A second consecutive decline of real GDP has been recorded in fiscal year (FY) 1998. Supported by the government’s measures in fiscal, monetary, and structural policy, positive growth is projected for FY1999.

The annual growth rate of real GDP dropped to -1.9% in FY1998 (April 1998 to March 1999), following -0.4% in FY1997. Since late 1997, difficulties in the financial system in the domestic market had reduced the confidence of households and the business sector, which resulted in a decline of domestic demand. In FY1998, private consumption increased only modestly by 0.1%, as the rise in unemployment weakened the sentiment of households and the rate of increase of wages has dropped. Private investment for plants and equipment dropped sharply, by 12.4% in FY1998. Due to the large decline of exports to Asian economies, total exports of goods and services declined by 3.7% in FY1998, while total imports of goods and services also declined by 7.5%.

In early 1999, some indicators showed that economic activities have begun to stabilize, supported by various government policy measures, while the overall economic situation remains very severe. In the first quarter of 1999, real GDP increased by 2.0% on a quarter to quarter basis (seasonally adjusted). The government has made considerable efforts to restore economic activities. Public works were substantially increased in supplementary budgets for FY1998 and the initial budget for FY1999 to boost the domestic demand. Financial markets have been settled as a result of the progress of the government’s measures for stabilizing the financial system. Expansionary monetary policy is reflected in a low and stable short-term interest rate. On the other hand, the rising unemployment rate and declining investment for plants and equipment reveal the still-severe economic situation.

In FY1999, the growth rate of real GDP is expected to be around 0.5%. This projection reflects the active government policy actions, including measures for stabilizing the financial system, those for stimulating demand such as tax deduction and increased public works, and those for supporting employment and business activities.

The rate of increase in the consumer price index (CPI) has been very stable, reflecting the sluggishness of overall economic activities and effects of deregulation. The increase in CPI was only 0.2% in FY1998, and is expected to stay very low in FY1999. Weakness in domestic demand is also reflected in the negative growth of the domestic wholesale prices index (WPI). The rate of increase in WPI was -2.1% in FY1998. In FY1999, it is again expected to be negative, reflecting the modest recovery of overall economic activities.

The prolonged economic slump has had serious impacts on the labor market, raising the number of unemployed and putting downward pressure on wages. The unemployment rate has exceeded 4% and recorded a historical high of 4.9%, in June of 1999. In FY1998, the number of employed declined by 0.9%, and unemployment rate rose to an annual average of 4.3%. Compensation of employees was also expected to decline by 1.1% in FY1998. In FY 1999, the severe situation of the labor market is expected to continue.

Reflecting sluggish domestic demand, imports dropped sharply in the first half of 1998 and remained flat in the later half of the year. Exports to the Asian economies have dropped significantly since late 1997, affected by the slowdown of economic growth in those economies, while exports to the US and EU had increased constantly. The current account surplus increased to 15.2 trillion yen (3.1% of GDP) in FY1998 from 12.9 trillion yen (2.6% of GDP) in FY1997. The increase in current account surplus in FY1998 was mainly attributed to the sharp drop in imports due to the economic slump and a fall in commodity prices. In FY1999, the current account surplus is expected to decline slightly. This projection assumes a decrease in export values due to the slower growth of the world economy and the increase in imports value due to the recovery in the petroleum price. The capital account deficit decreased from 15.3 trillion yen in FY1997 to 14.7 trillion yen in FY1998.

Net external assets have increased constantly, reflecting the current account. In calendar year (CY) 1998, gross external assets amounted to 345 trillion yen and gross external debts were 212 trillion yen. Consequently, net external assets totaled 133 trillion yen, which is equivalent to around one quarter of GDP.

In FY1998, foreign direct investments (FDI) outflow from Japan dropped by 21% from FY1997. It was notable that FDI outflow to the United States shrunk almost by half in FY1998, while that to Asia also declined by 44% due to the impact of the crisis. The amount of total FDI outflow was 5.2 trillion yen in FY1998, following 6.6 trillion yen in FY1997. FDI inflows to Japan increased significantly in FY1998 and reached 1.3 trillion yen, which is almost double the amount in FY1997.

The Japanese yen slipped by 20% from mid-1997 to mid-1998. The yen rose in late 1998 and almost returned to the level of mid 1997. In 1999, the yen has been stable at around 120 yen/US dollar.

Fiscal policy has played a major role in supporting weak economic activity through various measures including tax cuts and an increase in expenditure for infrastructure investment. In April and November 1998, the government launched two major economic stimulus packages. The total amounts of those packages were over 16 trillion yen and around 27 trillion yen respectively. Fiscal measures such as tax cuts and the increase in expenditure for infrastructure investment are included in the packages. To implement the packages, government expenditures were increased by a series of supplementary budgets for FY1998 and the budget for FY1999. The expenditure of the initial budget for the general account of the central government will increase by 5.4% in FY1999 over FY1998. The amount of tax cuts in the central and local governments totals more than 9 trillion yen, including permanent reductions in both personal and corporate income tax.. The total amount of public bonds is expected to increase to around 327 trillion yen (66% of GDP) in FY1999, up from 299 trillion yen in FY1998.

With the prolonged sluggish growth of the economy, the official discount rate has been at a historical low of 0.5%, since September 1995. In FY1998, the short-term interest rate was lowered further by the actions of the Bank of Japan (BOJ). Facing the severe economic situation, the Bank of Japan lowered its target for the overnight call rate from around 0.5 to around 0.25% in September 1998 in order to prevent the economy from falling into a deflationary spiral. The BOJ also took further action in February 1999 to lower initially its target for the call rate to around 0.15% and sought subsequently to reduce the rate as far as possible. Reflecting the actions of the BOJ, short-term interest rates declined in late 1998 and early 1999, and have been virtually zero since early March 1999. Long-term interest rates rose in late 1998 partly reflecting the increase in the issue of public bonds. The rise of long-term interest rates provoked serious arguments about the risk of damage to still fragile economic activities. However, long-term interest rates began to decline in early 1999 as the overall economic activity remained sluggish and short-term interest rates dropped further.

The cabinet approved the economic plan in July of 1999 which outlines the long-term perspective of the Japanese economy and society up to 2010. In the annex to the economic plan, the prospects of the main economic indicators up to 2010 are given as follows:

• Real growth rate: around 2% (a potential growth rate)
• Inflation rate: around 2%
• Unemployment rate : more than 3.5% less than 4.5%

Substantial efforts have been made to resolve the bad loan problems in the financial sector. The legislation for the recapitalization scheme and the comprehensive framework for dealing with banking problems has enabled fast restructuring in the banking sector and has contributed to the stabilization of the financial system. The legislated measures include the use of public funds to recapitalize the banking system and ways to address banking sector weaknesses through financial administrators, bridge banks, temporary nationalization and the purchasing of the assets of financial institutions. Under this new framework, some major banks are temporarily nationalized. In late March 1999, fifteen of the major banks received injections of public funds amounting to 7.4 trillion yen for recapitalization.

Source: Data are as submitted by member economies, unless otherwise specified.

Notes: (1) Budget balance refers to general government. It excludes the social security.

(2) Short-term interest rate refers to 3-month certificates of deposit (CDs).

Table 2. Forecasting Summary (% change from previous year)

Note: The official figures for 1999 refer to FY1999 (April 1999 to March 2000) and figures for 2000-2002 refer to FY1999-2010. The IMF forecast is from the World Economic Outlook (IMF, April 1999), figures for the period 2000-2002 refer to 2000 only. IMF revised its forecasts of real GDP growth to 0.2% for 1999 and 1% for 2000 (August 1999). The OECD forecast is from the OECD Economic Outlook (OECD, June 1999), figures for the period 2000-2002 refer to 2000 only.