Real GDP grew 0.7% year on year in July-September, marking the third consecutive quarter of growth and affirming that Japan’s economic recovery remains intact. While external demand detracted from growth for the first time in a year, its negative contribution was offset by growth in domestic demand, chiefly consumer spending. The economy consequently maintained a steady growth trajectory in July-September.

However, this favorable economic environment will very likely change dramatically from October-December. We expect the export-led recovery that has been under way since the start of this year to give way to a period of near-zero growth.

Industrial production statistics clearly indicate, in our view, that Japan’s recovery trend is losing momentum. Corporations are curtailing production in direct response to the slowdown in exports, reflecting an aversion to inventory accumulation in the current deflationary environment. We cannot rule out the possibility of a consensus emerging that the economic recovery will be cut short by a modest inventory correction in manufacturing industry between now and mid-2003.

Nonetheless, we see little risk an imminent relapse into a full-blown recession, for three reasons: (1) inventories are at extremely low levels; (2) we expect the US economy to avert a renewed recession; and (3) we expect domestic demand to continue to recover, albeit anemically.

The export slowdown may dampen expectations of an improvement in the employment environment, pressuring consumers
to retrench temporarily. Such an eventuality could interrupt the hitherto unexpectedly solid recovery in consumer spending. The export slowdown will also likely forestall a recovery in capital spending, the downtrend in which has recently been tapering off. On the bright side, a rising propensity to consume is stabilizing consumer spending, while replacement investment is bolstering aggregate capital spending. Against such a backdrop, we expect exports to regain a stable footing and domestic demand to re-embark on a moderate recovery in the second half of 2003.

While the economic ramifications of a faster nonperforming loan cleanup process continue to bear careful monitoring, we have concluded that under current conditions, an acceleration of the cleanup process would not have a major incremental
deflationary effect. We project about a ¥1-trillion increase in public-works spending in the FY02 supplementary budget.

We forecast real GDP growth of +0.9% in FY02 and –0.1% in FY03. On a nominal basis, we project GDP growth of –0.7%
in FY02 and –1.5% in FY03, which would be the fourth straight year of nominal GDP contraction.

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Inquires to: Economic Research Department, Nomura Research Institute
Telephone. 81-3-5255-1800

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