A Bad Case Of Double Vision in Japan

Will growth thrive or dive? Bulls and bears couldn't be more widely divided

Japan's economy is back on track, says one group of economists, and the growth of the past two years will continue in 2005. No, not true, insist their bearish opponents. The rising value of the yen is already crimping exports and earnings, while inventories of crucial electronic goods are rising, and consumer demand and capital expenditures have yet to really take off.

Who's right? No one knows, and that's the most extraordinary fact about Japan's economy. "There's an unusual lack of consensus right now," says Merrill Lynch Japan Securities (MER ) senior economist Takuji Aida. Bulls insist the sharp pullback in the country's economic indicators that began in the summer is just a temporary lull. Bears say the evidence is thin that Japan ever fully emerged from its 10-year funk and expect anemic growth in 2005 Gross domestic product growth estimates for the fiscal year that starts on Apr. 1 range from a near-recessionary 0.5% to a healthy 2.4%. The difference of opinion on the world's second-biggest economy is enough to affect estimates of global growth rates in 2005.

Other indicators yield no more clarity. On Dec. 28 the government announced industrial production in November rose a seasonally adjusted 1.5% because of higher demand for cars and steel. But the day before it reported a sharp drop in business confidence among large manufacturers in the last quarter of the year.

Each side in the growth debate can be persuasive. The optimists admit that slowing growth in China -- which now sucks up 19% of Japan's exports -- is a negative sign. But they argue that the worst is over and that overall demand from overseas, including the key U.S. market, will stay strong. Exports rose 13.4% in November from a year earlier. At the same time, imports climbed 28%, to a record high, indicating that domestic demand for raw materials and finished goods remains strong. What's more, the number of jobs is increasing for the first time since 1998: Unemployment fell to 4.5% in November, the lowest rate since January, 1999. Merrill Lynch expects the rate to keep falling -- all the way down to 3% by the end of fiscal 2006. That could lift income levels and sharply raise consumer spending.


So much rubbish, say the bears. First of all, not only are exports on the decline but the rising yen has also subtracted billions of dollars from Japanese exporters' bottom lines. And there is no end in sight to the dollar's weakness; some forecasters predict the yen will rise from the current 103 to the dollar to 95 by early 2006. "The only thing holding up the economy is exports," says Taro Saito, senior economist at NLI Research Institute. "Once that leg is kicked away, we'll be in recession."

Corporate leaders are a trifle more optimistic. "The economy might slow in the first half of 2005, but the pace of growth in the second half is expected to quicken with a recovery in the U.S. and China," Hiroshi Okuda, head of Japan's Keidanren business lobby and chairman of Toyota Motor Corp. (TM ), told the press on Jan. 5.

The government added to the confusion -- and bolstered the bears' case -- when it introduced new criteria on Dec. 8 for calculating GDP to better reflect changes in price data. One thing is clear: As measured by the new system, recent growth was not nearly as torrid as once thought. The revised numbers whacked GDP for 2003 from a heady 3.2% to just 1.9%. "The Cabinet Office's shift...has cut down Japan's tigerish-looking economy to more pussycat proportions," notes Peter Morgan, chief economist at HSBC Securities in Tokyo, in a recent report.

To be sure, even the most bearish analysts admit that Japan is not the mess it was five years ago, when banks were on life support and deflation was eating away at the economy. Then again, Japan's capacity to disappoint is almost limitless. Those consumers had better start shopping.

By Chester Dawson in Tokyo

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