The Japanese economic outlook is opaque. A Bank of Japan survey reports deteriorating business sentiment among major manufacturers in December. Clearly Europe’s sovereign debt crisis, the historic rise of the yen’s value and flood damage in Thailand are a cause of concern.

According to the central bank’s “tankan” survey made public on Dec. 15, the diffusion index of major manufacturers dropped to minus 4, a fall of 6 points from the plus 2 in September — the first drop in six months. The index figure is attained by subtracting the percentage of firms having negative business sentiment from the percentage of those having positive business sentiment.

The Japanese economy is not necessarily without bright spots. The business sentiment index for major nonmanufacturers was plus 4, a rise of three points from September — marking improvement for two consecutive quarters. That’s because this group is fairly insulated from bad economic conditions overseas and is profiting from firm demand due to reconstruction efforts in areas hit by the March 11 disasters.

Optimism must be guarded as business sentiment concerning economic conditions in March 2012 is bad — minus 5 for major manufacturers and zero for major nonmanufacturers. In November, the Bank of Japan had held the view that the pace of economic recovery was slowing down mainly because of the effects of economic conditions overseas.

Business sentiment in December remained unchanged at minus 3 for medium-size manufacturers and improved to minus 8 from minus 11 for small manufacturers. The sentiment figure in the same month for major electronic makers dropped by 16 points and that for the petroleum and coal sector fell by 13 points, although the figure for the auto industry rose by seven points to plus 20.

It must be kept in mind that if major firms in the electronic manufacturing industry and the automotive industry lose steam, it will impact subcontractors — mainly medium-size and small firms — thus affecting overall wages and employment in Japan.

The Bank of Japan must take a flexible approach to underpinning the economy. For its part, the government must work out measures to help increase investment in new fields including disaster prevention and environmentally friendly urban development.

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