15 December 2011 Economics Research

http://www.credit-suisse.com/researchandanalytics

Japan Economics Weekly

Research Analysts Hiromichi Shirakawa + 81 3 4550 7117 hiromichi.shirakawa@credit-suisse.com Takashi Shiono +81 3 4550 7189 takashi.shiono@credit-suisse.com

Focus of the week2 Economic outlook into 2013

We forecast real GDP growth to return to plus mid-1% territory into 2013 following a 0.8% contraction in 2011. We continue to believe the probability is low that the countrys trend real GDP growth rate, which is around +0.8%, will pick up materially in the foreseeable future, as the authorities remain focused on gradual fiscal tightening aimed at maintaining the social security systems status quo.

Business cycle update 12

December BoJ Tankan Survey showed deterioration of business sentiment

Money and credit update 19

Money stock continued to grow in November

Upcoming Indicators/Events Major Economic Data Japan Economic Forecasts

ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES ARE IN THE DISCLOSURE APPENDIX. FOR OTHER IMPORTANT DISCLOSURES, PLEASE REFER TO https://firesearchdisclosure.credit-suisse.com.

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Focus of the week

Economic outlook into 2013
We forecast real GDP growth to return to plus mid-1% territory into 2013 following a 0.8% contraction in 2011 We continue to believe the probability is low that the countrys trend real GDP growth rate, which is around +0.8%, will pick up materially in the foreseeable future, as the authorities remain focused on gradual fiscal tightening aimed at maintaining the social security systems status quo

Overview
Strong foreign demand led Exhibit 1: Real and nominal GDP growth Japan out of a cyclical trough Nominal GDP Real GDP 5.0 from 1Q 2009 onward, but 4.0 4.4 the domestic economy 3.0 2.3 moved back into contraction 1.6 1.4 2.0 mode following the Great 1.0 0.2 East Japan Earthquake of 0.0 March 11, with continued -0.8 -1.0 -0.6 appreciation of the yen also -2.0 weighing on activity. Real -3.0 -2.8 GDP for 2Q 2011 was down -4.0 more than 2% from the prequake (4Q 2010) peak, and even a 1.4% increase in 3Q 2011 still left price-adjusted Source: Cabinet office, Credit Suisse GDP down some 3.9% from the previous cyclical high in 1Q 2008. We expect to see another small contraction in real GDP in the final quarter of this year, which would translate into contraction of 0.8% for 2011 as a whole.
2010(a) 2011(p) 2012(e)

Even more troubling is a continuing decline in Japanese nominal GDP, which could have major ramifications for asset prices and longer-term fiscal sustainability. Nominal GDP increased to almost 515 trillion in 2Q 2007, but has followed a downward trajectory ever since, dropping below 470 trillion in 3Q 2011. Continued shrinkage during 4Q would translate into a substantial 2.8% contraction for 2011. Although this would be significantly better than the 6% fall in 2009, it is nevertheless worrying to see negative nominal growth for three of the past four calendar years. Public works spending and residential investment are back on the rise as a consequence of post-quake reconstruction, and the surprisingly rapid restoration of supply chains has helped to prevent exports from falling through the floor. GDP continues to contract, however, due to the greater impact of increased imports (a reflection of higher energy prices), weak consumer spending, and sluggish corporate capex. Ongoing industrial "hollowing out" has reduced the need for manufacturers to invest domestically, and fuel imports have also increased in volume terms owing to deterioration in energy efficiency. We attribute much of Japan's present woes to a continued decline in investment. Contraction of combined public- and private-sector investment including spending on power plants hastens the pace of capital stock obsolescence (increases the average vintage of capital), thereby reducing productivity and depressing the economy's trend growth rate, in our view. This creates a vicious cycle in which declines in the (domestic) income of households and firms cause the government's fiscal position to worsen, which in turn impacts on sentiment to the point where households and firms become reluctant to loosen their purse strings. In our view, breaking out of this cycle will require the
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government to focus greater resources on infrastructure investment, energy technologies, and meaningful tax incentives aimed at promoting capital spending by the private sector as a whole and non-manufacturers in particular. Over the past few years, however, the government has instead been prioritizing a moderate expansion of the social security system and a consumption tax hike intended to improve its longer-term sustainability. The cabinet-approved FY2012 tax reform plan actually does not include measures to stimulate investment, and rather contains de facto personal income tax hikes (to be introduced in 2013) in exchange for extension of tax incentives for environment-friendly passenger cars. It also looks for a consumption tax hike in FY2014. We do not anticipate an increase in the consumption tax to trigger significant "nonKeynesian effects" (i.e., stimulate consumption demand on a sustained basis by making households somewhat more optimistic about sustainability of the public pension system), and we see little prospect of the economy's trend growth rate rising if an almost exclusive focus on the consumption tax causes continued obsolescence of the capital stock to be ignored. We are forecasting real GDP growth of +1.4% for CY2012 (+1.5% for FY2015) based on the following relatively optimistic assumptions: (1) global growth of +3.4% for CY2012 as the world economy avoids falling into recession; (2) a moderate rise in the household sector's expected inflation rate in anticipation of the consumption tax being hiked from spring 2014; and (3) stable commodities prices and a relatively steady USD/JPY exchange rate. This would translate into an average real growth rate of +0.8% for the Japanese economy over the decade from 2003 through 2012. Our analysis, based on a growth accounting approach, puts Japan's long-term real growth rate at +0.8%, and so our forecast for next year is tantamount to an assumption that the ten-year average will be equal to the long-term growth rate.

Foreign demand
The world moved out of recession in 2010 as policymakers in major economies deployed aggressive stimulus and financial system stabilization measures, but we estimate that global real GDP growth slowed from +5.1% last year to +3.8% in 2011, reflecting such factors as: (1) an erosion of real incomes due to accelerating commodities inflation; (2) diminished expectations of monetary easing (particularly in emerging economies) as inflation rates continued to rise; and (3) the negative impact of the European sovereign debt crisis on financial markets and risk appetites. Global economic activity through early summer also appears to have been constrained to at least some extent by Japanese supply chain problems stemming from the Great East Japan Earthquake of March 11. We see a mix of positives and negatives as we contemplate the outlook for 2012, but we are forecasting only modest deceleration in global growth to +3.4% based on our expectation that a hard landing will be averted. On the plus side of the ledger, global inflation appears set to slow from +4.7% in 2011 to +3.6% in 2012, thereby giving advanced economies greater leeway to ease monetary policy. We see a high likelihood of monetary stimulus in nations that have yet to move into full austerity mode (including the US, Japan, Germany, and China). On the minus side, we forecast moderate contraction of the euro zone economy as the sovereign debt crisis continues to take its toll, anticipating that real growth will fall from +1.5% in 2011 to -0.5% in 2012.

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A continued appreciation of the yen (on a real effective Exhibit 2: Real exports exchange rate basis) also 30.0 24.2 appears likely to impede Japanese exports. We 25.0 expect USD/JPY to remain 20.0 somewhere near 75 15.0 throughout next year, but with the euro losing ground 10.0 against the dollar as a 5.0 0.1 consequence of ECBs 0.0 monetary easing, we forecast that EUR/JPY will fall to 92 in 1Q 2012 before leveling out.
2010(a) 2011(p)

2.1 2012(e)

2.5 2013(e)

Industrial production

Source: Cabinet office, Credit Suisse

We expect domestic industrial production to hit a flat patch in late 2011 / early 2012 but then to pick up speed through the middle of next year. The pace of recovery has slowed of late. While a 3.3% (month-on-month seasonally adjusted) fall in production for September was followed by a 2.4% increase in October, this translates into an increase of just 0.3% from the 3Q average. Moreover, with actual output levels falling short of the projection survey by METI in each of the past five months, it would appear that excess inventory levels are necessitating production cuts in some sectors. METIs survey currently forecasts that a 0.1% decline in output for November (reflecting the impact of flooding in Thailand) will be followed by a 2.7% rebound in December, which (if achieved) would still leave 4Q growth at a relatively weak +1.2% qoq. On a more positive note, recent production cutbacks appear to have stemmed from a predictable slowdown in shipments due to the post-summer contraction of foreign demand that had been signaled by US ISM data and other leading indicators, which has now stabilized and suggests that inventory adjustments will probably be quite modest and short-lived. Precisely, the ISM new orders index for US manufacturers showed a second successive improvement in November, and with PMIs for other major economies likely to stabilize relatively soon, we expect domestic production activity to be buoyed by stronger foreign demand through 2Q 2012. Our baseline scenario of a relatively soft landing (+3.4% global growth) for 2012 also suggests that manufacturers should benefit from solid export demand over the remainder of the year. It is also worth noting that Japanese manufacturers were forced to pay considerable attention to supply risk in 2011 owing to disasters such as the Great East Japan Earthquake and the more recent flooding in Thailand. It is therefore possible that producers placed slightly greater emphasis on precautionary inventories than might otherwise have been the case, and for this reason, we hesitate to characterize recent inventory buildup as "unintended." As such, we see little risk of the current production lull triggering significant cutbacks to hiring or investment.

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Industrial output is still down roughly 5% from before the Exhibit 3: Industrial production March 11 disaster and some 20.0 16.8 10% from levels prior to the 15.0 late 2008 global financial crisis, which suggests that 10.0 there is considerable upside 5.0 remaining. We forecast that this year's contraction 0.0 (estimated at -4.9%) will be -5.0 followed by a +5.6% rebound -4.9 in 2012, with production -10.0 likely to accelerate out of its current flat patch through the middle of the year and then settle back into a more Source: Cabinet office, Credit Suisse gradual uptrend in 2H.
2010(a) 2011(p)

5.6

5.7

2012(e)

Corporate prices
The CGPI rose 1.7% yoy in November, meaning that the inflation rate has fallen over 1% ppt from the recent (July) peak of +2.8%. The index had previously been driven higher by increases in prices of oil & coal products, iron & steel, nonferrous metals, and other basic materials as international commodities prices surged due to a rapid post-crisis rebound in global production activity and aggressive monetary easing in major economies, but commodities prices fell in 2Q 2011 and have since remained relatively steady. Our commodity analyst expects prices to remain somewhere near their 3Q 2011 levels throughout 2012, in which case base-year effects should cause basic materials prices to start declining (year-on-year) from 2Q 2012 onwards. Prices look set to continue falling for high-tech products (information & communications equipment, electronic components & devices, precision instruments), general machinery, and electrical machinery. In anticipation of these relatively strong deflationary pressures, we forecasting a 1.3% yoy decline in the CGPI for 2012 as a whole.

Exhibit 4: Changes in CGPI by item (contribution)

(yoy %, pp) Others Agriculture products, mining, elec. pow er, gas, etc.) Machinery and equipment Material-type products Overall 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0 -10.0 4Q06 3Q07 2Q08 1Q09 4Q09 3Q10 2Q11
Note: Material-type products include textiles wooden products, paper/pulp, chemical, plastic, oil/coal, glass/ceramics, iron/steel, non-ferrous metal, metal products. Source: BoJ, Credit Suisse

Exhibit 5: Changes in CGPI by major products

(yoy %) 15.0 10.0 5.0 0.0 -5.0 -10.0 -15.0 4Q06 Material-type products Machinery & equipments Agricultural products Mining

3Q07

2Q08

1Q09

4Q09

3Q10

Source: BoJ, Credit Suisse

Corporate profits
Corporate earnings look likely to remain in a mild slump through 1Q 2012 given that the post-quake rebound has ended, exports have slowed, and production levels are being cut,

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but subsequent recoveries in exports and domestic manufacturing output should help to move profits back into a cyclical upswing. The Ministry of Finance's Financial Statements Statistics of Corporations by Industry for 3Q 2011 showed a 3.6% qoq seasonally adjusted increase in ordinary profits on an allindustries basis (excluding finance and insurance), which marked the first rise in three quarters as economic activity rebounded from the Great East Japan Earthquake and its aftermath. Labor's relative share of income dropped to 68.5% on a value-added basis, thereby continuing its decline from the 1Q 2011 level of 69.2% (when profits were hit by the March 11 disaster). We see little prospect of a significant increase so long as firms remain in cost-cutting mode, which suggests that profit levels should be somewhat easier to maintain going forward. That said, while our global Exhibit 6: Recurring profits FX research team expects (trm yen) (%) USD/JPY to remain 70 Amount (LHS) 80 somewhere near 75 yoy % change (RHS) 60 throughout next year, it also 60 forecasts that EUR/JPY will 50 40 fall to 92 in 1Q 2012 due 40 20 largely to the euro losing 0 ground versus the dollar as a 30 consequence of ECB easing 20 -20 before leveling out from 10 -40 2Q onwards. Moreover, we 0 -60 forecast gradual deceleration CY 01 02 03 04 05 06 07 08 09 10 11 12 13 in global economic growth from +3.8% (estimated) in Note: MOF's corporate survey base (excluding financials and insurance), On CY2011 only Q4 2011 to +3.4% in 2012. This is our extimate. Source: MoF, Credit Suisse combination of a strong yen and a weaker world economy would obviously be detrimental to the international competitiveness of Japanese exporters, which suggests that the strong profit growth of 20032007 is unlikely to be repeated. Our current macroeconomic forecasts point to a relatively modest 1.2% yoy increase in ordinary profits (as measured by the MoF's corporate survey) for 2012 as a whole.

Work hours, employment, wages, and aggregate employee compensation

Work hours at the individual Exhibit 7: Employed population and total hours (per capita) level were worked indeed boosted by this year's Employed population Total hours w orked 1.5 1.3 recovery in industrial production, but the number 1.0 of workers has yet to pick up and appears unlikely to do so 0.5 0.5 0.2 in 2012. With aggregate work -0.1 0.0 hours remaining below their 0.0 -0.4 longer-term trend, we expect that manufacturers will -0.5 -0.4 achieve increases in output -0.8 -1.0 (where necessary) by asking existing workers to work longer hours rather than through additional hiring. A Source: MIC, MHLW, Credit Suisse further recovery in production could see aggregate work
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hours move above trend (potential) around the middle of next year and thereby give firms a greater incentive to start taking on new workers, but with the economy's negative output gap the amount by which actual GDP falls short of potential still exceeding 1%, we expect that capital utilization will continue to take precedence over labor inputs1, in which case any growth in worker numbers will probably be quite modest. The working population looks set to continue contracting, having already shrunk from 66.05 million in October 2010 to 65.37 million in October 2011 due to increasingly protracted unemployment and the impact of the March 11 disaster. This has enabled the unemployment rate to fall 0.6 ppt to 4.5% over the past year despite a 0.6% decline in the number of employed persons over the same period. Given that the number of retirees has continued to rise at a relatively constant pace, this shrinkage of the working population appears to reflect an increase in the number of people who have (temporarily) abandoned their job searches. Such people may start looking for employment once again if industrial production and (aggregate) work hours do indeed remain in recovery mode through the middle of next year, with the resulting increase in the labor force participation rate likely to prevent the unemployment rate from falling much below its current level. We therefore forecast an average unemployment rate of 4.4% for 2012. Turning our attention to the relationship between the unemployment rate and wages, we note that despite unemployment having dropped to 4.5% as of November 2011, the core wage (scheduled cash earnings) actually fell 0.1% yoy in October after having held steady a year earlier. This is consistent with our previous analysis of Japan's Phillips curve indicating that wage growth does not usually turn consistently positive until the unemployment rate establishes a firm foothold below 4%. Given our aforementioned expectation that the unemployment rate will decline only modestly in 2012, we forecast near-zero growth in scheduled cash earnings over the coming year. Based on the above, we expect the employee compensation component of nominal GDP to rise 1.0% in 2012 after an estimated 0.3% increase in 2011.

Exhibit 8: Scheduled earnings and unemployment rate

0.0 -0.1 -0.1 -0.2 -0.2 -0.3 -0.3 -0.4 -0.4 5.1 0.0 5.2 5.0 4.8 4.5 -0.3 -0.3 2010(a) 2011(p) 2012(e) 2013(e) 4.4 4.5 -0.3 4.6 4.4 4.2 4.0

Exhibit 9: Nominal employment compensation (GDP base)

1.2 1.0 0.8 0.6 0.4 0.2 0.0 -0.2 -0.4 2010(a) 2011(p) 2012(e) Employment compensation (GDP base) -0.3 2013(e) 0.2 0.3 1.0

Scheduled earnings
Source: MIC, MHLW, Credit Suisse

Unemployment rate (rhs)

Source: Cabinet office, Credit Suisse

Consumer spending and residential investment

Consumer spending slumped temporarily in the wake of the Great East Japan Earthquake, but has remained relatively strong over the past two years as a whole, reflecting the impact of special factors such as the "eco points" and "eco car" purchase incentive

During Japan's 20032007 economic upswing, employment began to pick up after the output gap fell below 1% in 1Q 2004.

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schemes, the analog-to-digital TV broadcasting switchover, and a post-quake boom in demand for energy-efficient and power-saving appliances. While demand for durable consumer goods (such as TVs and certain other household appliances) is unlikely to be sustained in 2012, we nevertheless expect overall consumption to be supported by: (1) a relatively benign outlook for employee compensation; (2) continued incentives to purchase new motor vehicles, including a reduced weight tax, the reintroduction of subsidies, and the recent extension of tax breaks for fuel-efficient vehicles by another three years; (3) the fact that post-quake tax hikes on individual income will not start kicking in until 2013; and (4) declining prices of basic necessities (a reflection of falling commodities prices) and the resulting boost to real income levels. The empirical literature has found evidence of so-called "habit persistence" in Japanese consumer spending (as in other major economies), while our own consumption function estimates have shown a statistically significant (autoregressive) relationship between current and previous per capita consumption. In other words, once consumers grow into the habit of spending at a relatively high level, they are likely to continue doing so unless forced to lower significantly their expectations regarding lifetime income. As such, we expect 2012 to be characterized by: (1) relatively high spending on entertainment, travel, and other services that may have been forgone in 2011 as households instead spent up on electrical appliances; and (2) increased demand for motor vehicles fueled by renewed policy stimulus. That said, even these cyclical positives are unlikely to boost growth in (macro-level) real private consumption beyond +1% annualized. The total number of households appears likely to peak in 2015, but Japan's total population has been in decline since 2010, the proportion of long-term unemployed remains high, and working-age households apparently continue to see a relatively strong precautionary saving motive. We expect the private Exhibit 10: Real GDP private consumption consumption component of 3.0 2.6 real GDP to rise 0.7% in Real GDP private consumption 2.5 2012 after an estimated 0.2% contraction in 2011. 2.0 Disposable income levels are 1.5 likely to fall in 2013 0.9 0.7 1.0 particularly for higher-earning 0.5 households as quakerelated tax hikes kick in, but 0.0 we nevertheless forecast -0.2 -0.5 +0.9% growth in private consumption given the likelihood of front-loaded demand ahead of a FY2014 Source: Cabinet office, Credit Suisse consumption tax hike.
2010(a) 2011(p) 2012(e)

Residential investment surged 22.4% qoq annualized in 3Q 2011 as construction resumed following quake-related delays and homebuyers sought to lock in a 100bp interest rate discount from the Japan Housing Finance Agency prior to its end-September termination. We expect to see retrenchment in 4Q 2011 and 1Q 2012 given the difficulty of sustaining such rapid growth, but residential investment should nevertheless remain in gradual recovery mode given that: (1) FY2012 tax system reforms will include tax breaks for purchasers of energy-efficient and earthquake-resistant homes and an expansion of gift tax exemptions for money used to finance home purchases; (2) the household income outlook appears relatively benign; and (3) continued deflation is likely to keep mortgage interest rates low and stable. We thus forecast +2.1% growth in the residential investment component of real GDP for 2012 after an estimated 5.0% increase in 2011. We then

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expect to see a further 2.7% increase in 2013 as construction activity is accelerated ahead of a FY2014 consumption tax hike.

Corporate capex
Corporate capex finally commenced a cyclical recovery in 2011 but has continued to lack upward momentum. The private non-residential investment component of real GDP contracted in four successive quarters through 3Q 2011 and is up just 2.6% from its postfinancial-crisis bottom. Firms apparently remain reluctant to channel funds into new capital investment given their excess production capacity, an uncertain economic outlook, a strengthening yen, and diminished growth expectations. And with domestic production activity set to hit a flat patch in late 2011 / early 2012, it is possible that firms will exercise even greater caution over the next few months. The MoF's quarterly survey shows corporate cash flow thought to be a leading indicator for capital investment back near post-financial-crisis levels as of 3Q 2011, while our seasonally adjusted estimate of the ratio of corporate capex to cash flow is well below the ten-year average (69.0%) at 53.4%. However, history suggests that ample cash flow alone is unlikely to encourage firms to loosen their purse strings until they start to see a greater likelihood of investments generating an acceptable return. We expect production capacity utilization to start rising (albeit perhaps only gradually) from around the middle of next year, in line with a rebound in foreign demand, but corporate sentiment appears unlikely to improve significantly until concerns over the European economic outlook and the strong yen are alleviated. Moreover, with the Japanese economy still saddled with an excessively high stock of production capital from a longerterm perspective, it is perhaps more likely that increases in cash flow will be directly invested in emerging markets offering a higher probability of positive growth. We therefore expect to see a very weak recovery in corporate capex by comparison with previous economic upswings, forecasting that the private non-residential investment component of real GDP will rise just 1.1% in 2012 after an estimated 0.5% contraction in 2011.

Exhibit 11: Manufacturing capital utilization ratio

90 85 80 75 70 65 60 55 50 00/3 01/3 02/3 03/3 04/3 05/3 06/3 07/3 08/3 09/3 10/3 11/3 12/3 13/3 14/3
Forecast

Exhibit 12: Real GDP capex

2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 2010(a) 2011(p) 2012(e) 2013(e) -0.5 0.5 1.1 1.7

Source: METI, Credit Suisse

Source: Cabinet office, Credit Suisse

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Consumer prices
We estimate that Japan's Exhibit 13: Core CPI and core core CPI inflation rate zero-inflation output gap core core CPI core CPI peaked at -7.4% 2 in early 0.0 -0.1 2009 as a consequence of -0.2 -0.2 -0.2 contracting demand, narrowed to -0.8% by 3Q -0.4 2010 in line with the post- -0.6 -0.7 crisis economic recovery, but -0.8 -0.7 -0.8 it has since widened back to -1.0 -1.0 -2.9% as of 3Q 2011, owing -1.2 to the impact of the Great -1.2 -1.4 East Japan Earthquake. This suggests to us that the (yearon-year) core-core CPI inflation rate is unlikely to Source: Cabinet office, Credit Suisse turn positive for quite some time to come. We are forecasting that a 0.8% decline in the core-core CPI for 2011 will be followed by 0.7% declines in both 2012 and 2013. Our commodity analyst expects oil prices to remain somewhere near their 3Q 2011 levels throughout 2012, and we therefore forecast core CPI inflation of -0.2% for 2011, -0.2% for 2012, and -0.1% for 2013 (implying that deflation will not end until 2014 at the earliest).
2010(a) 2011(p) 2012(e)

Monetary & fiscal policy [Monetary policy]

The Bank of Japan's Comprehensive Monetary Easing of October 5, 2010 established an Asset Purchase Program for buying up JGBs, corporate bonds, commercial paper, equity exchange-traded funds (ETFs), and Japan real estate investment trusts (J-REITs). This program has since been expanded on three occasions in March, August, and October of this year in response to the strengthening yen and slumping stock prices, and currently allows for 20 trillion in asset purchases and 35 trillion in fixed-rate funds-supplying operations against pooled collateral for a total of 55 trillion. We expect the BoJ to maintain an easing bias in 2012 given that the core CPI inflation rate looks likely to remain slightly below zero. It is possible that further easing measures will be announced in the first half of the year if continued escalation of the European sovereign debt crisis adds to existing financial market anxiety, with possible options including: (1) expansion of the Asset Purchase Program; (2) lowering of the interest rate paid on excess reserve balances from 0.10% to (say) 0.05%; and (3) an increase in the BoJ's rinban outright JGB purchases by around 200 billion or 300 billion per month. However, we do not expect such measures to have sufficient effect to reverse the yen's uptrend on a real effective exchange rate basis.

[Fiscal policy]
The government continues to advocate a "pay as you go" approach whereby permanent tax cuts or spending increases should always be balanced by other permanent spending cuts or tax hikes, with even the cost of reconstruction from the Great East Japan Earthquake which falls outside the scope of the Medium-term Fiscal Framework to be funded via purpose-specific tax hikes. We therefore see little prospect of fiscal policy providing significant economic stimulus any time soon.

This gap is calculated as the difference between actual GDP and potential GDP, with the latter estimated so as to be consistent with a zero inflation rate.

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Public investment and other discretionary expenditures continue to decline as a consequence of rising social security costs. With the government having promised to limit "primary expenditures" (general account spending excluding debt-servicing costs) to around 71 trillion through FY2014, the next five years or so are likely to see increased reconstruction-related investment offset by declines in other public works spending. We expect annual public investment to be boosted by over 2 trillion through FY2015 as the government deploys around 70% of its reconstruction budget, but a continued downtrend in other public spending is likely to prevent double-digit growth in the real public investment component of GDP. We forecast than an estimated 4.5% increase in FY2011 will be followed by growth of +5.1% in FY2012 and +2.9% in FY2013. The general government sector's social security outlays continue to grow by around 3 trillion4 trillion per annum as a consequence of increases in pension benefits and medical expenses for elderly households. Spending on medical care and nursing services is counted as government consumption for GDP purposes, and we therefore expect agingdriven increases in social security expenditures to boost government consumption by over 2% in both FY2012 and FY2013. On the revenue side of the ledger, the government is planning a number of tax hikes targeting both households (with personal income tax levies to be hiked by 2.1% for 25 years to pay for post-quake rebuilding, and the employment income deduction to be capped at 2.45 million for individuals who earn gross salaries of more than 15 million) and businesses (although it remains to be seen whether a proposed "carbon tax" can be implemented in the face of strong opposition from industry). That said, personal tax hikes look unlikely to kick in before 2013, which suggests that household-related tax policy for 2012 could have a mildly stimulatory impact (with proposed FY2012 reforms pointing to an extension of "eco car" tax breaks, a reduction of the motor vehicle weight tax, and interest rate discounts for loans used to purchase energy-efficient and earthquake-resistant homes). The special corporate tax for post-quake reconstruction is to be imposed from FY2012, but should have a roughly neutral impact on the effective tax rate while expanding the tax base given that the income tax rate will be lowered by 5% (as previously promised) prior to imposition of the new 2.4% levy. At this point in time our base-case scenario is for the consumption tax to be hiked to either 7% or 8% from FY2014 and then to 10% from FY2016, but we must stress that this schedule remains somewhat uncertain amid continued domestic political instability.

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Business cycle update

December BoJ Tankan Survey showed deterioration of business sentiment
Business conditions DI for large manufacturers dropped six points over the last quarter and returned to negative territory Deterioration of the index was substantial for electric machinery, non-ferrous metals and ceramics Foreign demand (Exhibits 14-19) We expect export volumes to temporarily correct temporarily in October-December The BoJs real export index for October fell 4.8% mom seasonally adjusted, the first decline in three months. Production trends indicate that production levels have normalized for many industries, and we are beginning to see the impact that global manufacturing sentiment, which has weakened since the summer, is having on exports. The recent US ISM new orders index and Chinas PMI showed the first signs that manufacturing sentiment is bottoming out, so we expect export volumes to correct in Oct-Dec and then recover in Jan-Mar. In contrast, the BoJ real imports index rose a substantial 4.7% mom. The breakdown shows a marked increase in the import of mineral fuels such as LNG, which points to the impact of the shift to thermal power generation resulting from nuclear power plant shutdowns. The trade deficit amounted to 273.8 billion. The structural increase in fuel imports means that weak exports immediately translate into a trade deficit. We will continue to closely monitor electric power policies. Industrial production (Exhibits 20-23) Production remains flat Industrial production rose 2.4% mom in October, stronger than the Bloomberg consensus expectation (+1.1%) and our forecast (+0.6%). However, this increase is a rebound from Septembers fall (-3.3%), so the October level of production is still lower than that in August by 0.9%. Todays data are broadly consistent with our view, since leading indicators such as the US ISM new orders index suggested a soft patch for exports and production in the September to November period. Corporate sentiment (Exhibits 24-25) December BoJ Tankan showed deterioration of corporate sentiment The December 2011 Tankan results showed deterioration of corporate sentiment, with the headline business conditions DI for large manufacturing firms dropping from +2 to -4. We believe that weakening of domestic consumer demand for electric appliances, the recent softening of global demand, and continued strength of the exchange rate are the main backgrounds. The three-month ahead index slipped 1ppt to -5, seemingly reflecting concerns over Europe. In our judgment, however, the index for March could turn out be better given that leading indicators for exports have improved lately.

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Corporate capex (Exhibits 26-29) Fourth straight contraction in corporate capex Investment in plant and equipment (excluding software) marked a third successive decline by falling 2.7%qoq on an all-industries basis (excluding the finance and insurance sectors). Capital spending by manufacturers rose 3.0%qoq after falling quite sharply in 2Q, which points to a resumption of investment that had previously been delayed by the Great East Japan Earthquake of March 11. However, this was more than offset by a fifth consecutive contraction in investment by non manufacturers (-5.8%qoq). October core machinery orders (orders from the private sector excluding shipping and electrical power) fell 6.9% mom, which was weaker than the Bloomberg consensus forecast (+0.5%). The background was weak orders from the non-manufacturing sector (core, -7.3% mom), while those from manufacturing and abroad turned positive (+5.5% mom, and 1.6% mom, respectively). On an unadjusted basis, however, core machinery orders continued to rise, growing 1.5% yoy, keeping the three-month moving average growth rate at a robust 4.5%, although the pace likely started slowing. Employment (Exhibits 30-34) Volatile jobless rate stems from increase in the labor force The nationwide unemployment rate was 4.5% in October, up 0.4pp from 4.1% in September. The driver was a rise in the labor force of 250K (September: -970K from February), rather than a drop in employment. The employed population in October was flat from September, while corporate employment fell slightly by 70K (September: -710K from February). Consumer sentiment (Exhibits 35-37) Consumer sentiment remains flat The November Economy Watchers Survey reported a 0.9pt month-on-month decline in the household activity-related DI. However, the only negative sub-component was retail related DI (-2.3ppt), as drinking and eating related (+3.2ppt), service related (+0.1ppt), and housing related (+3.1ppt) were all positive. Meanwhile, the DI for future economic conditions was down -1.8ppt month on month at 44.3. Consumer sentiment stayed almost flat, although it may deteriorate going forward. The November Consumer Confidence index was 38.1, down 0.5 pt from the previous month. The indices for overall livelihood (down 0.7pt), income growth (down 0.5pt) and employment (down 1.0pt) deteriorated, while willingness to buy durable goods (up 0.1pt) improved. Consumer spending (Exhibits 38-39) Oct Consumption was healthier than expected Real household consumption rose 0.3% mom in October, according to the MICs Household Survey (Family Income and Expenditure Survey, seasonally adjusted). Consumption in October remained resilient as it was 0.9% higher than the July-September average. Expenditure on clothing (+7.6%), healthcare (+10.2%), transportation and communications (+3.1%), and recreation (+2.2%) were healthy. In addition, real retail sales in October rose +1.6% mom for the first increase in four months and 0.2% higher than the July-September average. As for the future, since corporate bonuses were lower this winter than they were last year, we expect overall consumption to weaken over the year-end period.

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Residential investment (Exhibits 40-41) Steady increase follows end of reactionary decline after lastminute demand before expiration of eco point system for housing The number of new housing starts rose 3.9% mom (seasonally adjusted) in October, stabilizing after the reactionary decline (20.2% drop) following last-minute demand before the expiration of the eco point system for housing in July. Building starts rose for owneroccupied housing (up 2.8%), rental properties (up 3.8%) and built-for-sale housing (up 7.7%), and fell for flats for company housing (down 75.9%). Housing starts stood at 774,432 in annualized terms. According to the October Monthly Labor Survey, total cash earnings rose 0.1% yoy, with growth picking up over the previous month (up 0.0% in September). The decline in scheduled earnings narrowed with a 0.1% yoy drop (down 0.3% in September), but nonscheduled earnings rose 1.8%, improving over the 0.1% gain in September to support the headline figure. Public demand (Exhibit 42) Second supplementary budget consists primarily of financing support for SMEs and employment measures Real public works spending rose 9.3% in FY2009, for the first time in 15 years, thanks to the formulation of a large-scale supplemental budget and the decision to bring forward the public works budget as an additional stimulus measure. However, the DPJ government froze about 3tn worth of projects in the first supplementary budget, and the second supplementary budget for fiscal 2009 consists almost entirely of financing support for SMEs and employment measures. Public works spending amounts to only 500bn for regional infrastructure development. On a GDP basis, real public works spending has fallen quarter on quarter since autumn 2009. Wage and price indicators (Exhibits 43-45) Upward pressure on wages and prices remains limited According to the September Monthly Labor Survey, total cash earnings were unchanged yoy, narrowing the decline over the previous month (down 0.4% in August). Scheduled earnings were flat (down 0.0% yoy in September and 0.2% in August), but non-scheduled earnings rose 0.2%, an improvement over the 1.6% decline in August that supported the headline figure. Although there was no improvement in the number of employees, the unemployment rate fell due to a decline in the working population, and downward pressures on wages also appears to be weakening somewhat. October nationwide core core CPI (CPI excluding food and energy) was -1.0% yoy, widening the negative margin from September (-0.4% yoy). The November CGPI (Corporate Goods Price Index) was +0.1% mom, the first positive number since July, reflecting a slight weakening of the exchange rate.

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Exhibit 14: US Manuf. ISM Survey New Order Index

80 70 60 50 40 30 20 Oct02 Oct03 Oct04 Oct05 Oct06 Oct07 Oct08 Oct09 Oct10 Oct11

Exhibit 15: Manufacturing Survey New Order Index

50.0 40.0 30.0 20.0 10.0 0.0 -10.0 -20.0 -30.0 -40.0 -50.0 Nov 02

NY Fed Manuf acturing Surv ey Philadelphia Fed Business Outlook Surv ey Nov - Nov - Nov - Nov 03 04 05 06 Nov - Nov - Nov - Nov 07 08 09 10 Nov 11

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Source: NY Fed, Philadelphia Fed, Credit Suisse

Exhibit 16: China PMI Manuf. Survey

70 65 60 55 50 45 40 35 30 25 20 Nov -07 May -08 Nov -08 May -09 Nov -09 May -10 Nov -10 May -11 Nov -11
Source: Thomson Reuters DataStream, Credit Suisse

Exhibit 17: Real Trade Indices

(2005=100) 140 130 120 110 100
New orders Imports

Real Exports Real Imports

90 80 70 60 Oct02 Oct03 Oct04 Oct05 Oct06 Oct07 Oct08 Oct09 Oct10 Oct11

Source: BoJ, Credit Suisse

Exhibit 18: Customs-Cleared Trade Indices

50 40 30 20 10 0 -10 -20 -30 -40 -50 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11
Source: MoF, Credit Suisse

Exhibit 19: Current Account Balance

(trillion y en) 35 30 25 20 15 10 5 0 Oct02 Oct03 Oct04 Oct05 Oct06 Oct07 Oct08 Oct09 Oct10 Oct11 Current Account (LHS) Y oY (3MMA, RHS) (%) 100 80 60 40 20 0 -20 -40 -60 -80

Exports Imports Exports Imports

(mom) (mom) (y oy ) (y oy )

Source: BoJ, Credit Suisse

Exhibit 20: Industrial Production and Shipments

(2005=100)
120 110 100 90 80 70 60

Exhibit 21: Industrial Production and Shipments (2)

(%) 40.0 30.0 20.0 10.0 0.0 -10.0 -20.0 -30.0 -40.0 -50.0 Production Shipments Production Shipments (mom % chg) (mom % chg) (y oy % chg) (y oy % chg)

Production Shipments

Dec02

Dec03

Dec04

Dec05

Dec06

Dec07

Dec08

Dec09

Dec10

Dec11

Oct07

Apr08

Oct08

Apr09

Oct09

Apr10

Oct10

Apr11

Oct11

Note: Production data in October and November are METI's forecasts. Source: METI, Credit Suisse

Source: METI, Credit Suisse

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Exhibit 22: Industrial Inventory Index and Inventory to Shipment Ratio

(2005=100) 160 150 140 130 120 110 100 90 80 Oct02 Oct03 Oct04 Oct05 Oct06 Oct07 Oct08 Oct09 Oct10 Oct11 Inv entory index Inv entory to shipment ratio index

Exhibit 23: Industrial Inventory Changes

(%) 10.0 5.0 0.0 -5.0 -10.0 -15.0 -20.0 Oct07 Apr08 Oct08 Apr09 Oct09 Apr10 Oct10 Apr11 Oct11 Seasonally adjusted mom % chg Y oY % chg

Source: METI, Credit Suisse

Source: METI, Credit Suisse

Exhibit 24: BoJ Tankan Survey (Business Conditions DI)

40 30 20 10 0 -10 -20 -30 -40 -50 -60 -70 Large manuf acturers Large non-manuf acturers

Exhibit 25: Business Watchers Survey for Manufacturers and the Nomura PMI
(%) 60 50 40 30 20 10 0 Nov -03 Nov -04 Nov -05 Nov -06 Nov -07 Nov -08 Nov -09 Nov -10 Nov -11
Source: Cabinet Office, the BLOOMBERG PROFESSIONAL service

("good""bad"%points

Future condition DI Nomura/JMMA Manuf acture PMI

Dec-97 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09 Dec-11

Source: BoJ, Credit Suisse

Exhibit 26: Core Machinery Orders (1)

(billion y en) 1200 1100 1000 900 800 700 600 Oct02 Oct03 Oct04 Oct05 Oct06 Oct07 Oct08 Oct09 Oct10 Oct11

Exhibit 27: Core Machinery Orders (2)

(%) 30 20 10 0 -10 -20 -30 -40 -50 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11
Source: Cabinet Office, Credit Suisse

Seasonally adjusted mom % chg Y oY % chg

Source: Cabinet Office, Credit Suisse

Exhibit 28: Floor Area of Construction Started (nonresidential)

(%) 80 60 40 20 0 -20 -40 -60 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11
Source: MLIT, Credit Suisse

Exhibit 29: Average Office Vacancy Rates

16.0 14.0 12.0 10.0

Floor area RHS Y oY % chg LHS

1000) 7000
6000 5000 4000 3000 2000 1000 0

(%)

Toky o Nagoy a Osaka

8.0 6.0 4.0 2.0 0.0

Sep-99

Sep-01

Sep-03

Sep-05

Sep-07

Sep-09

Sep-11

Source: Miki Shoji, Credit Suisse

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Exhibit 30: Changes in the Number of Workers

(%) 0.6 0.4 0.2 0 -0.2 -0.4 -0.6 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11
Source: MIC, Credit Suisse

Exhibit 31: Changes in the Non-Farm Payroll Number

(%) 1.4 1.2 1 0.8 0.6 0.4 0.2 0 -0.2 -0.4 -0.6 Seasonally adjusted mom%

Seasonally adjusted mon%

Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11

Source: MIC, Credit Suisse

Exhibit 32: Unemployment Rate

(%) 5.5 5 4.5 4 3.5 3 No. of unemploy ed (RHS) Unemploy ment Rate (LSH) (10 thousand) 360 340 320 300 280 260 240 220 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11
Source: MIC, Credit Suisse

Exhibit 33: Job Offers to Applicants Ratio

(X) 1.2 1.1 1 0.9 0.8 0.7 0.6 0.5 0.4 Oct02 Oct03 Oct04 Oct05 Oct06 Oct07 Oct08 Oct09 Oct10 Oct11

Source: MLHS, Credit Suisse

Exhibit 34: New Job Offers (Including Part-Time Employees)

(%) 30 20 10 0 -10 -20 -30 -40 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11
Source: MHLW, Credit Suisse

Exhibit 35: Consumer Sentiment Index

(%) 55 50 45 40 35 30 25 20 Nov -04 Nov -05 Nov -06 Nov -07 Nov -08 Nov -09 Nov -10 Nov -11

Seasonally adjusted mom % chg y oy % chg

Note: Data before April 2004 use old base. Source: Cabinet Office, Credit Suisse

Exhibit 36: Business Watchers Survey Current Business Conditions for Households (1)
(%) 60 55 50 45 40 35 30 25 20 15 10 Nov 02 Nov 03

Exhibit 37: Business Watchers Survey Current Business Conditions for Households (2)
(%) 70 60 50 40 30 20 10 0

Household activ ity -related (Retail)

Food and bev erage Serv ices Housing Oct02 Oct03 Oct04 Oct05 Oct06 Oct07 Oct08 Oct09 Oct10 Oct11

Nov 04

Nov 05

Nov 06

Nov 07

Nov 08

Nov 09

Nov 10

Nov 11

Source: Cabinet Office, Credit Suisse

Source: Cabinet Office, Credit Suisse

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Exhibit 38: Real Household Spending

(%) 8 6 4 2 0 -2 -4 -6 -8 -10 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11
Source: MIC, Credit Suisse

Exhibit 39: Retail Sales

(%) 6 4 2 0 -2 -4 -6 -8 -10 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11
Note: Retail sales indices, % mom chg. Source: METI, Credit Suisse

Seasonally adjusted mom % chg y oy % chg

Seasonally adjusted mom % chg y oy % chg

Exhibit 40: New Housing Started

(1000 units)
120 110 100 90 7 80 70 60 50

Exhibit 41: New Housing Started (2)

(million )
10 9 8

(%) 60.0 40.0 20.0 0.0 -20.0 -40.0 -60.0 Oct07 Apr08 Oct08 Apr09

Units (mom % chg) Square meter (mom % chg) Units (y oy % chg) Square meter (y oy % chg)

Units (LHS) Square meters (RHS)

6 5 4

Oct02

Oct03

Oct04

Oct05

Oct06

Oct07

Oct08

Oct09

Oct10

Oct11

Oct09

Apr10

Oct10

Apr11

Oct11

Source: MLIT, Credit Suisse

Source: MLIT, Credit Suisse

Exhibit 42: Construction Orders from Public Sector

y oy % chg 80

Exhibit 43: Corporate Prices

Y oY % 10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0 -10.0
CGPI CSPI

Orders f rom central gov ernment Orders f rom local gov ernment

60 40 20 0 -20 -40 -60 -80 Sep-08 Mar-09

Sep-09

Mar-10

Sep-10

Mar-11

Sep-11

Nov 02

Nov 03

Nov - Nov 04 05

Nov 06

Nov - Nov 07 08

Nov 09

Nov - Nov 10 11

Note: Quarterly base, but monthly base for 2009. Source: MLIT, Credit Suisse

Source: BoJ, Credit Suisse

Exhibit 44: CPI

Y oY % 3.0
2.0 1.0 0.0 -1.0 -2.0 -3.0 Oct02 Oct03 Oct04 Oct05 Oct06 Oct07 Oct08 Oct09 Oct10 Oct11 Core CPI Core core CPI

Exhibit 45: Nominal Wage Indices

Y oY % 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 -8

Total Cash Earnings Scheduled Earnings Oct03 Oct04 Oct05 Oct06 Oct07 Oct08 Oct09 Oct10 Oct11

Oct02

Source: MIC, Credit Suisse

Source: MHLW, Credit Suisse

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Money and credit update

Money stock continued to grow in November
Money stock continued to grow in November with the yoy growth of M2 accelerating from +2.8% to 3.0% Steady growth of money stock amid continued moderate shrinkage in nominal GDP suggests a pickup in precautionary demand for money, in our view The BoJ decided to expand the size of its asset purchase program at its regular Monetary Policy Meeting in October. The BoJ continues to watch market and FOMC, and positioned to emphasize its credit risk taking for the moment. BoJ current account and monetary base (Exhibit 46) The monetary base expanded a substantial 41.2% mom (seasonally adjusted, annualized) in November. The pace of year-on-year growth clearly picked up from 17.0% to 19.5%. Growth in banknotes in circulation slowed slightly from the last month (+2.4% yoy), while growth in current account balances accelerated sharply from +84.6% in October to 99.1% in November, showing that the BoJ has continued to keep monetary conditions loose since it increased its asset purchase program on October 27. Money stock (Exhibit 47) The November money stock data published by the BoJ showed M2 growth up 3.0% yoy, up from the previous month. M2 was up 3.5% mom, seasonally adjusted, for the third straight month of positive growth. M3 and M1 increased 2.5% yoy and 5.1% yoy, respectively. Broadly defined liquidity accelerated with 0.2% yoy growth and rose 0.8% mom in seasonally adjusted terms for the first positive growth in four months. Bank lending (Exhibits 48-50) The November Principal Figures of Financial Institutions show average outstanding loan and discount amounts increasing 0.2% yoy for the banking sector, recording the second consecutive month of positive growth. The outstanding loan balance for regional banks and tier 2 regional banks rose 1.9%, sustaining positive growth, while the city banks loan balance was 1.3%, a clear improvement over the 1.6% decrease in October. This suggests that reconstruction loan disbursement, which had been slow to get started, is finally getting underway. Credit markets (Exhibits 51-53) Spreads in the credit market are widening somewhat as a result of heightened risk aversion induced by anxiety over the US and European economies and expectations for enhanced monetary easing. With LIBOR standing firm, the LIBOR-OIS spread has widened slightly as the OIS has dropped. The spread between corporate bonds and JGBs is widening. In particular, the spread between A-rated corporate bonds and JGBs is currently 19.94, the highest level since May 2011. That said, this is about 30% of the spread at its peak just after the financial crisis, and remains stable, in our view.

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Exhibit 46: Monetary Base

(trn 140 120 100 80 60 40 20 0 Nov 02 Nov 03 Nov 04 Nov 05 Nov 06 Nov 07 Nov 08 Nov 09 Nov 10 Nov 11 BOJ current account balances Monetary base

Exhibit 47: Money Stock (M2)

Y oY % 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0

Nov 02

Nov 03

Nov 04

Nov 05

Nov 06

Nov 07

Nov 08

Nov 09

Nov 10

Nov 11

Source: BoJ, Credit Suisse

Source: BoJ, Credit Suisse

Exhibit 48: Average Outstanding Bank Lending (Banks and Shinkin Banks)
y oy % 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 Nov -05 Nov -06 Nov -07 Nov -08 Nov -09 Nov -10 Nov -11 Banks Banks special f actor adjusted

Exhibit 49: Outstanding Bank Lending (Domestic Banking Accounts)

(Y oY ,%) 6 4 2 0 -2 -4 -6 Oct-97 Oct-99 Oct-01 Oct-03 Oct-05 Oct-07 Oct-09 Oct-11

Source: BoJ, Credit Suisse

Source: BoJ, Credit Suisse

Exhibit 50: CP Underwritten by Banks

(Y oY %) 20 10 0 -10 -20 -30 -40 Nov -06 Nov -07 Nov -08 Nov -09 Nov -10 Nov -11

Exhibit 51: LIBOR-OIS Spread (3-month)

(pp) 0.30 0.25 0.20 0.15 0.10 0.05 0.00 Sep09 Dec09 Mar10 Jun10 Sep10 Dec10 Mar11 Jun11 Sep11

Source: BoJ, Credit Suisse

Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Exhibit 52: Money Market Rates

(%) 1 0.8 0.6 0.4 0.2 0 -0.2 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11
Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

Exhibit 53: Credit Spreads

100 90 80 70 60 50 40 30 20 10 0 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Aa, Spread A, Spread Baa, Spread

O/N call rate TIBOR3M TIBOR6M

Note: Credit spreads are calculated using the Bloomberg Fair Market Value index and JGB5Y yields. Source: the BLOOMBERG PROFESSIONAL service, Credit Suisse

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Upcoming Indicators/Events
November Trade Balance: Wednesday 21 December
Credit Suisse forecast: Deficit of -17.5bn (nsa) November 2010: Surplus of 157.6bn (nsa) Japanese exports and Exhibit 54: Exports, imports, and trade balance industrial production appear 1,200 50 to have entered a flat patch 1,000 since the summer as the 40 800 global economy has 600 30 continued to slow. The 400 20 200 Ministry of Economy, Trade 0 10 and Industry's survey of -200 production forecasts for 0 -400 Trade balance (Billion yen) October shows that -600 -10 Exports (yoy%, RHS) -800 manufacturers planned to cut Imports (yoy%, RHS) -20 production 0.1% mom in -1,000 November due to the severed supply chain resulting from flooding in Source:MoF, Credit Suisse Thailand, and we expect that exports will be similarly weak. According to the customs-cleared trade statistics for the first 20 days of November, exports fell 7.2% yoy for the second straight month of negative yoy growth, and there is a good chance that growth undercut the previous years level in November as a whole. We believe it is unlikely that exports picked up in late November, given the damage caused by flooding in Thailand and the increasing severity of the European debt problem. Accordingly, we expect that customs-cleared exports slowed further from the 3.8% yoy decline in October to an approximately 8.0% drop in November as a whole. At the same time, we expect that imports continued to grow yoy, as in October, due to the rise in imports of liquid natural gas replacing the nuclear power no longer being generated while nuclear power plant operations are suspended. However, the disruption in supply chains as a result of flood damage in Thailand decreased the import of parts, and as a result we expect that imports slowed sharply from 17.9% yoy growth in October to approximately 6.6% growth. As a result, we forecast a substantial trade deficit of about 585.5 billion in November (280.2 billion deficit in October).
Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11
CS Est. 0.8 ----585.5

Upcoming Indicators
Dec 20 (Tue) 13:30 14:00 8:50 8:50 Indicator All Industry Activity Index (Oct) Indexes of Business Conditions (Oct, final) Flow of funds (Q3 prelim) Trade Balance (Nov) BOJ Monetary Policy Meeting (mom%) Leading CI Coincident CI (nsa, bn) Prior -0.8 97.2 100.7 -(Nov 10) 157.6

Dec 21 (Wed)

Source: BoJ, Cabinet Office, Ministry of Public Management, Home Affairs, Posts and Telecommunications, MoF, METI, MHLW, MLIT, Credit Suisse

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Major Economic Data

2011/03 Consumption-related indicators Real spending by all households Real spending by wage-earners Real disposable income Average propensity to consume Department store sales Super store sales Convenience store sales Household activity-related DI Consumer sentiment index Monthly wages Real monthly wages Labor market conditions Unemployment rate # of workers # of unemployed # of non-labor force Job offers to applicants ratio Job offers Job seekers New job seekers Corporate-related indicators Industrial production Production Production Shipments Inventory Inventory to sales ratio Manufacturers' operating ratio Machinery orders Core machinery orders Foreign demands New housing starts Construction starts (floor) YoY % YoY % YoY % YoY % YoY % YoY % YoY % YoY pts YoY pts YoY % YoY % s.a. % s.a, MoM 10k s.a, MoM 10k s.a, MoM 10k s.a. s.a. MoM s.a. MoM s.a. MoM -8.2 -10.5 -3.0 72.6 -14.9 3.5 9.2 -21.2 -2.6 -0.1 -0.1 4.6 -46 1 45 0.63 1.0 -0.5 -7.1 2011/04 -2.0 -1.6 -1.8 72.9 -2.0 3.8 3.3 -21.1 -8.6 -1.4 -1.9 4.7 -14 2 15 0.61 -1.7 1.8 5.8 2011/05 -1.2 -0.3 -2.9 74.7 -1.9 3.6 7.5 -9.9 -8.0 1.0 0.6 4.5 -10 -9 22 0.61 0.6 0.5 1.1 2011/06 -3.5 -3.5 -5.9 73.6 0.1 5.1 11.1 3.6 -7.3 -0.7 -1.0 4.6 4 6 -13 0.63 3.4 0.7 -0.7 2011/07 -2.1 -2.6 1.1 0.1 6.9 11.5 2.4 -5.6 -0.2 -1.2 4.7 -4 5 0 0.64 1.6 -1.2 4.0 2011/08 -4.1 -4.7 -1.9 -2.0 2.4 9.1 0.3 -5.0 -0.4 -1.2 4.3 -16 -24 20 0.66 1.6 -0.8 0.9 2011/09 -1.9 -2.8 -1.4 -2.1 0.6 -2.0 3.7 -2.7 -0.4 -1.0 4.1 30 -16 -6 0.67 0.5 -0.5 -1.5 2011/10 -0.4 -1.8 -3.8 -0.2 3.5 16.6 5.3 -2.3 0.1 -0.2 4.4 7 23 -27 0.67 1.4 0.2 2.5 2011/11

1.2 -2.9

s.a. MoM % YoY % YoY % YoY % s.a.(2005=100) s.a.(2005=100) s.a. MoM % YoY % s.a. MoM % YoY % YoY % s.a. annualized, 10k YoY % s.a. MoM %

-15.5 -13.1 -12.1 3.5 108.6 73.6 1.0 9.1 -10.8 23.2 -2.4 80.7 -2.2 32.2

1.6 -13.6 -16.1 3.3 124.8 72.8 -3.3 -0.2 -2.1 17.1 0.3 79.8 28.1 -4.6

6.2 -5.5 -8.0 7.7 120.7 82.1 3.0 10.5 -6.6 10.6 6.4 81.5 11.9 -7.6

3.8 -1.7 -1.8 4.0 111.9 86.4 7.7 17.9 -5.9 -3.2 5.8 81.7 13.5 -0.7

0.4 -3.0 -3.0 4.1 116.4 86.9 -8.2 4.0 -9.8 -13.5 21.2 95.5 2.3 -3.8

0.6 0.4 0.2 5.8 114.8 89.0 11.0 2.1 32.3 10.0 14.0 93.4 16.7 15.1

-3.3 -3.3 -2.9 5.5 119.2 85.8 -8.2 9.8 -21.7 -13.9 -10.8 74.5 -18.2 -16.7

2.2 0.1 -0.3 7.0 118.1 89.3 -6.9 1.5 1.6 -15.6 -5.8 77.4 3.0 9.2

* Contracted rate is the number of contracts sold divided by the number of units for sale. Source: MIAC, Department Store Assoc., Chain Store Assoc. Convenience Store Assoc., Cabinet Office, MHLW, METI, MLIT, MoF, BoJ, JREI, Credit Suisse

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Japan Economics Weekly

Major Economic Data (continued)

2011/03 Contracted rate for condominiums Tokyo metropolitan area Kinki area Prices Nationwide core CPI Tokyo core CPI Domestic CGPI Raw materials Intermediate goods Final goods CSPI External demand Trade balance Exports Imports Trade volume Exports Imports Real trade balance Exports Imports Balance of payments Current account balance Current account balance Trade and services Trade balance Service balance Income accounts Capital and financial balance Financial account Direct investment Portfolio investment Changes in reserve assets Business conditions indices Coincident CI Leading CI % % YoY % YoY % YoY % YoY % YoY % YoY % YoY % billion yen YoY % YoY % YoY % YoY % s.a. MoM % s.a. MoM % s.a. MoM % billion yen s.a. billion yen billion yen billion yen billion yen billion yen billion yen billion yen billion yen billion yen billion yen MoM % MoM % 79.7 74.9 0.2 -0.8 2.0 20.8 2.9 0.1 -1.1 186.3 -2.3 12.0 -3.3 5.5 -24.8 -8.1 -1.5 1,738.6 806.2 267.5 236.8 30.6 1,635.9 -754.6 -659.3 -152.7 -8,125.1 -1,858.0 -9.5 -3.3 2011/04 76.1 70.1 -0.3 -0.5 2.6 19.8 3.4 0.7 -0.7 -467.7 -12.4 9.0 -11.6 1.3 -35.6 -7.0 1.8 412.4 575.9 -792.1 -412.0 -380.1 1,290.6 1,174.3 1,190.8 -614.0 9,455.2 -27.4 -1.1 -6.9 2011/05 79.2 77.6 -0.2 -0.3 2.2 18.4 3.3 0.4 -0.9 -857.3 -10.3 12.4 -10.8 5.5 11.4 4.7 3.3 585.9 385.7 -790.6 -771.3 -19.3 1,453.9 -101.3 -108.2 -614.8 3,598.5 -217.8 3.6 1.8 2011/06 79.2 74.9 -0.3 -0.4 2.5 20.7 3.7 0.6 -0.7 67.3 -1.6 9.8 -2.7 1.7 48.5 8.5 0.2 538.9 937.2 25.3 129.9 -104.6 604.8 -178.3 -183.3 -639.1 -4,718.8 -30.0 3.8 2.9 2011/07 76.2 75.1 0.1 0.0 2.8 22.9 4.3 0.8 -0.3 67.9 -3.4 9.9 -5.3 -2.6 -4.6 0.3 1.9 990.2 752.5 -182.9 123.3 -306.2 1,246.7 -753.1 -754.4 -959.4 3,715.4 -18.2 -0.1 1.4 2011/08 69.9 68.2 0.2 -0.2 2.6 22.6 4.0 0.6 -0.3 -779.6 2.8 19.2 0.9 6.0 0.3 0.1 0.0 407.5 652.6 -877.3 -694.7 -182.6 1,353.9 3,100.5 3,104.4 -511.7 3,248.8 -3,995.8 0.1 -0.6 2011/09 77.7 66.2 0.2 -0.1 2.5 19.0 3.8 0.6 0.0 293.9 2.3 12.2 1.5 1.0 20.8 3.4 -1.6 1,584.8 1,186.6 255.2 373.2 -118.0 1,393.7 -1,789.6 -1,783.0 -1,860.5 -6,426.0 -22.2 -1.6 -2.5 2011/10 70.6 74.1 -0.2 -0.4 1.6 21.3 3.0 -0.4 0.1 -280.2 -3.8 17.9 -3.9 6.0 -31.9 -4.9 4.7 562.4 518.6 -481.6 -206.1 -275.4 1,121.5 -527.7 -565.4 -877.7 534.1 -240.0 1.1 0.1 2011/11

-0.5 1.7 16.5 2.7 -0.4

* Contracted rate is the number of contracts sold divided by the number of units for sale. Source: MIAC, Department Store Assoc., Chain Store Assoc. Convenience Store Assoc., Cabinet Office, MHLW, METI, MLIT, MoF, BoJ, JREI, Credit Suisse

15 December 2011

23

15 December 2011

Japan Economic Forecasts

As of 15 December 2011
2011
Q1 Q2 Q3E Q4E Q1E

2012
Q2E Q3E Q4E Q1E

2013
Q2E Q3E Q4E 10

FY
11E 12E 13 10

CY
11E 12E 13

Real GDP Private consumption Private residential investment Private non-residential investment RealGDP Private inventory (contribution) qoq% annualized Government consumption Public investment Net exports (contribution) Exports Imports Nominal GDP (yoy%) Industrial production (yoy%) Industrial production (qoq%) CPI (core, yoy%) CPI (excluding food and energy, yoy%) Unemployment rate (%) Trade balance to GDP (%) Current account balance to GDP (%) Fiscal balance to GDP (%) Overnight call rate (%) 5yr JGB yields 10yr JGB yields USD/JPY
Notes:

-6.6 -4.9 7.3 -3.5 -2.9 1.9 -7.2 -0.6

-2.0 1.1 -7.8 -2.1 0.0 2.9 29.8 -3.9

5.6 3.0 22.4 -1.6 1.1 0.9 -3.9 2.3 32.7 14.9 -2.9 -3.3 4.3 0.2 -0.5 4.4 -0.6 2.2 -

-0.5 -0.3 -9.8 1.2 -0.4 5.5 7.9 -1.2 -7.6 -0.4 -3.4 -1.4 0.5 0.1 -0.5 4.4 -0.6 2.2 -

1.6 -0.1 1.9 1.8 0.3 2.7 7.8 0.0 0.3 0.1 -1.6 2.2 1.6 -0.1 -0.6 4.3 -0.5 2.4 -

1.3 0.8 5.8 2.5 0.1 -0.4 4.7 0.1 5.4 4.2 0.0 8.4 1.8 -0.2 -0.6 4.4 -0.4 2.1 -

1.5 0.8 3.6 1.8 0.1 1.6 3.2 0.1 3.8 2.7 -1.2 5.5 1.5 -0.3 -0.7 4.4 -0.5 1.8 -

1.7 1.3 1.3 1.5 0.1 1.5 6.0 0.0 0.6 0.6 0.3 6.4 1.3 -0.2 -0.7 4.4 -0.6 1.5 -

1.2 0.9 1.8 1.3 0.0 1.6 6.2 -0.3 0.1 1.6 0.1 5.9 1.2 -0.1 -0.7 4.5 -0.7 1.4 -

2.1 0.9 3.0 1.9 -0.1 5.2 6.3 -0.1 3.0 3.3 0.2 5.5 1.5 -0.1 -0.7 4.5 -0.8 1.1 -

1.7 0.9 2.8 1.5 0.2 2.9 1.0 0.0 3.9 3.8 0.3 5.4 1.4 -0.1 -0.7 4.5 -0.7 1.2 -

1.5 0.9 4.7 1.1 0.1 2.9 0.7 0.0 3.9 3.8 0.2 5.3 1.3 0.0 -0.7 4.5 -0.8 1.0

3.1 1.6 2.3 3.5 0.8 2.3 -6.8 0.8 17.2 12.0 1.1 5.4 -0.9 -1.3 5.0 1.1 3.4

-0.5 0.2 3.5 -1.4 -0.4 2.3 4.5 -0.9 -1.7 4.4 -2.8 -1.1 0.0 -0.6 4.4 -0.8 2.1

1.5 0.7 2.7 1.6 0.1 1.7 5.1 0.0 2.9 2.5 -0.2 6.6 -0.2 -0.7 4.4 -0.6 1.7

1.5 0.9 2.9 1.4 0.0 3.0 2.9 -0.1 2.4 2.7 0.2 5.2 0.0 -0.7 4.5 -0.8 1.0

4.4 2.6 -4.3 0.5 0.8 2.1 0.4 1.7 24.2 11.1 2.3 16.8 -1.0 -1.2 5.1 1.4 3.6 -

-0.8 -0.2 5.0 -0.5 -0.4 2.2 -2.1 -0.8 0.1 5.7 -2.8 -4.9 -0.2 -0.8 4.5 -0.5 2.2 -

1.4 0.7 2.1 1.1 0.2 2.2 6.2 -0.2 2.1 3.0 -0.6 5.6 -0.2 -0.7 4.4 -0.5 2.0 -

1.6 0.9 2.7 1.6 0.0 2.4 4.7 -0.1 2.2 2.4 0.2 5.6 -0.1 -0.7 4.5 -0.8 1.2 -

-0.2 -21.7 4.5 -2.2 -13.1 -2.0 -0.8 -1.4 4.7 0.5 2.8 1.7 -4.0 -1.7 -4.0 -0.3 -0.9 4.6 -1.4 1.7 -

- -10.0 -11.8 -12.6 -14.5

0.0-0.1 0.0-0.1 0.0-0.1 0.0-0.1 0.0-0.1 0.0-0.1 0.0-0.1 0.0-0.1 0.0-0.1 0.0-0.1 0.0-0.1 0.0-0.1 0.0-0.1 0.0-0.1 0.0-0.1 0.0-0.1 0.0-0.1 0.0-0.1 0.0-0.1 0.0-0.1

0.50 1.25 82.3

0.35 1.18 81.6

0.40 1.05 77.7

0.45 1.30 75.3

0.50 1.25 76.1

0.60 1.20 78.4

1.20 79.8

80.0

- 0.50 - 1.25 - 82.3

0.50 1.25 76.1

0.00 1.05 82.6

0.45 1.30 75.3

80.0

1. q/q percentage changes at annualized rates 2. IP growth is calculated by using non-seasonally adjusted actual figures, while forecast figures are calculated based on seasonally adjusted figures

3. Policy rate and JGB yields are end of period data Source: Cabinet Office, MoF, METI, Statistics Bureau, Credit Suisse estimates

Japan Economics Weekly

24

FIXED INCOME RESEARCH > ECONOMICS RESEARCH > DEVELOPED COUNTRIES

Dr. Neal Soss, Managing Director Chief Economist and Global Head of Economics +1 212 325 3335 Eric Miller, Managing Director Global Head of Fixed Income and Economic Research +1 212 538 6480

EURO AREA AND UK ECONOMICS

Neville Hill, Director Head of European Economics +44 20 7888 1334 neville.hill@credit-suisse.com Violante di Canossa, Vice President +44 20 7883 4192 violante.dicanossa@credit-suisse.com Yiagos Alexopoulos, Analyst +44 20 7883 7536 yiagos.alexopoulos@credit-suisse.com Christel Aranda-Hassel, Director +44 20 7888 1383 christel.aranda-hassel@credit-suisse.com Axel Lang, Analyst +44 20 7883 3738 axel.lang@credit-suisse.com Giovanni Zanni, Director European Economics Paris +33 1 70 39 0132 giovanni.zanni@credit-suisse.com Steven Bryce, Analyst +44 20 7883 7360 steven.bryce@credit-suisse.com

US ECONOMICS
Dr. Neal Soss, Managing Director Head of US Economics +1 212 325 3335 neal.soss@credit-suisse.com Dana Saporta, Director +1 212 538 3163 dana.saporta@credit-suisse.com Peggy Riordan, Assistant Vice President +1 212 325 7525 peggy.riordan@credit-suisse.com Jonathan Basile, Director +1 212 538 1436 jonathan.basile@credit-suisse.com Jill Brown, Vice President +1 212 325 1578 jill.brown@credit-suisse.com Jay Feldman, Director +1 212 325 7634 jay.feldman@credit-suisse.com Henry Mo, Vice President +1 212 538 0327 henry.mo@credit-suisse.com

ASIA
JAPAN ECONOMICS Hiromichi Shirakawa, Managing Director +81 3 4550 7117 hiromichi.shrirakawa@credit-suisse.com NON-JAPAN ECONOMICS Dong Tao, Managing Director Head of Non-Japan Asia Economics +852 2101 7469 dong.tao@credit-suisse.com Takashi Shiono, Associate +81 3 4550 7189 takashi.shiono@credit-suisse.com

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