Country Report

Japan

October 2007

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Japan 1

Japan

Executive summary 2 Highlights

3 Outlook for 2008-09 3 Political outlook 4 Economic policy outlook 5 Economic forecast

Monthly review: October 2007 9 The political scene 11 Economic policy 13 Economic performance

Data and charts 16 Annual data and forecast 17 Quarterly data 18 Monthly data 20 Annual trends charts 21 Monthly trends charts

Country snapshot 22 Political structure

Editors: Miho Tanaka (editor); Gerard Walsh (consulting editor) Editorial closing date: September 25th 2007 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: To request the latest schedule, e-mail [email protected]

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Executive summary Highlights

October 2007

Outlook for 2008-09 • The immediate task of the new Liberal Democratic Party (LDP) prime minister, Yasuo Fukuda, will be to improve the support ratings for his government, especially in rural communities. • The government would prefer to hold the next election to the lower house, which is not due until September 2009, some time in 2008, but the opposition will be pressing for the poll to take place as early as possible. • Mr Fukuda will face a difficult balancing act between growth-oriented and redistributionist policy agendas. Volatile domestic politics will constrain Mr Fukuda!s foreign policy options. • The opposition Democratic Party of Japan (DPJ) will take advantage of its newly won majority in the upper house to censure the government, probably in March 2008, in an attempt to force an early general election. • The Economist Intelligence Unit previously assumed that an increase in the consumption tax would be announced in 2008, to take effect in 2010, but we now believe that the increase will be delayed by a year. • With further US interest rate cuts in the pipeline and weaker GDP growth data releases, the Bank of Japan (the central bank) will postpone the next increase in its target for the overnight call rate until mid-2008.

Monthly review • Shinzo Abe resigned suddenly as prime minister on September 12th following his failure to gain the support of the DJP for the renewal of the anti-terror law. • Of the two candidates who stood to replace Mr Abe, the LDP opted for Mr Fukuda!s reputation for efficient governance and moderate foreign policy over Taro Aso!s outspoken style. • Japan!s support in the Indian Ocean for the allied forces in Afghanistan will end on November 1st if the government fails to renew the anti-terror law in time. • The government has revised down its GDP growth estimate for the second quarter of 2007. GDP shrank by 0.3% in real terms compared with the previous quarter, rather than growing by 0.1% as originally indicated. • The yen has appreciated against the US dollar since August, imposing big losses on the numerous Japanese individual investors who have recently bought foreign-denominated stocks and bonds.

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Outlook for 2008-09

Political outlook

Domestic politics Yasuo Fukuda of the ruling Liberal Democratic Party (LDP) became Japan!s new prime minister on September 25th following the sudden resignation of Shinzo Abe earlier in the month. The public reaction to the LDP!s choice of the country!s new leader is yet to be seen, but will be crucial to the survival of the LDP as the dominant party in Japanese politics. Following the loss of its majority in the election to the House of Councillors (the upper house of parliament) in July, the LDP!s fear of losing the next election in the House of Representatives (the lower house) is immense. It will try to regain the public!s confidence and support by addressing the voter concerns that led to its recent election defeat. Particular efforts will be made to resolve such domestic issues as the scandal in which the state admits to having lost around 50m pension records, economic disparities between cities and rural areas, and misuse of political funds. Mr Fukuda and his new government will have to strike a difficult balance between appeasing the rural electorate and repairing the country!s fiscal position. In order to achieve the government!s target of bringing the primary budget (that is, the budget excluding debt repayments) into balance by fiscal year 2011/12 (April-March), an increase in the consumption tax will be required, but it is doubtful whether the LDP government will dare to broach such politically sensitive subjects as tax rises before the general election. An extraordinary parliamentary session, which was opened by Mr Abe just before he resigned, will resume on October 1st now that the new prime minister and his cabinet are in place. It will be dominated by the renewal of anti-terror legislation, which permits among other things Japan!s participation in the refuelling of US warships in the Indian Ocean. The main opposition Democratic Party of Japan (DPJ) will continue its opposition to the LDP-backed bill in the upper house, and will demand transparency in the details of the legislation using the DPJ!s newly won right (as the majority party in the chamber) to investigate government matters. Having hinted at his openness to compromise on this matter, Mr Fukuda may be able to reach a deal with the DPJ. The recently victorious DPJ may seem to be in the ascendant, but it has yet to establish its credentials as an alternative party of government. Formed in 1998 through the merger of several small opposition parties, the DPJ is a young entity, and this is the first time that it has been the biggest party in the upper house. In order to maintain momentum, the DPJ will have to clarify its policy platform. The party must also tread carefully in using its new dominance in the upper house: merely blocking government legislation will do little to convince voters that it is a credible alternative to the LDP as a responsible party of government. There are also concerns about the quality of the party’s leadership. The DPJ!s leader, Ichiro Ozawa, is ageing and ailing, and his appeal to voters is mixed.

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The next election to the lower house of the parliament is due by September 2009, but is likely to be called earlier, as the lower house rarely serves a full term. The opposition parties, led by the DPJ, will continue to call for an early election in the coming months. The pressure on the ruling LDP to call an election will mount in the next parliamentary session, which opens in late January 2008 for six months, particularly when the budget for 2008/09 is debated. The welfare minister will be grilled by the opposition parties on progress regarding the lost pension records, as Mr Abe promised in March to solve the problem "within a year". The two legislative chambers will come into dispute over who is to be appointed as the next governor of the Bank of Japan (BOJ, the central bank) in March, when the term of the current governor, Toshihiko Fukui, expires. If the LDP ignores the upper house!s decisions on any of these issues, the DPJ can go as far as issuing a censure motion against the prime minister or any of his cabinet members, and this could trigger a resignation or even a general election. Whenever the next election is held, the LDP will inevitably lose many of the seats that it won in its landslide victory in 2005, but it is likely to remain the largest party. The recent upper house election suggests strongly, however, that Japanese politics has entered a new phase of volatility.

International relations A degree of reticence is expected in Japan’s international dealings, given that Mr Fukuda will need to focus on domestic issues, leaving him little time to formulate and impose an assertive foreign policy. Mr Fukuda!s views on foreign policy are known to be moderate"he favours closer relations with neigh- bouring countries. Ties with the US should stay cordial; Mr Fukuda needs to rebuild US confidence in Japan!s remaining a reliable ally in a potentially volatile region, particularly if the anti-terror law lapses. Japan!s relationship with China will continue to improve under Mr Fukuda!s leadership. Tensions remain, however. This is partly because of military co-operation between the US, Australia and Japan (with India also having been invited to join in August), which is arousing Chinese concern, and partly because of China!s rapid military build-up, which Japanese policymakers fear is aimed at increasing Chinese influence in the region at Japan!s expense. Resource competition will also strain relations, with one flashpoint likely to be the development of gasfields in the East China Sea, an area that both countries claim as their territory.

Economic policy outlook

Policy trends Japan!s poor fiscal position remains a concern. The government will continue to pursue a policy of fiscal consolidation, but the level of government debt, at around 180% of GDP in 2007/08, will remain the highest by far of any OECD economy. As a result of the ongoing fallout on world financial markets from problems with US subprime mortgages, which started in early August, US monetary policy has been loosened, the benchmark federal funds rate having been cut from 5.25% to 4.75% on September 18th. The differential between US and Japanese interest rates has narrowed more than expected in response to the recent turmoil. The Economist Intelligence Unit now forecasts that the BOJ

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will delay until mid-2008 the next increase in the overnight call rate (OCR) target from its current level of 0.5% to 0.75%. Previously, we expected an increase before the end of 2007. Monetary policy will be tightened progressively from mid-2008 through to the end of 2009.

Fiscal policy Although the government is expected to cut spending aggressively in order to limit the budget deficit to less than 2.5% of GDP in 2008-09, pressure on the public finances will remain intense. On August 6th the government released a revised fiscal forecast suggesting that it will only just bring the primary budget (that is, the budget excluding debt repayments) into balance in 2011/12. This compares with a budget surplus of 0.2% of GDP in that year forecast earlier in 2007, and suggests that improvements in the fiscal position may take longer than expected to achieve. We believe that the government!s revised fiscal forecast will require an increase in the consumption tax, but, given the recent political uncertainty, we assume that the 2-percentage-point rise in the tax from 5% to 7% previously expected in 2010 is now likely to be delayed until 2011.

Monetary policy The volatility in global financial markets since August and the subsequent cuts in the US federal funds rate have altered our view regarding the speed at which that the BOJ will tighten monetary policy. Interest-rate spreads have narrowed, rather than widening as previously expected. The GDP growth estimate for the second quarter of 2007 was revised down by the government in early September. The BOJ last raised its target for the OCR by 25 basis points to 0.5% on February 21st 2007, and pressure on the central bank to increase the OCR again has subsequently lessened. For this reason, together with the disappointing GDP data revisions published recently, we do not expect the OCR to be raised before the end of 2007 (previously we had forecast an increase of 25 basis points). Concerns about the strength of the US economy will dissuade the BOJ from raising the OCR aggressively in 2008. We now expect only two rate rises next year, in the second and fourth quarters, taking the OCR to 1%. In 2009, however, the pace of tightening will pick up, with quarterly increases taking the OCR to 2% by year-end.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2006 2007 2008 2009 Real GDP growth World 5.3 5.1 4.8 4.7 US 2.9 1.9 2.1 2.8 EU27 3.0 2.7 2.4 2.3 Exchange rates US$ effective (2000=100) 84.6 81.1 79.2 79.8 US$:€ 1.26 1.36 1.38 1.32 SDR:US$ 0.68 0.65 0.64 0.65 Financial indicators US$ 3-month commercial paper rate 5.03 5.16 4.70 4.80 € 3-month interbank rate 3.08 4.12 4.40 4.38

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International assumptions summary (% unless otherwise indicated) 2006 2007 2008 2009 Commodity prices Oil (Brent; US$/b) 65.3 69.4 69.0 63.3 Gold (US$/troy oz) 604.5 667.5 685.0 606.3 Food, feedstuffs & beverages (% change in US$ terms) 16.1 19.3 4.1 -1.1 Industrial raw materials (% change in US$ terms) 49.6 12.2 -5.8 -12.4 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. Despite recent global financial market volatility, the outlook for world economic growth is healthy. Although global GDP growth (on a purchasing power parity basis) is forecast to slow gradually from an estimated 5.1% in 2007 to an average of 4.8% in 2008-09, this still represents a robust performance by the world economy, helped in part by continued strong growth in the big emerging- market economies. China in particular is forecast to post rapid growth, and this will have a positive impact on Japan as trade ties between the two countries continue to develop. Although the pace of growth in Japan!s biggest trading partner, the US, is forecast to accelerate to 2.1% in 2008 and 2.8% in 2009, the risk of a recession in the US remains at 40%. Strong demand, an aggressive OPEC policy of maintaining petroleum prices at high levels and a large geopolitical risk premium will continue to support international oil prices (dated Brent Blend), which will average US$69/barrel in 2008 and will then ease to US$63.3/b in 2009 as new crude capacity comes on stream.

Economic growth Gross domestic product by expenditure (¥ trn at chained 2000 prices where series are indicated; otherwise % change year on year) 2006a 2007 b 2008c 2009c Private consumption 304.3 308.8 313.9 317.9 0.9 1.5 1.7 1.3 Public consumption 95.3 96.0 96.9 97.7 0.4 0.7 1.0 0.8 Gross fixed investment 128.3 129.4 131.8 134.5 3.6 0.9 1.8 2.1 Final domestic demand 527.9 534.2 542.7 550.2 1.4 1.2 1.6 1.4 Stockbuilding 1.6 0.9 0.4 0.5 0.1d -0.1 d -0.1d 0.0d Total domestic demand 529.5 535.1 543.1 550.7 1.5 1.1 1.5 1.4 Exports of goods & services 80.6 86.7 92.4 98.5 9.6 7.5 6.5 6.7 Imports of goods & services -60.5 -61.9 -65.4 -70.2 4.6 2.3 5.6 7.4 Foreign balance 20.1 24.8 27.0 28.3 0.8 0.8 0.4 0.2 GDP 549.0 559.8 570.0 579.0 2.2 2.0 1.8 1.6 a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts. d Contribution to real GDP growth (as a percentage of real GDP in previous year). We have revised down our GDP growth estimate for 2007 to 2% (from 2.3% previously), following the release of revised data in early September showing a

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quarter-on-quarter fall in GDP in the second quarter: rather than growing at 0.1% as indicated in the government!s preliminary estimate published in mid- August, GDP actually shrank by a seasonally adjusted 0.3% in real terms relative to the previous quarter. Economic expansion in Japan will moderate to 1.8% in 2008 and 1.6% in 2009, but this is a fair performance by Japanese standards. The country has benefited from a buoyant external sector, boosted by the weakness of the yen and strong growth in corporate investment. Both factors will fade in the wake of a strengthening yen and tighter financing conditions in 2008-09, but household consumption and residential investment are expected to pick up the baton. The outlook for private consumption is reasonably bright. The labour market is tighter than at any point since the bursting of the asset-price bubble in the early 1990s, and, with companies continuing to report a shortage of workers, this situation will persist over the forecast period. The unemployment rate fell to 3.6% in July, its lowest level for nine years. Wage growth has, however, been sluggish so far in 2007"total scheduled wages at companies with 30 or more employees were up by 0.6% year on year in July. This partly reflects demographic shifts, with increasing numbers of expensive retirees being replaced by cheaper young recruits. The extensive use by firms of part-time employees, who are cheaper pro rata to employ than full-timers (as they enjoy fewer benefits), may also be putting downward pressure on incomes. We expect corporate investment growth, which has been a major factor in the Japanese economy!s strong performance since 2003, to continue to moderate in 2008-09. Given that foreign demand for Japanese goods is set to soften, trading conditions for many companies are likely to become more challenging, although this will not prevent the export sector from continuing to perform strongly overall. The value of the yen is expected to come under upward pressure, meaning that Japanese manufacturers of export goods will be in for tougher times.

Inflation Consumer prices are forecast to remain flat in 2007. Inflationary pressures will build gently over the forecast period, causing prices to rise by 0.5% in 2008. Not only are capacity constraints starting to bite, but companies also continue to report labour shortages. Above-trend economic growth, coupled with more good news on land prices, should also help to put upward pressure on consumer prices in 2008. Sustained (albeit slower) GDP growth in 2009 will continue to exert mild inflationary pressure on the economy, and consumer price inflation is forecast to accelerate to 0.8% in that year.

Exchange rates Although we assume that the BOJ will not raise interest rates in 2007 until the second quarter of 2008, the yen!s appreciation against the US dollar will continue. As the yen rises, most of the remaining yen carry trade will be unwound, leading to a substantial backflow of funds into Japan. (The carry trade involves investors borrowing in low-yielding currencies, such as the yen, and investing in higher-yielding ones, such as the New Zealand dollar.) This will contribute to a sharp strengthening of the yen in 2008-09, not only against the US dollar but also against the euro. The yen is forecast to appreciate steadily, averaging ¥106.3:US$1 in 2008 and ¥96.5 in 2009.

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External sector Despite the negative impact of high international oil prices on Japan!s external position, the current account is set to record further large surpluses, equivalent to an average of 4.7% of GDP, in 2008-09. The merchandise trade surplus will remain substantial, rising to over 3% of GDP in 2009, with exports likely to fare well as a result of buoyant growth in the Chinese market. In addition, the income surplus will remain sizeable, largely because of strong inflows from Japan!s overseas portfolio and direct investments. The services balance will remain in deficit to the tune of less than 1% of GDP. The buoyancy of demand for shipping services should help to boost services exports, although this will be more than offset by brisk growth in outbound tourism.

Forecast summary (% unless otherwise indicated) 2006 a 2007 b 2008c 2009c Real GDP growth 2.2 2.0 1.8 1.6 Industrial production growth 4.5 1.8 1.7 1.4 Gross fixed investment growth 3.6 0.9 1.8 2.1 Unemployment rate (av) 4.1 3.8 3.5 3.3 Consumer price inflation (av) 0.2 0.0 0.5 0.8 Consumer price inflation (year-end) 0.3 0.3 0.7 1.0 Short-term interbank rate 1.5 1.8 2.0 3.0 Government balance (% of GDP) -2.5 -2.6 -2.2 -2.0 Exports of goods fob (US$ bn) 615.8 664.8 736.3 816.7 Imports of goods fob (US$ bn) 534.5 567.9 616.1 643.9 Current-account balance (US$ bn) 170.5 203.4 232.8 256.1 Current-account balance (% of GDP) 3.9 4.7 4.7 4.6 Exchange rate ¥:US$ (av) 116.3 117.8 106.3 96.5 Exchange rate ¥:€ (av) 146.0 159.8 146.4 127.4 Exchange rate ¥:US$ (year-end) 119.0 112.5 100.5 94.5 Exchange rate ¥:€ (year-end) 157.0 156.4 135.7 122.4 a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

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Monthly review: October 2007 The political scene

Mr Abe is succeeded by The erstwhile prime minister, Shinzo Abe, emerged from the July 29th election

Mr Fukuda as prime minister to the House of Councillors (the upper house of parliament) a chastened and vulnerable figure. The backbenchers in his ruling Liberal Democratic Party (LDP) blamed him for their discomfiture and wanted sooner or later to replace him with someone more acceptable to the public. The opposition Democratic Party of Japan (DPJ), meanwhile, felt emboldened by its victory at the polls and was determined to frustrate Mr Abe’s every initiative in order to force him to call an election to the more powerful House of Representatives (the lower house) while voters were still angry. Also indicative of Mr Abe’s weakness were the seemingly incessant attacks by the press and the public prosecutor!s office on members of his cabinet, related to alleged wrongdoing. After having lost four ministers earlier this year, Mr Abe reshuffled his cabinet in August in an attempt to remove the likely targets of the public prosecutor!s office and regain the policy initiative. By bestowing several portfolios on senior figures in the LDP’s major factions, he hoped in addition to compensate for his unpopularity with voters and bolster his standing within the LDP. Mr Abe realised that he was not capable of imitating his predecessor as prime minister, Junichiro Koizumi, who ignored the wishes of the factional leaders and appealed directly to the Japanese public.

The factions were happy to claw back some of the power that they used to enjoy, while the prosecutors continued to harry the government, driving the new agricultural minister, Takehiko Endo, from office within days of his appointment and hinting at the possibility of action against Mr Abe himself. As the sharks circled, Mr Abe decided to stake his career on the fate of a single measure: renewing the anti-terror law. The law allows the Self-Defence Force (Japan!s de facto military) to stay in the Indian Ocean, whence they provide support to the allied forces in Afghanistan, and it needed to be renewed before its expiry on November 1st. Representatives of the US government had declared on several occasions that the renewal of this law was essential to US-Japanese bilateral relations and that the opposition DPJ, under the leadership of Ichiro Ozawa, should therefore come to an accommodation with the LDP on this score. But Mr Ozawa refused to co-operate. Over time Mr Abe!s government resigned itself to the fact that there was no way to persuade the DPJ majority in the upper house to endorse the anti-terror measure, and that the only way to pass it would therefore be to use the LDP’s two-thirds majority in the lower house to override a veto. Controversial at the best of times in consensus- oriented Japan, such a strategy by Mr Abe, who was already unpopular, would have offended the Japanese electorate even more.

In early September Mr Abe publicly reiterated his determination to shepherd the anti-terror law through parliament. At an Asia-Pacific Economic Cooperation (APEC) summit in Sydney, Australia, on September 8th-9th Mr Abe reportedly promised the US president, George W Bush, that he would succeed in

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that endeavour. On his return to the capital, Tokyo, he duly opened the extraordinary parliamentary session on September 10th. In the afternoon of September 12th, however, a sullen and apparently ill Mr Abe stunned Japan by publicly announcing his retirement from office, in effect ending his own political career. It is difficult to imagine a more curious series of events. For whereas Mr Abe’s departure gave the LDP a chance to set aside the controversial law and to choose someone more attractive as prime minister, it also deprived the parliamentary session of its purpose and left the country in a state of confusion.

Mr Ozawa and his colleagues in the upper reaches of the DPJ were overjoyed by Mr Abe’s resignation. To them, it was a development that confirmed voters’ sense the LDP was incapable of providing determined rule, and therefore increased the opposition’s appeal. Yet the LDP remains in control of the more powerful lower house of the parliament, and will consequently have at least one chance to right the ship of state by forming a new government. To this end, the LDP immediately decided to hold an internal election for its party presidency on September 23th, the winner of which would by dint of the party’s dominance in the lower house automatically become the prime minister. In the first few days after Mr Abe’s fall the foreign minister, Taro Aso, a relatively charismatic leader who was politically and personally close to the erstwhile leader, looked like the most promising candidate for office. However, the tide turned quickly. Within a day of Mr Abe!s announcement that he was stepping down, the leaders of the LDP!s biggest factions had all come out in support of Yasuo Fukuda, a more traditional, uncharismatic LDP politician who had served as Mr Koizumi’s chief cabinet secretary and enjoyed a reputation for efficient government and moderate foreign policy. Evidently most LDP members felt that they had had enough of the more outspoken and controversial style of rule embodied by Mr Koizumi and, less spectacularly, by Mr Abe, and had decided that they would prefer some of the old stability. It is not clear whether the Japanese people will be comfortable with the return of "grey" leadership, but from the LDP’s perspective Mr Fukuda probably appears a safe bet. On September 23th, 386 out of the LDP!s 527 elected politicians voted for Mr Fukuda as their new party president, and on September 25th he was officially announced as Japan!s new prime minister.

Japan’s foreign policy hangs in The political events of the last six weeks have cast a shadow over Japan’s

the balance foreign affairs. First, there is the stark difference between the international agendas of the ruling LDP-New Komeito coalition and of the opposition DPJ, which officially wants to emphasise Japan’s relations with the UN over its existing relationship with the US. The DPJ insists that the dispatch of Japanese forces overseas should be allowed only with UN authorisation. But even in the current LDP government with Mr Fukuda’s emergence as party president and prime minister, there is still considerable room for uncertainty. For although he purports to believe that Japan must extend the anti-terror law as a means of sustaining the close relationship with the US that it has developed over the past few years, he has not explained how he would overcome the DPJ’s opposition to that legislation. Mr Fukuda similarly says that he dislikes the pressure tactics that Mr Aso, as foreign minister, adopted towards North Korea and that he

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himself would take a more flexible diplomatic approach, but this too would depend on the state of relations with the US and the other participants in the six-party talks (involving North and South Korea, Japan, the US, China and Russia) on the North Korean nuclear issue. Another question is whether the new prime minister will need to strengthen his hand by calling a lower house election earlier than the latest con- stitutionally allowable date of September 2009. On the one hand, this would compel the government and the opposition to put aside policy formation and focus on the campaign and its aftermath, a process that could use up several months. On the other, there is no way to be sure that going to the people would redound to the LDP’s benefit: equally possible would be a further erosion of the ruling party’s power in parliament. The upshot would be to extend the period of uncertain leadership well into the future, leaving Japan in the interim without a clear foreign policy.

Economic policy

Political uncertainty The economic stagnation of the 1990s and early 2000s eventually led Japan to overshadows economic policy adopt a range of reforms, including the deregulation of various industries, recapitalisation of the banking system and progressively more ambitious corporate restructuring. Junichiro Koizumi, the prime minister from 2001 to 2006, was perceived as the most effective of the reformers largely because it was during his tenure that economic recovery finally got going. It may seem paradoxical, but steady GDP growth ended up turning many of the public against the prospect further reform, as people started to feel that they had made enough sacrifices and could now safely begin to return to their traditional cultural and business norms, which tend to prioritise collective social values over individual ambition. Public criticism of the widening gap between rich and poor, disparities in the distribution of economic gains between various parts of Japan, and concern that Mr Koizumi’s policies were disproportionately benefiting young capitalists consequently mounted just as Mr Koizumi stepped down as prime minister in favour of Shinzo Abe last year. The July 29th 2007 upper house election represented another step in the process of reaction, for the basis of the success of the opposition Democratic Party of Japan (DPJ) was its appeal to those rural communities that had historically supported the ruling Liberal Democratic Party (LDP) but had become angry about the government’s relentless cuts in public works spending. With the ruling coalition significantly weakened and having lost control of the upper house, there was little chance that the government would be able take politically controversial (if economically desirable) steps such as promoting further private-sector restructuring, deregulating the agricultural sector in order to facilitate the conclusion of new free-trade agree- ments (FTAs) with other countries, and initiating public discussion of the need for gradual fiscal retrenchment.

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Mr Koizumi's reforms With an eye to both the LDP’s leadership vote and the next lower house

slow down contest, Yasuo Fukuda espoused policies that would appeal to important segments of the population. For example, he announced that he intended to sponsor bills that would discourage official corruption of the kind that had so offended voters over the past year. Pension reform, too, figured strongly in his policy agenda. When the social security agency admitted the loss of records documenting 50m pension payments, Mr Abe’s failure to address the problem adequately alienated voters. More questionable was Mr Fukuda!s determination to increase the government’s financial support for disadvantaged regions by expanding infrastructure spending, offering greater subsidies for farmers or providing tax credits to companies investing in rural areas. Although politically and socially advisable, such efforts to reduce disparities between Japan’s rich and poor regions would inevitably slow the country’s efforts at agricultural liberalisation and increase the government’s budget deficit, which currently stands at around 2.5% of GDP. His proposal to freeze the fees that elderly people pay for healthcare would also contribute to a rise in the fiscal deficit. Such a move could severely damage Japan’s long-term fiscal health, given a rapidly ageing population. Since displacing Taro Aso as the favourite in the LDP leadership race, Mr Fukuda has tried to edge back from this populist agenda towards a conservative stance"pledging to continue in the path of reform, for instance, and to tighten fiscal policy if necessary to prevent further budgetary deterioration"but the fact remains that he has already committed himself to generous economic policies. Mr Fukuda!s election as the LDP!s leader will not give him the authority required to make politically unpopular choices, and he will still confront a DPJ-controlled upper house that will continue to agitate for an early general election. Until these issues become clearer, the new government will almost certainly choose to pursue a voter-friendly approach at the expense of painful structural reforms and fiscal tightening.

The DPJ's view on the Also interesting is the gradual evolution of the opposition DPJ’s views on

central bank matters monetary policy, including the question of the membership of the policy board at the Bank of Japan (BOJ, the central bank). The DPJ traditionally opposes the BOJ!s appointment of figures who have significant contacts with the ruling LDP, the Ministry of Finance or elements of the bureaucracy. This means that Toshiro Muto, the BOJ!s current deputy governor, Heizo Takenaka, who served as Mr Koizumi!s reformist minister of economic and fiscal policy, and other leading contenders for the office of BOJ governor will probably not be appointed when the present governor, Toshihiko Fukui, and two of his deputies step down in March 2008. In the meantime, the DPJ has moved away from its advocacy of looser monetary policy and towards the BOJ’s present emphasis on the need to raise interest rates. It seems that the DPJ is trying to reassure the Japanese people, and particularly businessmen, that it does not consist of irresponsible populists but rather of dutiful parliamentarians who, if elected, can be trusted with the business of running the government.

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Economic performance

The latest revisions In early September the government revised its preliminary report for the

downgrade GDP growth second quarter of 2007. The latest data release shows that, rather than growing at 0.1% as originally indicated in the government!s preliminary estimate, published in mid-August, GDP actually shrank quarter on quarter by a seasonally adjusted 0.3% in real terms. The contributions to growth from government investment and household consumption were revised down in the new data. The critical factor in this first economic contraction since the fourth quarter of 2004 was a sharp and unexpected decline in corporate investment. Business investment which, along with exports, has been one of the pillars of Japan!s robust economic performance in the past three years, has now contracted for two quarters in succession. This comports with the recent figures on industrial production, growth in which has slowed gradually in recent months, to stand at just 2% year on year in July. Inventories have increased slowly over this period, although not to alarming levels. Machinery orders, a leading indicator of future corporate investment, especially in the manufacturing sector, conversely rose in July, which suggests that corporations may soon resume their expansionary trajectory. Meanwhile construction orders, which capture investment trends among the ever more important exporting firms, were fairly strong in mid-2007, heralding better GDP growth in the latter half of the year. Overall, the downturn in the second quarter seems to be a transitory event that, barring any additional shocks to the economy, should be reversed in the second half of 2007.

Expenditure on gross domestic product (% change year on year unless otherwise indicated; chained 2000 yen; seasonally adjusted) 2006 2007 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Private consumption 1.8 1.4 -0.2 0.5 1.4 1.2 Private plant & equipment investment 5.2 7.3 6.9 11.0 7.0 1.5 Private residential investment 1.7 1.3 0.1 0.9 -0.6 -2.4 Government consumption -0.8 0.7 0.2 1.4 1.2 0.8 Government fixed investment -1.0 -5.8 -14.3 -9.2 -8.4 -5.1 Stockbuilding (private)a 0.0 -0.1 0.2 0.1 0.0 -0.1 Stockbuilding (public)a 0.0 0.0 0.0 0.0 0.0 0.0 Exports of goods & services 13.0 10.1 9.4 6.3 7.4 7.4 Imports of goods & services 6.5 6.5 2.6 2.7 1.7 1.0 GDP 2.6 2.2 1.4 2.5 2.6 1.7 Implicit GDP deflator -1.3 -1.1 -0.7 -0.6 -0.6 -0.3 a Contribution to growth. Source: Cabinet Office.

The country may be There are, unfortunately, other clouds on Japan’s horizon. First among these is

vulnerable to recession the persistence of mild deflation, as reflected in the national consumer price index, which the Bank of Japan (the central bank) and others consider a key measure of price trends. This gauge of inflationary pressure remained flat, or slightly negative during July in year-on-year terms, while the level of prices in

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the capital, Tokyo"a leading indicator of future national prices"decelerated from a slightly positive pace in early 2007 into negative territory in June, July and August. Also troubling is the popular anxiety apparent in the results of polls of consumer sentiment, which reveal that people are concerned about stagnant wages, the rising prices of food and petroleum products, the recent increase in the residence tax and the tightening of regulations covering consumer lending.

Inflation indicators, 2007 (% change, year on year) Mar Apr May Jun Jul Aug Consumer prices, national -0.1 0.0 0.0 -0.2 0.0 n/a Consumer prices, Tokyo 0.1 0.1 0.0 -0.2 -0.1 -0.2 Corporate goods prices 2.7 3.6 4.5 4.5 3.6 2.2 Corporate services prices 0.6 1.1 1.4 1.5 1.6 n/a

Sources: Bank of Japan; Ministry of Internal Affairs and Communications.

Then came the August financial crisis in the US subprime mortgage market, which has caused the yen to appreciate and has had adverse effects on the Japanese stockmarket and the country’s economic outlook. The first of these dynamics became evident when global investors started selling off their positions in Asia!s local markets as their confidence weakened following the crisis and the subsequent tightening of credit conditions. This caused the yen to appreciate sharply against the US dollar, thereby imposing big losses on those numerous Japanese individual investors who had recently bought foreign- denominated stocks and bonds. Meanwhile, and partially independently, the sale of assets caused a 16.4% decline in the Nikkei average of 225 corporate stocks at the peak of the crisis in a single week during August 12th-18th. The impact of these developments on consumption has yet to be seen, but the recent events could bring more disappointing economic growth results for another quarter or two.

Unfortunately, the other shoe has yet to drop. With financial markets largely seizing up in North America, where credit spreads have widened dramatically, and housing prices on that continent decreasing at an estimated year-on-year pace of 4-5%, there are grounds to worry that household consumption in the US will start to decline in late 2007 or early 2008. Taking into consideration the possibility that the current credit-market turmoil may be sustained, the Economist Intelligence Unit puts the odds of a US recession in 2007-08 at around 40%. Given that this would severely damage Japan’s exporters, would discourage corporate investment and would undermine household confidence in a manner that almost inevitably curtails consumption, the likelihood of a recession in Japan during that period is to be adjudged to be similar.

Savings remain high by Japan’s savings rate is extraordinarily high by the standards of advanced

developed-country standards industrialised economies, and plays a powerful role in the country!s economic performance. Since the collapse of the asset-price bubble in 1989-91, the country has been awash with capital, interest rates have remained low and corporate investment very high. The inexorable increase in productive capacity, together with the weakness of household consumption, implies that the country must

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export a great deal of its industrial output and that the government must provide a significant degree of budgetary stimulus. Economists long expected the resolution of this problem of excess savings (or, from an alternative standpoint, inadequate demand) to be reached with the retirement of the post-second world war baby-boomer generation; when those people left the workforce, their savings were projected to collapse and their consumption to expand.

The long-term outlook for With these expectations in mind, the fact that consumption has not risen

consumption looks doubtful significantly even after five years of GDP growth and the cresting of the wave of retirement appears paradoxical. Most observers would attribute this lack of responsiveness to the failure of wages to strengthen, which in turn stems from companies’ progressively greater use of part-time and temporary staff. But if this is the correct explanation, the situation should soon improve, as most employers have now reduced their permanent payrolls to the limit allowed by their need to maintain a core of dedicated, long-term personnel. This analysis, however, misses an important point: that the dismantling of the traditional lifetime employment model may not be as significant in attenuating wage increases as the longer-term trend towards younger workers. Put simply, firms are replacing their older, more expensive staff with fresh graduates who are willing to accept lower levels of compensation. This trend, moreover, is likely to persist for the decade or so during which the baby-boomers gradually leave the labour pool. Consumption may therefore remain weak for many more years, as Japan continues to suffer from an excessively high saving rate and consequently remains dependent for economic growth on a combination of government deficits and expansion in net exports. This pattern, together with the country’s growing receipts from its existing overseas investments, virtually guarantees that the Japanese current account will continue to run a large, and diplo- matically controversial, surplus until well into the next decade.

Wages and costs, 2007a (% change year on year where series are not indicated) Feb Mar Apr May Jun Jul Average monthly wages, all industries (¥) 301,447 315,592 311,569 306,867 573,522 440,010 -1.8 -0.7 -0.9 -1.0 -1.4 -3.6 Average monthly wages, manufacturing (¥) 319,944 328,509 330,385 324,758 588,693 554,958 -3.2 -3.1 -3.3 -2.6 -1.3 -6.3 Average monthly overtime earnings, all industries (¥) 25,956 26,207 27,170 25,749 25,551 25,529 -0.2 -1.2 0.8 -0.3 -1.2 -1.8 Average monthly overtime earnings, manufacturing (¥) 39,605 39,465 39,814 37,297 38,664 38,990 -2.8 -4.1 -3.7 -4.2 -4.7 -4.7 Unit labour costs (2000=100) 87.4 87.7 n/a n/a n/a n/a -3.5 -3.2 n/a n/a n/a n/a a Companies with 30 or more employees. Sources: Ministry of Health, Labour and Welfare; OECD.

Monthly Report October 2007 www.eiu.com © The Economist Intelligence Unit Limited 2007 16 Japan

Data and charts Annual data and forecast

Production to remove 2003a 2004a 2005a 2006a 2007 b 2008c 2009c GDP Nominal GDP (US$ bn) 4,231.5 4,607.1 4,549.6 4,365.8 4,352.0 4,941.4 5,565.6 Nominal GDP (trn) 491 498 501 508 513 525 537 Real GDP growth (%) 1.5 2.7 1.9 2.2 2.0 1.8 1.6 Expenditure on GDP (% real change) Private consumption 0.4 1.6 1.5 0.9 1.5 1.7 1.3 Government consumption 2.4 1.8 1.7 0.4 0.7 1.0 0.8 Gross fixed investment -0.3 1.4 2.6 3.6 0.9 1.8 2.1 Exports of goods & services 9.2 14.0 6.9 9.6 7.5 6.5 6.7 Imports of goods & services 3.9 8.1 5.8 4.6 2.3 5.6 7.4 Origin of GDP (% real change) Agriculture -6.0 -6.9 1.9 0.4b 0.6 0.7 0.6 Industry 3.2 9.1 1.3 1.5b 1.3 1.2 1.4 Services 1.3 1.2 2.7 2.5b 2.3 2.1 1.7 Population and income Population (m) 127.2 127.3 127.5 127.5 127.5 127.4 127.4 GDP per head (US$ at PPP) 27,849 29,411 30,851 31,996 33,460 35,026 36,515 Recorded unemployment (av; %) 5.3 4.7 4.4 4.1 3.8 3.5 3.3 Fiscal indicators (% of GDP) Public-sector balance -7.9 -6.2 -6.4 -2.5 -2.6 -2.2 -2.0 Public-sector debt interest payments 1.3 1.2 0.9 0.7 0.6 0.5 0.8 Public-sector primary balance -6.6 -5.0 -5.6 -1.7 -1.9 -1.7 -1.2 Net public debt 157.4 163.3 173.1 177.6 182.4 184.1 185.7 Prices and financial indicators Exchange rate ¥:US$ (end-period) 107.1 104.1 118.0 119.0 112.5 100.5 94.5 Exchange rate ¥: (end-period) 131.1 134.5 137.3 146.0 159.8 146.4 127.4 Consumer prices (end-period, %) -0.4 0.2 -0.4 0.3 0.3 0.7 1.0 Producer prices (av, %) -1.3 1.2 3.1 5.0 3.1 1.5 1.0 Stock of money M1 (% change) 4.3 4.1 6.0 0.2 2.6 4.2 4.0 Stock of money M2 (% change) 1.3 0.3 0.3 -0.7 -0.6 3.3 3.1 Money market interest rate (av; %) 0.002 0.001 0.001 0.280 0.599 0.787 1.790 Current account (US$ bn) Trade balance 106 132 94 81 97 120 173 Goods: exports fob 449 539 568 616 665 736 817 Goods: imports fob -343 -407 -474 -535 -568 -616 -644 Services balance -34 -38 -24 -18 -28 -35 -49 Income balance 71 86 103 118 145 159 146 Current transfers balance -8 -8 -8 -11 -11 -12 -14 Current-account balance 136 172 166 171 203 233 256 International reserves (US$ bn) Total international reserves 665 835 836 881 – – – a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts. Source: IMF, International Financial Statistics.

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Quarterly data

Production to remove 2005 2006 2007 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Outputa GDP at chained 2000 prices (annual rate; ¥ trn) 539.8 541.8 545.0 548.2 547.6 555.1 559.1 557.4 Industrial production index (2000=100) 100.9 103.8 104.1 105.4 106.6 109.0 107.4 107.9 Industrial production index (% change, year on year) -0.1 3.9 2.6 4.0 5.6 5.0 3.2 2.3 Employment, wages & prices Employed (m) 64.17 63.56 62.83 64.18 64.26 64.00 63.10 64.78 Unemployed (‘000) 2,860 2,870 2,860 2,797 2,733 2,613 2,717 2,557 Unemployment rate (%)b 4.2 4.3 4.4 4.2 4.1 3.9 4.1 3.8 Real gross earnings (2005=100)ac 99.7 101.0 99.8 101.1 100.0 101.9 99.0 101.1 Consumer prices, Tokyo (2005=100) 99.9 99.9 99.7 100.3 100.4 100.2 99.8 100.2 Consumer prices, Tokyo (% change, year on year) -0.5 -0.9 -0.3 0.1 0.5 0.3 0.1 -0.1 Corporate goods prices (2000=100) 100.9 102.5 103.1 104.4 106.7 106.3 106.4 108.8 Financial indicators Exchange rate ¥:US$ (av) 111.2 117.3 116.9 114.4 116.2 117.7 119.4 120.7 Exchange rate ¥:US$ (end-period) 113.2 118.0 117.4 115.0 117.8 119.0 117.7 123.2 M1 (end-period; ¥ trn) 385.6 399.2 400.3 398.1 391.7 398.6 402.1 – M1 (% change, year on year) 5.6 5.6 4.8 3.8 1.6 -0.1 0.4 – M2+CDs (end-period; ¥ trn)d 710.0 721.8 718.4 718.4 717.7 728.2 729.0 – M2+CDs (% change, year on year)d 2.0 2.0 1.5 0.9 1.1 0.9 1.5 – Discount rate (end-period; %) 0.10 0.10 0.10 0.10 0.40 0.40 0.75 – Call money rate (end-period; %) 0.00 0.00 0.00 0.04 0.26 0.26 0.51 – 3-month CDs rate (av; %)d 0.03 0.03 0.05 0.13 0.38 0.42 0.54 – TOPIX (end-period; Apr 1st 1968=100) 1,412 1,650 1,728 1,587 1,611 1,681 1,714 – Sectoral trendsa Mining & manufacturing production (2000=100) 100.5 102.8 104.0 105.5 106.6 108.5 107.3 – Investment goods production (2000=100) 94.9 97.7 95.8 99.6 99.5 101.4 100.1 – Consumer goods production (2000=100) 95.6 96.7 98.3 99.3 98.5 100.7 99.4 – Producer goods production (2000=100) 106.5 109.5 110.7 111.3 114.5 116.5 115.5 – Machinery orders, net new, incl ships (¥ bn)e 7,171 7,108 7,627 7,867 7,423 7,624 7,596 – Total construction starts (m sq metres) 46.0 46.8 47.0 47.3 46.8 48.2 45.6 – Residential construction starts (m sq metres) 27.2 26.5 26.6 27.4 27.0 27.7 26.6 – Retail sales (2005=100) 97.6 105.0 99.3 98.5 98.1 104.8 98.7 – Foreign trade (¥ bn) Exports fob 16,684 18,161 17,667 18,103 19,290 20,186 19,884 20,482 Imports cif -14,771 -15,841 -16,213 -16,336 -17,240 -17,555 -17,284 –17,957 Trade balance 1,913 2,321 1,455 1,767 2,050 2,631 2,599 2,525 Foreign payments (US$ bn)f Merchandise trade balance fob-fob 21.34 22.91 16.81 18.49 20.42 25.59 24.99 23.83 Services balance -6.70 -4.82 -1.07 -6.50 -5.57 -5.11 -2.55 -6.38 Income balance 29.18 23.21 35.53 25.19 32.86 24.58 38.98 31.52 Net transfer payments -1.12 -0.76 -4.00 -2.45 -2.16 -2.09 -4.23 -2.25 Current-account balance 42.69 40.54 47.27 34.73 45.55 42.97 57.18 46.72 Reserves excl gold (end-period) 831.92 834.28 837.71 849.79 866.53 879.68 892.68 897.57 a Seasonally adjusted. b Percentage of the labour force. c Manufacturing. d Certificates of deposit. e 280 firms. f Bank of Japan. Sources: OECD, Main Economic Indicators; Statistics Bureau, Government of Japan, Monthly Statistics of Japan; IMF, International Financial Statistics.

Monthly Report October 2007 www.eiu.com © The Economist Intelligence Unit Limited 2007 18 Japan

Monthly data

Production to remove Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Exchange rate ¥:US$ (av) 2005 103.9 104.9 105.3 107.4 106.9 108.6 111.9 110.7 111.1 114.8 118.4 118.6 2006 115.5 117.9 117.3 117.1 111.6 114.5 115.7 115.9 117.0 118.7 117.4 117.1 2007 120.6 120.5 117.3 118.9 120.7 122.6 121.6 116.7 n/a n/a n/a n/a Deposit rate (%) 2005 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.2 0.1 0.1 0.2 0.2 2006 0.2 0.2 0.2 0.3 0.3 0.2 0.4 0.5 0.5 0.4 0.4 0.5 2007 0.5 0.5 0.7 0.7 0.7 0.6 0.7 n/a n/a n/a n/a n/a Lending rate (%) 2005 1.4 1.4 1.4 1.4 1.4 1.4 1.4 1.4 1.4 1.4 1.4 1.4 2006 1.4 1.4 1.4 1.4 1.4 1.4 1.4 1.6 1.6 1.6 1.6 1.6 2007 1.6 1.6 1.9 1.9 1.9 1.9 1.9 1.9 n/a n/a n/a n/a M1 (% change, year on year) 2005 4.6 5.0 5.5 5.8 5.3 5.0 5.2 5.3 6.1 6.0 5.9 6.0 2006 5.8 5.6 5.5 4.5 4.0 3.8 3.2 2.4 1.7 1.1 0.6 0.2 2007 0.2 0.2 -0.1 0.2 0.4 n/a n/a n/a n/a n/a n/a n/a M2 (% change, year on year) 2005 0.3 0.2 0.3 0.3 0.0 -0.2 -0.2 -0.2 0.0 0.1 0.1 0.3 2006 0.1 0.0 0.0 -0.4 -0.5 -0.5 -0.5 -0.6 -0.6 -0.7 -0.7 -0.7 2007 -0.6 -0.4 -0.4 -0.2 0.0 n/a n/a n/a n/a n/a n/a n/a Industrial production (% change, year on year) 2005 0.8 4.0 2.5 0.9 0.1 -0.3 -1.3 0.2 0.8 2.4 3.6 5.6 2006 2.2 2.2 3.5 3.3 3.7 4.9 5.7 6.0 5.1 6.3 4.6 4.3 2007 2.6 4.0 3.0 2.4 2.3 2.3 1.7 n/a n/a n/a n/a n/a Retail sales (% change, year on year) 2005 1.2 0.4 0.3 3.2 3.1 3.0 1.4 1.6 0.2 -0.2 1.0 1.2 2006 0.0 0.9 1.1 -1.3 0.3 0.2 0.0 1.1 0.2 0.3 -0.1 -0.6 2007 -0.8 -0.3 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Stockmarket index (Nikkei Stock Average) 2005 11,388 11,741 11,669 11,009 11,277 11,584 11,900 12,414 13,574 13,607 14,872 16,111 2006 16,650 16,205 17,060 16,906 15,467 15,505 15,457 16,141 16,128 16,399 16,274 17,226 2007 17,383 17,604 17,288 17,400 17,876 18,138 17,249 16,569 n/a n/a n/a n/a Consumer prices (% change, year on year; av) 2005 0.2 -0.1 0.0 0.1 0.1 -0.5 -0.3 -0.3 -0.3 -0.8 -1.0 -0.4 2006 -0.1 -0.1 -0.2 -0.1 0.1 0.5 0.3 0.9 0.6 0.4 0.3 0.3 2007 0.0 -0.2 -0.1 0.0 0.0 -0.2 0.0 n/a n/a n/a n/a n/a Unemployment rate (%) 2005 4.5 4.7 4.8 4.7 4.6 4.2 4.3 4.2 4.2 4.5 4.4 4.0 2006 4.5 4.2 4.4 4.3 4.1 4.1 4.0 4.1 4.2 4.2 3.9 3.7 2007 4.0 4.1 4.2 4.0 3.8 3.6 3.5 n/a n/a n/a n/a n/a Total exports fob (US$ bn) 2005 42.4 46.2 54.8 51.3 44.9 50.4 49.5 47.2 53.4 51.5 49.9 53.4 2006 43.4 49.6 58.1 52.3 51.1 54.8 54.6 53.0 58.4 55.9 59.3 59.4 2007 49.4 53.3 56.6 55.2 54.4 59.4 58.1 n/a n/a n/a n/a n/a Total imports cif (US$ bn) 2005 40.6 35.8 44.2 42.4 42.1 42.4 41.7 46.1 44.8 44.3 44.9 45.8 2006 46.4 41.6 49.8 46.8 47.7 47.7 47.2 51.3 49.8 50.4 49.8 49.9 2007 49.4 45.2 48.7 52.0 51.2 49.4 52.6 n/a n/a n/a n/a n/a

Monthly Report October 2007 www.eiu.com © The Economist Intelligence Unit Limited 2007 Japan 19

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Trade balance fob-cif (US$ bn) 2005 1.9 10.4 10.6 8.9 2.8 8.0 7.8 1.0 8.6 7.1 5.1 7.7 2006 -3.1 8.0 8.3 5.5 3.4 7.0 7.4 1.7 8.6 5.5 9.5 9.5 2007 0.0 8.1 7.9 3.3 3.2 10.0 5.5 n/a n/a n/a n/a n/a Foreign-exchange reserves excl gold (US$ bn) 2005 830.6 829.9 827.2 832.9 832.3 832.8 828.8 837.1 831.9 830.2 831.1 834.3 2006 837.7 836.4 837.7 844.4 848.0 849.8 856.4 863.4 866.5 870.7 881.0 879.7 2007 879.4 888.7 892.7 899.0 894.9 897.6 907.3 n/a n/a n/a n/a n/a Budget revenue (US$ bn) 2005 3,302 2,915 3,847 3,662 3,719 7,658 3,731 4,194 3,981 2,731 3,774 7,153 2006 3,611 3,046 4,117 3,797 4,367 8,305 4,092 4,366 3,784 3,173 3,985 7,434 2007 4,065 3,125 3,896 3,921 4,355 8,581 4,799 4,247 n/a n/a n/a n/a Budget expenditure (US$ bn) 2005 -2,315 -1,912 -8,229 -9,602 -2,086 -6,300 -3,002 -1,977 -7,196 -2,582 -6,278 -3,666 2006 -2,295 -1,882 -8,284 -8,687 -1,920 -6,021 -2,901 -1,763 -7,489 -2,503 -6,088 -3,471 2007 -2,262 -1,893 -8,767 -8,238 -2,385 -5,873 -2,922 -1,772 n/a n/a n/a n/a Budget balance (US$ bn) 2005 987 1,002 -4,382 -5,941 1,632 1,358 729 2,217 -3,215 148 -2,504 3,487 2006 1,316 1,164 -4,167 -4,889 2,448 2,285 1,191 2,603 -3,706 670 -2,103 3,963 2007 1,803 1,232 -4,871 -4,316 1,970 2,708 1,877 2,475 n/a n/a n/a n/a

Sources: IMF, International Financial Statistics; Haver Analytics.

Monthly Report October 2007 www.eiu.com © The Economist Intelligence Unit Limited 2007 20 Japan

Annual trends charts

Production to remove Annual trends charts

Real GDP growth Consumer price inflation (% change) (av; %)

Japan OECD World Japan OECD World 4.5 3.5

4.0 3.0 2.5 3.5 2.0 3.0 1.5 2.5 1.0 2.0 0.5 1.5 0.0 1.0 -0.5 2003 04 05 06 07 08 09 2003 04 05 06 07 08 09

Source: Economist Intelligence Unit. Source: Economist Intelligence Unit.

Budget balance Primary balance (% of GDP) (% of GDP)

Japan OECD Japan OECD 0.0 2.0 -1.0 1.0 -2.0 0.0 -1.0 -3.0 -2.0 -4.0 -3.0 -5.0 -4.0 -6.0 -5.0 -7.0 -6.0 -8.0 -7.0 2003 04 05 06 07 08 09 2003 04 05 06 07 08 09

Source: Economist Intelligence Unit. Source: Economist Intelligence Unit.

Main destinations of exports, 2006 Main origins of imports, 2006 (share of total) (share of total)

Other US Other China 43.0% 22.5% 51.0% 20.5%

US China 11.8% 14.3%

South Korea Saudi Arabia 7.8% 6.4% Hong Kong Taiwan Australia UAE 5.6% 6.8 4.8% 5.5%

Source: Economist Intelligence Unit. Source: Economist Intelligence Unit.

Monthly trends charts

Production to remove Monthly trends charts

International trade Exchange rate (US$ m) (¥:US$)

Exports Imports Balance 125 60.0

50.0 120

40.0 115 30.0

20.0 110

10.0 105 0.0

-10.0 100 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul 2004 05 06 07 2004 05 06 07 Source: Economist Intelligence Unit. Source: Economist Intelligence Unit.

Wage growth Unemployment rate (% change, year on year) (%)

Real wages Nominal wages 5.2 3.0 5.0 2.0 4.8 1.0 4.6 0.0 4.4 -1.0 -2.0 4.2 -3.0 4.0 -4.0 3.8 -5.0 3.6 -6.0 3.4 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul 2004 05 06 07 2004 05 06 07 Source: Economist Intelligence Unit. Source: Economist Intelligence Unit.

Price inflation Retail sales (% change, year on year) (% change, year on year)

Consumer prices Producer prices 4.0 7.0 6.0 3.0 5.0 2.0 4.0 1.0 3.0 2.0 0.0

1.0 -1.0 0.0 -2.0 -1.0 -2.0 -3.0 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan 2004 05 06 07 2004 05 06 07

Source: Economist Intelligence Unit. Source: Economist Intelligence Unit.

Country snapshot Political structure

Official name Japan

Form of government Representative democracy

The executive The prime minister is chosen by a ballot of the Diet (parliament) and appoints a cabinet, a majority of whose members must also be members of the Diet

Head of state Emperor Akihito

National legislature Bicameral Diet, comprising the 480-member House of Representatives (the lower house), elected every four years, and the 242-member House of Councillors (the upper house), elected for six-year terms, with one-half of its number elected every three years. There are 300 single-seat constituencies and 180 seats filled by proportional representation in the House of Representatives

Legal system A US-style Supreme Court, appointed by the cabinet, presides over a legal system of lesser courts divided into four arms: the High Court, district courts, family courts and summary courts

National elections The last election for the lower house was in September 2005; the next election for the chamber must be held by September 2009. The last election for the upper house was held on July 29th 2007; the next is due in July 2010

National government In early August 2007 the ruling Liberal Democratic Party (LDP) held 306 seats in the lower house. The LDP!s coalition partner, New Komeito, held 31 seats. The largest opposition party, the Democratic Party of Japan (DPJ), held 113 seats

Main political organisations Government"coalition of the LDP and New Komeito Opposition"DPJ; Japan Communist Party; Social Democratic Party

Main members of the cabinet Prime minister Yasuo Fukuda (LDP) Chief cabinet secretary Nobutaka Machimura (LDP)

Key ministers Agriculture, forestry & fisheries Masatoshi Wakabayashi (LDP) Defence Shigeru Ishiba (LDP) Economy, trade & industry Akira Amari (LDP) Education, culture, sports, science & technology Kisaburo Tokai (LDP) Finance Fukushiro Nukaga (LDP) Foreign affairs Masahiko Koumura (LDP) Health, labour & welfare Yoichi Masuzoe (LDP) Internal affairs & communications Hiroya Masuda (non-affiliated) Justice Kunio Hatoyama (LDP) Land, infrastructure & transport Tetsuzo Fuyushiba (New Komeito)

State ministers Economic & fiscal policy Hiroko Ota (non-affiliated) Financial services & administrative reform Yoshimi Watanabe (LDP) Gender equality & social affairs Yoko Kamikawa (LDP) Privatisation of postal services Hiroya Masuda (non-affiliated)

Central bank governor Toshihiko Fukui