Japan: Touching Bottom--and Staying There

Japan's latest bout with recession seems to be in the final round. A sustainable recovery is hardly on the horizon, however, because of festering problems in banking and government finance.

The Bank of Japan's first-quarter Tankan survey of some 9,000 companies offered fresh signs that the current downturn is close to bottoming out. The main index of business sentiment among large companies stabilized at the fourth-quarter reading of -38 after falling for a year (chart). The index is the share of those reporting better conditions minus those reporting worse. A negative sign means more pessimists than optimists. Expectations for the second quarter improved sharply, to -27.

But rising expectations are concentrated among large companies, which tend to export and thus enjoy the benefits of improving global conditions and a weaker yen. Smaller outfits, most of Japanese industry, still reported worsening conditions, reflecting the ongoing erosion of domestic demand.

Near-record joblessness and falling wages have left consumer spending to languish as companies slash costs. That includes sending more production to China, meaning that some jobs are gone for good. The February jobless rate stood at 5.3%, with two applicants for every job offer, and the rate is expected to hit 6% this year.

In addition, capital spending by businesses remains in a steep slide. Profits are suffering through 2 1/2 years of declining consumer prices, which in February were down 1.2% from a year ago. The Tankan shows that while large companies expect a 36.8% rise in profits in the coming year, they still plan to cut capital outlays by 8.4%. Small companies expect to slash spending by 16.2%.

The crucial bridge between improving business sentiment and a true recovery will be financial conditions. But despite the tsunami of liquidity pumped out by the BOJ this past year, bank lending is still falling, limited by nonperforming loans. And until conditions stop deteriorating, the threat of an out right financial crisis remains real.

By James C. Cooper & Kathleen Madigan

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