The Bank of Japan’s quarterly “tankan” report released on July 2 shows that business sentiment among large manufacturers in the April-June period as shown by the diffusion index (D.I.) rose three points from the previous quarters to minus 1 — an improvement for the first time in three quarters. Medium-size and small manufacturers added 1 point to reach minus 6.

Behind the improvement is the temporary easing of the yen’s rise, falls in oil prices, brisk car sales and strong demand induced by the reconstruction from the 3/11 disasters. But the government and enterprises must guard against downside risks such as weakening of domestic demand, the European sovereign debt crisis and a slowdown in the Chinese economy.

The D.I. is determined by subtracting the percentage of firms with poor business sentiments from the percentage of firms with good business sentiments. The D.I. for carmakers rose 4 points to plus 32, mainly thanks to government subsidies for eco-friendly car purchases. Domestic car sales in June topped more than 500,000 units — an increase of 43.6 percent from a year before and a rise for nine consecutive months. The D.I. for electric and electronic machinery makers and that for the nonferrous metal sector rose 3 points to minus 14 and 22 points to plus 11, respectively.

Major nonmanufacturers saw their D.I. rise 3 points to plus 8 — a an increase for the fourth straight quarter. Equipment investment planned by both major manufacturers and nonmanufacturers for fiscal 2012 increased 6.2 percent from the previous year. On the downside, business sentiment in the oil and coal sector fell 33 points to minus 33, and medium-size and small manufacturers fell 2 points to minus 12.

Attention must be paid to the fact that many sectors are cautious about business prospects in the coming quarter. Among the 12 nonmanufacturing sectors, only two sectors among major firms reported good prospect while none among medium-size and small firms reported good prospects. The budget for eco-friendly car subsidies will be used up this summer, and the demand driven by reconstruction from the 3/11 disasters will peak as well this season.

The strong yen is accelerating manufacturers’ moves to shift their production bases to foreign countries. In the January-March period, capital investment by overseas subsidiaries of manufacturers rose 27 percent from a year before to about $10.4 billion (about ¥830 billion), for the eighth straight quarterly rise. The government and the BOJ should move flexibly to help enliven domestic economic activities. Concentrating solely on the state’s financial reconstruction will damage the economy.

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