopted measures that are now transforming the way business is conducted in Japan.

Foreign Direct Investment into Japan Rose by 144% During First Half of FY 2004

During the first six months of FY2004, foreign direct investment into Japan reached approximately $20.32 billion. This 144% increase was more than was generated over the entire 2003 fiscal year.

Portfolio Investment Into Japan Also Rose Significantly

Net purchases of Japanese equities and bonds by foreign investors totaled €15.26 trillion in 2004. This is the highest level since Japan began compiling these statistics in 1981. In addition, as of September 30, 2004, 82 major publicly-traded companies in Japan were at least 30% owned by overseas investors compared to 47 a year earlier.%.

• GDP Growth in 2004 Weakened After Blistering 5.8% in First Quarter

Japan's real GDP contracted by 0.5% in annualized terms during the final quarter of 2004. Dragged down by weaker than expected consumer spending and external demand, this fall marked the third consecutive quarterly contraction, following revised falls of 0.3% in July-September and 0.2% in April-June.

For the full year, however, strong 5.8% growth during the first quarter, helped push up real GDP by 2.6% over the course of 2004. This marked a second straight year of growth, and reflects Japans best performance since the economy grew by 3.4% in 1996.

• Current Consolidation Encourages Corporate Efficiency and Change

One of the most important objectives of Japans ongoing transition has been the need to remove structural barriers. This includes cross-shareholdings, relationship-based main bank lending and an overly cumbersome regulatory environment. While these practices helped Japan to industrialize, they now lead to a misallocation of resources and to protect marginal companies and other entities at the expense of the nations overall efficiency and competitiveness.

As a result, the current slowdown, while unfortunate, may represent a blessing in disguise. It can be seen as a long term positive exerting additional pressure on companies and individuals to maintain the pace of change now taking place in Japan.

• The Differentiation Between Winners and Losers is now in Process

Japan has faced significant criticism over its perceived inability to differentiate between winners and losers. Reforms passed in the late 1990s, however, have helped to introduce market forces and to dramatically change this dynamic. The entry of foreign companies and investors has also created a competitive need for Japanese companies to adjust to these pressures. This is true not only for firms, financial institutions, sectors and regions, but also employees and students who are just beginning to plan their careers.

• Economic Divergence Makes if Necessary to Look Beyond Macro Data

As Japan introduces a more flexible business environment, greater efficiencies will be achieved and winners and losers identified. Therefore, while it was always a mistake to view Japan as a nation where everyone worked together to pursue common goals, in the future it will be increasingly necessary to look beyond the macro data. The resulting differentiation will help to improve Japans underlying competitiveness.

Despite Current Weakness, Japanese Consumers Shows Tremendous Promise

Given the realization that a sustainable recovery must be based upon improving domestic demand, analysts have been closely watching the Japanese consumer. As the latest data shows that households lowered their consumption by 1.3% during the fourth quarter of 2004, many express concern whether Japan is making any progress in stimulating consumer demand.

A report from Japans Cabinet Office, however, noted Japanese consumers grew less pessimistic in January, as the outlook for incomes and employment improved. Confidence among households with two or more people rose to 47.4 from 44 in December.

Foreign companies including GE Capital and Citigroup are moving to take advantage of forecasted growth by expanding their consumer finance operations in Japan. Japanese firms are also moving to offer a broader range of consumer-oriented services.

• Domestic M&A Leading to Further Restructuring and Rationalization

Changing regulations and lending practices, along with a generational transfer of assets and a changing business orientation are creating a need for a wider range of corporate finance techniques. This includes management buyouts, M&A transactions and asset securitization, such as the rising use of REITs in the real estate market. Shareholder relations are becoming more important and senior managers who do not realize their objectives and profitability targets will be required to justify their efforts.

U.S. and other foreign direct and portfolio investors are advised to pay closer attention to these developments in Japan so that they might benefit from these trends and the many opportunities that are emerging.

 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.
 
For additional information on economic and financial trends in Japan, please contact
Akihiro Tada, Executive Director of JETRO NY at
Tel: 212-997-0416,
Fax: 212-997-0464,
E-mail: Akihiro_Tada@jetro.go.jp