NEWS ANALYSIS: Japanese Firms' Optimism Rises Despite Surging Yen

TOKYO -- Japanese firms are more optimistic about the business outlook, a central bank survey showed Monday, but weak capital spending reinforced doubts as to whether a hesitant recovery in the world's second-largest economy can be sustained.


The Bank of Japan's quarterly "tankan" survey, one of the most closely watched barometers of future economic health, showed an improvement in the sentiment index for big manufacturers to minus 17 from minus 22 in September.


Although the index fell short of economists' median forecast of minus 15, sentiment in the four key business sectors covered by the poll improved for the fourth quarter in a row f the first time this has happened since 1988.


"The headline numbers were a bit soft, but the substance of the survey was pretty strong," said James Malcolm, an economist at U.S. investment bank J.P. Morgan in Tokyo.


Crucially, Malcolm and other economists said, the yen's 15 percent surge against the dollar since summer has not greatly affected Japan's export sector.


"The current dollar/yen exchange rate is not dealing a fatal blow to companies," said Kagehide Kaku, a former BOJ official and now deputy chairman of Daiwa Institute of Research.


The BOJ said big manufacturers planned for an exchange rate of 107.93 yen per dollar in the latest survey, compared with 113.58 yen in the September poll, and economists said a rise through 100 yen could take a psychological toll on business. A rise in the yen makes Japanese exports more expensive.


The dollar briefly jumped half a yen on the tankan to a high of 102.80 yen.


A senior Finance Ministry official, Zembei Mizoguchi, said the yen remained too strong, against both the dollar and the euro, because Japan's recovery was not yet self-sustaining.


Closely watched plans for corporate investment in factories and equipment, which accounts for about 15 percent of national output, came in slightly worse than expected.


The survey showed that big firms planned to slash capital spending by 10.8 percent in the fiscal year ending in March. The BOJ said the figure was the weakest since 1983.


Economists said the spending cuts could have an overall dampening effect on the economy, but they also showed that companies were forging ahead with efforts to cut the excess capacity that has dragged down growth for much of the decade.


"If Japanese firms are serious about restructuring, they must continue cutting their capital expenditure. If they do that, that's good for the microeconomy, but it's not going to be good for the macroeconomy," said Robert Feldman, chief economist at Morgan Stanely Dean Witter Co.


Expectations that corporate restructuring will boost profits f firms on average are counting on a 16.8 percent increase this year, according to the tankan f has fueled a brisk rally in Tokyo shares this year.


But the stock market failed to respond Monday to the survey, with the benchmark Nikkei 225 average closing down 0.37 percent at 18,205.08.


The tankan broadly confirmed the picture of a patchy, fragile recovery despite emergency government spending of more than 120 trillion yen ($1.17 trillion) since 1992, including an 18 trillion yen package agreed last month.


The economy shrank 1 percent between July and September after growing surprisingly strongly in the first half of 1999.


With general elections due by next October, Shizuka Kamei, policy chief of the ruling Liberal Democratic Party, said the survey showed the pump-priming had to continue. "We cannot yet loosen our grip," Kamei told reporters.


The U.S. ambassador to Japan, Thomas Foley, agreed.


"Now that there are signs of a recovery, it is important that Japan continue to take the measures necessary to encourage and support economic activity, until that recovery is clearly and firmly in place," said Foley, whose government has long harried Tokyo to do all that is necessary to restore growth.


A striking feature of the survey was the divergence in sentiment among major companies as well as between bigger and smaller firms f disparities that economists said could put a lid on the recovery.


Susumu Takahashi, chief economist at Japan Research Institute, said the optimism of consumer electronic firms contrasted with the mood at conventional industries such as steel and shipbuilding.


For the recovery to become self-sustaining, business needs to improve in these industries too. But that, Takahashi said, risks creating a Catch 22.


"The structural reforms that these lagging sectors will require, such as shedding excess labor, may stand in the way of a swift recovery in the economy," he said.