The business condition in Japan had been on a moderate but consistent deterioration since mid-2015. However, the December BoJ Tankan showed that it may have staged an unexpected turnaround in the second half of 2016. Large manufacturers' business condition DI improved from 6 to 10. As the chart below shows, the business condition DI is not just a sentiment indicator. It has a high correlation with the corporate profits and the improvement in the DI suggests that the corporate profits likely have expanded in the last quarter of 2016.
Small-sized manufacturers also saw improvements in their business conditions. The corporate profits of manufacturers should turn out to be even better, as yen has continued to depreciate after the survey period.
Non-manufacturers seem less sanguine on their business conditions. Large non-manufacturers' business condition DI remained unchanged at 18 in December. However, we do see divergences among non-manufacturers. Smaller non manufacturers seem to have had slightly better quarter than their larger peers.
There are also industry-wise divergences. Industries such as business services and information services saw improvements in their DIs. It was chiefly the deterioration in the inbound tourism related industries such as retailing, hotels and restaurants that pulled back the overall business conditions of non-manufacturers.
Corporate managers remain cautious
While Tankan results showed that the business condition did improve in the current quarter, we also see that corporate managers seem cautious on the sustainability of the improvements. Forecast DIs for business condition show across the board deterioration for the next quarter. While it is true that Japanese corporate managers tend to be cautious as a norm, they seem more cautious than usual. Despite the improvements in business conditions, Japanese corproate managers revised down their capital expenditure plan for FY2016 to 5.5% year on year growth in the latest December survey, down from the 6.3% growth planned as of September survey.
We have a sympathy toward such cautious view. The second half of 2016 did bring better results than expected and the yen has unexpectedly weakened, but there is little fundamental factors to grasp on to start to believe that 2017 would bring a better economic environment. Structural reforms effort under Abe administration has faltered. The BoJ is no longer commited to reflating the Japanese economy on its own. Globally, uncertainties seem to be on the rise, symbolized by the uncertainty the new Presidency in the United States brings.
The yen depreciation and the unexpected buoyancy in corporate profits does provide an opportunity for Japanese policy makers to try to revive reflationary momentum and we should not be too dismissive of the upside risks. However, we still think the balance is tilted toward more downside risks than upside.