No. 26 — July 7, 2000

 

Weekly Review

TANKAN RESULTS IMPROVE, BUT CONDITIONS IN JAPAN NOT CAUSE FOR CELEBRATION
--- by Arthur J. Alexander

The bullish results of the Bank of Japan's June tankan (short-term survey of business prospects), announced July 4, ignited celebratory fireworks by already-optimistic financial analysts. The improvement in the quarterly poll's headline statistic — the diffusion index of business conditions among large manufacturers, which is calculated by subtracting the percentage of pessimistic responses from the percentage of positive ones — exceeded even the upbeat preannouncement consensus forecast of movement to minus 4 from the last tankan's minus 9 (see JEI Report No. 14B, April 7, 2000). In fact, this closely tracked statistic advanced into positive territory with a reading of 3. Improvements in business sentiment were recorded across the board for almost all of the issues covered by the survey questionnaire.

Such positive results led to a flurry of predictions that the central bank soon might raise the overnight interbank lending rate from its near-zero level of the last 17-plus months. Although BOJ's decisionmaking Policy Board has not published formal criteria for abandoning its strategy of zero interest rates, members have suggested that sustainable capacity expansion is at the top of the list.

The June tankan contained some encouraging data in this regard. In the aggregate, large enterprises plan to increase investment 4.6 percent in FY 2000 compared with a predicted cutback of 14.2 percent in FY 1999. Improvements also were reported for midsize and smaller companies, although in those cases, the numbers remained negative. For all businesses regardless of industry, expected investment spending was headed in the right direction, with a 0.1 percent slippage projected for FY 2000 versus a forecast reduction of 9.2 percent in FY 1999. At the same time, blanket gains were noted in the reduction of excess capacity.

Whether these figures meet the BOJ Policy Board's criterion for a sustained rise in investment is a hot topic among financial cognoscenti in Tokyo. Current betting puts the chances of a vote for a rate increase at the July 17 Policy Board meeting at 60 percent and at more than 75 percent by September. The prices of interest-rate swaps suggest that the market favors a September move.

A closer look at the tankan numbers reveals that business conditions are not universally rosy. Among the most optimistic group — big producers — positive reactions outweighed negative ones for the first time since June 1997 (see Figure 1). However, negative sentiments still were the norm for smaller manufacturers and nonmanufacturing firms of all sizes (see Figure 2). Small companies overall have not been optimistic about their prospects since 1991. For small nonmanufacturers, the diffusion index was minus 25 in the June tankan. Although the outlook for them clearly is better, these firms are a long way from setting off fireworks.

Not all small businesses are alike, though. Communications, for instance, is one of the stronger industries in Japan. Its index generally was robust from 1995 through mid-2000, dropping below zero for just a single quarter in 1998. Spending by this industry in the mid-1990s, stimulated by the deregulation of cellular telephone and cable television services, sustained the entire economy in its short-lived recovery. Current investments by Internet and other information technology competitors reflect today's hot market. This example indicates that it may be inappropriate to make sweeping generalizations about broad classes of industries and companies.

Nonetheless, the data behind the diffusion index suggest little cause for celebration. Tankan respondents have the choice of not just two descriptions of business conditions, "favorable" and "unfavorable," but also a third option, "not so favorable," that is in between. Perhaps a better translation of this phrase is "less favorable" since the response still has a positive connotation.

Most survey answers are the middle one (see Table 1). By not using these responses, the diffusion index disregards the sentiments of one-half to two-thirds of the tankan participants. More than a third of all small firms chose the unfavorable reading in both March and June. Less than a fifth of the companies in any group deemed business prospects good. Among nonmanufacturers, the rate was 10 percent or less, with minimal improvement from March to June.

Table 1: Share Choosing Each Alternative for Business Conditions,
March 2000 and June 2000

March 2000 Survey

June 2000 Survey

Large

Medium

Small

Large

Medium

Small

Manufacturing Firms

aaFavorable

13%

15%

12%

19%

17%

13%

aa Not so favorable

65

58

50

65

61

53

aa Unfavorable

22

27

38

16

22

34

Nonmanufacturing Firms

aa Favorable

9

9

8

10

10

8

aa Not so favorable

66

58

56

68

59

57

aa Unfavorable

25

33

36

22

31

35

Source: Bank of Japan

A transition matrix, which isolates changes among categories from one period to the next, provides a different analysis of the tankan results (see Table 2). The magnitude of improvement diminishes with the size of the company, and the share shifting out of the unfavorable category falls with firm size; the move to the most positive choice also drops. Thus, between March and June, the largest decline in unfavorable responses occurred among big manufacturers, with the entire share moving into the favorable column. Small manufacturers registered less of a decline in unfavorable sentiments; most of that change showed up under the not-so-favorable heading. Improvements for nonmanufacturers of all sizes were considerably weaker than for producers.

Table 2: Change in Share Choosing Each Alternative for Business Conditions
Between March 2000 and June 2000

Large

Medium

Small

Manufacturing Firms

aa Favorable

6

2

1

aa Not so favorable

0

3

3

aa Unfavorable

-6

-5

-4

Nonmanufacturing Firms

aa Favorable

1

1

0

aa Not so favorable

2

1

1

aa Unfavorable

-3

-2

-1

Source: Bank of Japan

One area where gains were uniform was profitability. All firms responding to the June tankan survey projected improvement on this score in FY 2000. Inventories as well as excess capacity also looked better for the typical firm.

The employment information was more mixed, however. Large manufacturers reported sharp reductions in the ranks of excess workers, but they still had the greatest number of redundant employees. In June, the diffusion index for excess employment stood at 30, with a September forecast of 25. Small enterprises seem to have more or less completed their employment adjustment, as indicated by diffusion indices of 16 for manufacturers and 11 for nonmanufacturers. Only modest changes were reported for the spring, although these were in the right direction. With more cuts required in excess employment, workers are likely to continue to be anxious about their job prospects.

Another area where signs of progress were evident was in bank financing. Small companies, in particular, borrow to fund investment in plant and equipment and work in process. Larger businesses have had better luck at financing investment from retained earnings; they also have access to capital markets. Firms of all sizes that filled out the June tankan questionnaire indicated that the lending attitudes of banks had improved, with big companies in the best position. For small operations, "severe" responses outnumbered "accommodative" answers by a slim margin. The credit crunch that made headlines a year or two ago is over, but banks now are more careful about who they lend to.

In short, the June tankan showed that business sentiment, expectations and plans generally had improved since mid-1998. The fact remains, however, that the overwhelming weight of the responses to the survey still was negative. Thus, Tokyo is correct in arguing that Japan's economic fortunes are improving. Admittedly, not all sectors are participating with equal vigor, but the trend clearly is upward.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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