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The decline in corporate sentiment among large manufacturers slowed for the first time in five quarters but remains weak overall, according to the Bank of Japan’s quarterly “tankan” survey released Monday.

The diffusion index for large manufacturers came to minus 38, the same as the previous quarter, fueling hopes that one of the sputtering main engines behind the global economy is ready to bottom out thanks to a turnaround in exports.

The diffusion index shows the percentage of companies who view business conditions as good minus the percentage of companies who say conditions are bad.

Large manufacturers projected an 11-point improvement in the outlook for the next quarter, lifting the index to minus 27.

However, they also indicated that they intend to cut spending on new plant and equipment by a further 8.4 percent in the current fiscal year, up from the 6.7 percent cut in fiscal 2001.

Any benefits from an overseas rebound are unlikely to trickle down to the rest of the economy, economists said.

“Domestic demand remains weak, and foreign demand by itself is not going to pull the economy forward,” said Mamoru Yamazaki, chief economist at BNP Paribas Japan. “The economy is worsening at a slower pace, but the survey is not an indication of a turnaround.”

The economy is crippled by deflation, poor domestic demand and a banking sector saddled with bad loans.

In March, the DI for large nonmanufacturers remained unchanged at minus 22. These companies were slightly more optimistic about business conditions in the next quarter, with the DI forecast inching up marginally to minus 21.

Conditions deteriorated for smaller manufacturers, who have been hardest hit by a decade full of starts and stops, with the DI worsening to minus 51 from minus 49 in the previous survey. The DI for small nonmanufacturers fell to minus 42 from minus 39 in December, and the next few months will bring little improvement for smaller companies, they predicted.

Unable to benefit directly from any surge in exports, small manufacturers’ outlook for June stood at minus 51, the survey shows, while that for small nonmanufacturers fell 4 percentage points to minus 46.

Companies in all categories said they intend to cut expenditures for fiscal 2002. Large nonmanufacturers said they plan to cut expenditures 8.4 percent from fiscal 2001, while small to midsize firms said they intend to cut spending by 16.2 percent.

The cuts come despite projected rises in pretax profits for the current fiscal year.

Large manufacturers predict a 36.8 percent jump in pretax profits for fiscal 2002, which would be a dramatic rebound from the 45.1 percent loss in the year ended March 31. Small manufacturers project a 58.4 percent surge in pretax profits for the current fiscal year from the 48.5 percent loss recorded the previous year. Small and midsize nonmanufacturers, meanwhile, expect a 17.4 percent increase against a 12.7 percent fall in pretax profits the year before.

“Inventory adjustments are occurring at a good pace, but companies are not sure at all whether domestic demand will also recover,” said Yasunari Ueno, chief market economist at Mizuho Securities Co. “Few are sure whether an increases in profits and revenues will become an established trend as expected.”

Companies usually understate investment projections at the beginning of the fiscal year, making subsequent upward revisions likely. But the size of the projected cuts make it unlikely that corporate spending will rise above current levels, said Yamazaki of BNP Paribas.

Even with a boost in overseas sales, companies are more likely to put most of the extra cash flow into paying off debts rather than into new spending, he said.

Monday’s tankan results and the diminishing hope of any improvement in the coming months are unlikely to influence BOJ policymaking, economists said.

In its assessment of the economy in late March, the central bank said the current cyclical recovery will be modest.

The BOJ has repeatedly said that Japan cannot stage a sustained recovery until banks get rid of their bad loans, which limit banks’ risk-taking ability.

The tankan survey’s diffusion indexes for bank lending and company funding show the DI measuring large companies’ impressions of banks’ lending attitudes fell to 5 from 14 in December. A smaller DI indicates an impression of stricter lending.

Small companies’ impressions of bank lending, meanwhile, were more severe. The DI for the category worsened to minus nine from minus six in the previous survey.

While stricter bank lending threatens to choke growth by withholding credit from borrowers in the medium-term, economists say this may be a sign of health in the financial system if it means banks are raising interest rates to match the risk.

The Bank of Japan surveyed 8,651 companies for the tankan between February 22 and March 29.

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