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Economics: Japan Economics – Markets – Strategy JP: What virtuous cycle? • In the past three months, the markets have swung from worrying about a recession to factoring in a rate hike by the BOJ by the year-end. Neither scenario will materialize • There will be no recession but growth will fall to 1.6% in 2008 from 2% in 2007 • This year, the 1.0% (QoQ, sa) expansion recorded in 1Q08 will be as good as it gets. The central bank’s “virtuous cycle” between exports, production, profits and business and household spending has gained no traction. The gradual decay in export growth since early 2006 has become more pronounced, owing to cooler demand from Asia and the US. Corporate margins are being squeezed by higher fuel and commodity prices. Households have little prospect of seeing wage growth emerge from longterm stagnation; as inflation rises, the likelihood is for consumers to tighten their belts • In this context, the Bank of Japan (BOJ) has no room to lift the overnight call target rate of 0.50% this year. Rising inflationary expectations, however, raise the odds that the central bank could seize the opportunity to lift interest rates if economic data improves. This could come as early as 1Q09; although we have ‘downgraded’ the annual average YoY growth rate to 1.6% for 2009, in QoQ terms growth should actually average a relatively stronger 0.7%, versus a 0.3% QoQ average this year JAPAN The global electronics cycle remains in a slump Exports will keep slowing… In 1Q08, exports rose by a surprisingly strong (seasonally adjusted) 4% QoQ, despite the yen having appreciated by about the same degree in real tradeweighted terms. In the next six months, we expect the yen to give back some of those gains, with our forecast being for USD/JPY to finish the year at 107.00. But this will mean little for the export growth outlook, in the face of what will be continued weakness in the global electronics cycle. The hopeful pick-up in the US semiconductor equipment book-to-bill ratio in 4Q07 has all but dissipated, and as at Apr08 the ratio is almost back down to where it was six months ago - a subparity 0.81. Given that the bookto-bill ratio tends to lead Japan’s export cycle by about three to six months, shipments are likely to remain soft for the remainder of the year (Chart 1). Further putting the brakes on export growth will be the slowdown in global growth -10 -15 Lim Su Sian • (65) 6878 1740 • limsusian@dbs.com Chart 1: Electronics cycle still in the doldrums % YoY Ratio 25 20 15 10 5 0 -5 US semi BB ratio (RHS) Merch exports Latest: Apr08 Jan-00 Jul-01 Jan-03 Jul-04 Jan-06 Jul-07 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 142
Economics – Markets – Strategy Economics: Japan this year, particularly in Asia, which now buys close to half Japan’s exports. This year we expect growth in the Asia 10 economies (including China and India) to slow to 6.1% on average, from 7.0% last year. The US, while skirting a recession, will also see sub-par growth of 2.0%; this market accounts for around 18% of Japan’s exports. So, even as demand from markets like Central and Eastern Europe continues to barrel on at over 40% YoY every month, cooler economic growth in Japan’s key markets will still result in declining shipments, as has been the case for the past several months (Chart 2). In quarter-on-quarter terms, this means markedly slower export growth of 2.3% QoQ on average for the next three quarters. In YoY terms, however, export growth for the full year will look a (misleadingly) strong 12.2%, from 8.6% in 2007. Sequentially, import growth will also be moderate at 1.8-2% QoQ, though in annual average YoY terms this translates to a 6.0% rise. Net of imports, exports should contribute 1.2%-pts to overall GDP growth for the year. … further hurting corporate earnings Chart 2: Export contributions from Asia, US falling %-pt contrib to export growth 20 15 10 5 0 -5 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Asia C&E Europe, Russia Rest of world Latest: Apr08 N. America Mid-East Exports, % YoY The soft conditions facing exporters, which account for some 20% of the economy, will not help overall corporate earnings, which are already under significant strain owing to the surge in cost of inputs like oil and commodities. According to the MOF’s first-quarter corporate survey, revenues fell 1.5% YoY during the quarter, largely reflecting a contraction in revenues among non-manufacturers. More notably, operating profits were down 14.2% YoY across all industries, the biggest decline in six years (Chart 3). According to our estimates, profit margins peaked in the second to third quarter of 2007, and are currently undergoing a relatively sharp correction in both the manufacturing and non-manufacturing sectors (Chart 4). These poor business conditions explain why we saw business spending growth of just 0.2% QoQ in 1Q08. Indeed, for the remainder of the year we believe Demand from Asia, US is weakening Export growth to slow Cooling external demand and higher input costs are hurting corporate profits Chart 3: Sales, profits contracting % YoY 40 30 20 10 0 -10 -20 -30 -40 Operating profits Sales Latest: 1Q08 Jun-97 Jun-99 Jun-01 Jun-03 Jun-05 Jun-07 Chart 4: Profit margins rapidly thinning Profit to sales ratio, sa 6 5 4 3 2 1 0 Latest: 1Q08 All indust Manuf Non-manuf Jun-97 Jun-99 Jun-01 Jun-03 Jun-05 Jun-07 143
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