Japan: An end to capital punishment?
15 March 2010
So far, Japan’s economic recovery has been driven primarily by strengthening export demand, particularly from the rest of Asia, with additional support from fiscal policy, which has boosted household spending. The latest GDP data provided the first signs of life in business capital spending, with private non-residential investment rising for the first quarter in seven in Q409, up 0.9% on the quarter. So just as we have been pleasantly surprised by the recent pace of growth of exports and consumption, might we also see a stronger-than-expected recovery in capital spending in the coming year?
The marked improvement in the health of Japan’s corporate sector at the end of last year might provide cause for optimism. In Q409, sales rose for the third consecutive quarter, leaving them just 3% lower than a year earlier. And Japanese firms have reaped the benefits from savage cost-cutting through the downturn. Recurring profits jumped by more than 35% on the quarter in Q409, to more than double their level a year earlier – the first year-on-year increase in profits in ten quarters and the second largest rise since the survey began more than 50 years ago. As a result, profits rose back to about two-thirds of their pre-crisis peak in Q107, leaving firms in better shape to consider new investment.
Sales and profits growth 
Source: MoF and Daiwa Capital Markets Europe Ltd.
Nevertheless, other data suggest that firms remain cautious about their capital spending plans. The latest machine orders data, which are a useful guide to investment three-to-six months ahead, showed orders down almost 4%M/M in January. The weakness was concentrated in the non-manufacturing sector, which has so far experienced a relatively muted recovery, and where orders posted a double-digit percentage decline. In contrast, orders from the manufacturing sector, which has benefited most from the revival in export demand, rose for the second consecutive month to almost 35% above their level one year earlier.
Machine orders and investment growth*
*Figure for Q110 machine orders is a forecast.
Source: Cabinet Office and Daiwa Capital Markets Europe Ltd.
The recent orders data therefore suggest that, while the recovery in investment looks set to continue over coming quarters, the pace of growth will remain muted. But this should hardly come as a surprise. Although the economy is probably now in its fourth consecutive quarter of expansion, a vast amount of spare economic capacity persists – manufacturing output remains more than 15% below its pre-recession peak, and, overall, there remains a negative output gap of about 6%. Therefore, while sales and profits should continue to recover, on the whole firms are more likely only to replace, rather than increase, capital over the near term. And while the forthcoming BoJ Tankan survey (due on 1 April) is likely to indicate a further pick up in planned investments, capital spending, while no longer providing a drag on the economy, is not set to become a significant engine of growth until 2011 at the earliest. With the pace of consumption growth likely to slow as the fiscal incentives to spend wane, that will mean that the Japanese economy will remain highly reliant on foreign, and in particular Asian, demand for the immediate future.
Emily Nicol, Junior Economist
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