MW-59 -- Economic Recovery in 2004? Don't Blow It, Japan

J@pan Inc Magazine Presents:
Weekly Financial Commentary from Tokyo

Issue No. 59
Tuesday, January 13, 2004

ICA January 15 Event

PRESENTER: Jeff Funk - Professor of Business at the Institute for
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TOPIC: Key Technologies, Applications and Strategies for the
Mobile Internet

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Date: Thursday, Jan 15
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Foreign Correspondents' Club

++ Viewpoint: Economic Recovery in 2004? Don't Blow It, Japan

The Bottom Line:
o To global investors, Japanese equities are now more attractive
than they have been in years. In order of preference,
the consensus seems to prefer:
a) emerging markets,
b) the Eurozone, and
c) Japan that order, while there is a professed aversion to US

Actually, underweighting US stocks in a global portfolio is
not easy, simply because of the large weight that the US
market has come to occupy in terms of global market
capitalization. In other words, if you want to significantly
underweight US equities but are generally bullish on equities,
you have to raise your exposure to all alternatives -- the
Eurozone, Japan, Asia-Pacific without Japan and the emerging

o Investors have positioned themselves in reflation plays on the
assumption that a classic, synchronized recovery in the world's
economies has not yet been fully discounted, particularly in
bond yields. To do this means going overweight in basic
materials, industrials, energy and, to a lesser extent,
technology and the financials.

o In Japan, this movement took a little bit of a different
twist, as it coincided with the realization that Japan's
financial system may not be as bad off as feared, and that the
government stood ready to bail out any financial institution
that presented a threat to the financial system. Consequently,
the best-performing sectors of the Topix in 2003 were
iron/steel (+74.5 percent for the year), banks (+69.7
percent), insurance (+71.0 percent), broker stocks (+69.7
percent) and shipping companies (+60.7 percent), reflecting
both a more sanguine view of financial sector risk and
positioning for economic recovery.

o Money Watch believes these trends will persist through the
first half of 2004, meaning there will be no major shift in
market perceptions like we saw in the second quarter of 2003.
However, as investors have spent the past year trying to
position themselves for an economic recovery and less
worrisome balance sheet risk, they are likely to begin culling
stocks that were seen as related to such themes as digital
consumer electronics, China and global economic recovery but
which cannot actually produce both top line growth and
relatively attractive profit margins. In other words,
investors are likely to become more selective.

o In 2003, a stock with a good story was good in many cases for
a "triple" or a "double" simply because it ceased to be priced
for bankruptcy. In 2004, the stocks with the good story and
the earnings fundamentals to back it will continue to perform,
while those bereft of fundamentals could well see
profit-taking, or at the very least, underperformance.

o As of the interim financial reports in September 2003, 20
percent of 1,500 nonfinancial companies are expecting to
report historically high levels of ordinary consolidated
profits. These companies will account for 60 percent of total
reported consolidated corporate profits. The earnings
polarization between the winners and losers is even greater
than in the previous peak in corporate profits in March 2001,
where one in four companies reported historically high
corporate profits (as opposed to one in five now), while
accounting for 50 percent of total corporate profits.

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++ Viewpoint: Economic Recovery in 2004? Don't Blow It, Japan

The prognosis for the US economy and stock market for 2004 is more
mixed than it has been in recent memory, while the consensus as
reflected by fund manager surveys such as the Merrill Lynch and
Reuters surveys indicate that the US market remains the least
attractive of the major equity markets. In order of preference, the
consensus seems to prefer: a) emerging markets, b) the Euro zone and
c) Japan. The Japan equity market is still viewed as among the
cheapest of any of the major developed markets, while the yen is the
currency seen as having the most appreciation potential in 2004.

Conversely, more and more global investors apparently see the
euro as becoming overvalued, while gold is also increasingly
perceived as slightly overvalued. The consensus also believes
that the synchronized global economic recovery is not yet fully
priced into global financial markets, particularly the bond
market. Essentially all global investors are positioned for
global reflation trades, and there is apparently a strong cyclical
bias in anticipation of a classic cyclical upturn.

In terms of sector preferences, global investors apparently strongly
prefer basic materials, followed by general industrial machinery,
technology, energy, media, insurance, banks and telecom, in that
order. Conversely, the current tendency is to remain underweight
utilities, staples, automobiles, retailers and pharmaceuticals. In
addition, as confidence in the synchronized recovery increases, there
is growing preference for larger-cap stocks over small-cap stocks,
which is shown in the better performance over the past month of the
S&P 500 over the S&P/Barra Small Cap index.

This consensus view could well continue to work for the next several
months, until: a) the downdraft in the US dollar reverses, and/or b)
the US Federal Reserve moves to tighten US monetary policy. However,
most analysts see no such move by the Fed within 2004, which everyone
knows is an election year, while the dollar depreciation could become
even more unruly in 2004.

On a global basis, financials, information technology, consumer
discretionary and health care are the most important sectors in terms
of market capitalization, and thus it is more important that investors
get these sectors right vis-・vis their global benchmarks. Despite
stellar performance in 2003, basic materials and the industrials have
so far been underperforming in 2004. If this trend continues through
the first quarter of the year, global investors will be forced to
reassess their bullish positions on energy, basic materials and
industrials, ostensibly to the benefit of the currently preferred
underweight sectors of consumer staples, health care, retailers and

Dollar Depreciation
In looking at annual changes since 1980 in currencies from the
Group of Seven leading industrialized nations, the only times a
G-7 currency lost 20 percent of its value against a G-7 counterpart in
one year (the exception being the coordinated dollar devaluation in
the wake of the 1985 Plaza Accord) were the devaluation of the
Italian lira against the dollar and yen during the 1992 crisis in
the European Exchange Rate Mechanism, and the 22.8-percent decline in
the euro against the yen in 1999, after the launch of the single
currency. Otherwise, no G-7 currency has been allowed to fall more
than 20 percent against another G-7 currency in over 20 years. This
has led some to suggest that a 20-percent depreciation in a year was a
"maximum speed limit." Indeed, the combination of the falling
dollar and rising long-end interest rates were what are generally
considered to be the cause of the Wall Street crash towards the end
of 1987.

But the Crash of '87 barely shows up on the long-term charts of US
stock prices. There are also those who argue that the dollar's
downward trajectory is no crisis, but simply an unwinding from
overvalued levels that's adding additional stimulus to the US economy,
which in turn is lifting growth in the rest of the world. Indeed, the
massive buying of US Treasuries by Asian nations (particularly Japan)
is entirely rational, as it seeks to support domestic employment and
to keep its currency competitive. Japan and the rest of Asia today are
in some ways like the Europeans after WWII -- using cheap exports to
the US to power their economic revival and maintain domestic

Despite growing US deficits, the system, like then, has been stable
and sustainable because of massive inflows into the US from Japan and
Asia. Between January and October of last year, Japanese purchases of
US debt accounted for roughly half of non-resident net purchases. Last
year, the Bank of Japan used over 20 trillion yen to intervene in the
currency markets to brake the yen's appreciation. The money used for
these interventions is essentially borrowed money. Conversely, US
buying of foreign equities last year hit record levels, with 40
percent of this going to Japan financial markets. Tokyo Stock Exchange
(TSE) statistics indicate that US-based investors were providing well
over 50 percent of the net buying of Japanese equities.

Thus, despite the growth in US deficits, the system has been stable
and sustainable. Indeed, the US in the past has prospered under such
arrangements, as was shown under the old Bretton Woods regime.

Japan Becomes More Attractive
Global investors see Japan as relatively more attractive than it
has been in years as the good economic and corporate news that the
Japanese stock market began to discount in earnest from May 2003
continues to emerge. Japanese companies are beginning to recover
some of their lost international competition. The World Economic
Forum's recent ranking of Japan's overall international
competitiveness improved to 16th, compared to a low of 21st two
years earlier.

The following areas appear to be the main drivers for this
1. Rapid diffusion of new digital consumer electronic
2. Soaring China demand.
3. Significant improvement in balance-sheet risk and the
nonperforming loans of banks.
4. Continuing restructuring and re-engineering of corporate
business models.

The ability of Japanese companies to cope with the domestic malaise is
improving. Behind the recovery is an improvement in business-generated
profits. Business-generated profits before interest and other expenses
at the companies surveyed by the Nikkei Business Daily averaged 22.4
billion yen in fiscal 2002, the second highest level after the 23
billion yen in fiscal 2000, in the midst of the IT boom. At the same
time, profits that are necessary to pay expenses essential for
corporate activities kept declining, sinking to a record 20.8 billion
yen on average, compared with 32.8 billion yen for fiscal 1992.
Business-generated profits are the sum of operating profits, interest
income and dividend income.

Thus corporate survivability came to 1.6 billion yen per company
on average in fiscal 2002, according to a survey by The Nikkei
Business Daily. The survivability had been in negative territory
for 10 straight years since fiscal 1992, following the bursting
of the asset-inflated economic bubble. The Nikkei survey covered
852 nonfinancial companies listed on the first section of the
Tokyo Stock Exchange whose consolidated financial data over the
past 10 years is available.

Underlining their efforts to streamline their finances, these
companies saw interest and bill discounts paid drop to 3.4
billion yen on average from 11.3 billion yen for fiscal 1992. At
the same time, dividend payments shrank to 2.8 billion yen from
3.5 billion yen per company on average. In an effort to keep
improving their financial standing, many companies introduced
stock buyback programs even if they earned ample profits. While
profits per share increased, less money was paid out for
dividends, thus sacrificing shareholder returns.

When it came to the survivability of individual companies, Nippon
Telegraph and Telephone Corp. (9432) ranked first, followed by
Toyota Motor Corp. (7203), Nissan Motor Co. (7201) and Honda
Motor Co. (7267) Of the 852 companies surveyed, 349 had a positive
earnings survivability number. NTT improved its profitability by
implementing large-scale restructuring measures affecting about
100,000 employees at its two money-losing regional units. Toyota saw
its business-generated profits before interest exceed NTT's 1.38
trillion yen to reach more than 1.4 trillion yen. But the automaker
had larger corporate tax and other payments than NTT did. Nissan
accelerated sales of excess assets, such as stockholdings and real
estate. Consequently, it reduced its interest-bearing liabilities,
excluding its sales financing, to zero from 2 trillion yen as of the
end of fiscal 1998.

Once the flagship sector of Japan's global competitiveness,
electrical machinery makers in general now show poor survivability.
Sony Corp. (6758) has the lowest survivability, followed by Matsushita
Electric Industrial Co. (6752) and Hitachi Ltd. (6501) Sony's
business-generated profits before interest were 199.8 billion yen, but
profits that are necessary to pay expenses came to more than double
the amount for the company, totaling 457 billion yen. Their average
earnings figure as a measure of their survivability at 123 firms was a
negative 8.3 billion yen, staying in minus territory for the 11th
straight year.

From the second half of 2003, there was a noticeable trend toward
upgrades in the credit ratings of Japanese corporations by the
major credit rating agencies, including not only Japan's JCR and
R&I, but also Moody's, Standard and Poor's and Fitch. Excluding
Fitch, the four rating agencies upgraded the credit ratings of 33
companies in the fourth quarter of last year, compared to eight in the
first quarter, 14 in the second quarter and 23 in the third. For the
full year, 78 companies had their credit ratings raised, up 60 percent
from the previous year. Among the companies that received credit
upgrades over the past year were: Shinsei Bank (expected to be
re-listed in the first quarter of 2004), Nissan, KDDI (9433), Brother
Industries (6448), Aozora Bank (not listed), Stanley Electric (6923),
Hitachi Construction (6305), and Calsonic Kansei (7248).

A Nikkei survey shows that of the 1,510 companies (excluding the
financials and over-the-counter companies) with March fiscal years and
reporting interim financial reports in September 2003, 20 percent are
expecting to report historically high levels of ordinary consolidated
profits, and that these companies will account for 60 percent of total
reported consolidated corporate profits. This contribution is expected
to produce overall consolidated ordinary corporate profit growth of 20
percent for the fiscal year ending March 2004.

However, the earnings polarization between the winners and the losers
is even greater than in the previous peak in corporate profits in
March 2001, where one in four companies reported historically high
corporate profits (as opposed to one in five presently) but accounted
for "only" 50 percent of total corporate profits. The noteworthy
characteristics of these "winning" companies are:

* They are able to grow their top line sales at a much higher
rate than average and certainly higher than Japan's GDP growth
rate. On average, the companies expecting to report
historically high levels of earnings foresee sales growth
averaging 6 percent per annum, versus only 2 percent growth
for all listed companies.

* They have managed to keep their cost-of-sales ratios to a
level much lower than their peers. The average cost-of-sales
ratio for these companies is 68.2 percent compared to an
overall average for all listed companies included in the study
of 74.4 percent.

Thus while investors in 2003 were actively bidding up the stock prices
of companies with weak balance sheets thought to have been given a
reprieve by recovering export markets and bank rescues, such stock
price gains are unlikely to be sustained in 2004 as the polarization
in sales growth and profit margins between the winners and losers
widens further.

Industry Consolidation
Sixty-four companies were delisted from the TSE in 2003, following a
historically high of 78 in 2002. Yet very few of these companies were
delisting due to bankruptcy. Indeed, most of them were related to
group and industry restructuring -- the combining of several companies
under a holding company structure or the absorption of a listed
subsidiary into the parent company. Interestingly, 2003 was not a year
in which a wave of "pure" M&A transactions were instrumental in
accelerating industry consolidation and restructuring.

According to Refco, the number of M&A transactions excluding those
within the same group last year was down by over 3 percent from the
previous year. Mergers like that between Yuasa and Nippon Battery
created a new entity with the second-largest global market share
in lead batteries. The merger between Nippon Sanso and Taiyo Toyo
Sanso further solidified their commanding domestic market position
and made them better positioned to compete with US and European majors
in Asia. Matsushita continues to consolidate its considerable resources
into a better-coordinated, operationally more efficient whole.

At the same time, there were key purchases by foreign-capital firms
such as the Ripplewood Holdings purchase of Japan Telecom, the Cerebus
purchase of Aozora Bank and Colony Capital's purchase of Daiei's
Fukuoka operations. In total, purchases by such investment companies
in 2003 increased by 3.5-fold over 2002 levels. While initially
shunned as outsiders looking for a quick buck, these investment funds
boast a track record so far that has been generally good, and there is
a grudging appreciation of the role they can play in Japan's

Demographics Help Earnings
Most analysis of Japan's rapidly aging society has heretofore focused
on the fiscal and macroeconomic implications of this aging. Japan's
savings rate as announced late in 2003 has declined to under 7
percent, compared to a level of 15 percent as late as 1991. In
particular, the savings ratio of "unemployed" (i.,e., retired) older
households is minus 20 percent or so. Moreover, the decline in
average savings ratios is expected to accelerate further after
2007, with some seeing Japan's savings ratio falling to 4 percent by

While most discussion heretofore of Japan's rapidly aging society
has focused on the negative implications of this aging on the
economy and Japan's fiscal health, some analysts are now
beginning to focus on the positive impact the equally rapidly
aging of Japan's work force will have on corporate profits over
the next decade. Daiwa Research Institute has estimated the
impact of retiring older workers by industry sector between 2001
and 2011, and came up with the conclusion that the profits of large
corporations could be boosted by as much as 2-3 percent per annum
(other factors being assumed equal) by the increasing retirement of
workers now in their 50s. Moreover, the impact would be greater for
small- and medium-sized companies, where ordinary profits could be
boosted by over 7 percent per annum over the next 10 years.

While aging of Japan's population is accelerating, Japanese
companies have been undergoing painful restructuring and holding
back on large new capital-expenditure initiatives, creating a
level of aggregate free cash flow not seen in many years. As
companies continue trimming labor costs, the composition of Japan's
savings is in effect shifting from individuals to the corporate
sector. Aggregate household savings in 1998 were just under 34
trillion yen, but had shrunken to 18 trillion yen by 2002 and could
further shrink to 12 trillion yen by 2008. Given the noticeably higher
average age of production capacity in Japan, these trends will at some
point provide powerful support for a renewed wave of capital

The Risk of Overly Zealous Policies
As for the yen risk, most analysts agree with the claim by Japanese
companies that they are now less exposed to an appreciating yen than
they were in 1996. The negative impact of the rising yen is
ameliorated at least over the short term by increasing production by
manufacturers overseas and increased hedging on the part of
export-oriented companies. However, many companies have made their
earnings forecasts and business plans based on an assumed dollar
exchange rate of around 110 yen. Additionally, companies that will be
adversely affected by a strong yen are automakers and electric
machinery producers, and it is firms in these industries that are
leading the current recovery of overall corporate earnings.

However, there is no denying that the yen's appreciation may be
having a bigger impact on corporate and investor sentiment than it is
actually having on revenues and earnings. The presidents of leading
exporters have stated that current yen levels are close to the level
that will be difficult for them to deal with. For example, Nobuo
Yamaguchi, chairman of the Japan Chamber of Commerce and Industry,
stated late last year that (the current yen level) approaches the
"critical point."

But the combined operating profit posted in Europe and Asia, excluding
Japan, by listed Japanese companies exceeded the amount they made in
North and South America for the six-month period ended September, a
survey conducted by The Nihon Keizai Shimbun shows. Profit in the
Americas dropped 15 percent year on year due to the dollar's decline
against the yen, while their profit in Europe nearly doubled thanks in
part to the appreciation of the euro. Also, earnings in Asia rose in
line with the continued expansion of the Chinese market. The survey of
505 firms with fiscal years ending in March showed that profit from
the Americas shrank by 3.9 percentage points to 12.0 percent of the
global total. The percentage rose 1.6 points to 4.0 percent in Europe
and inched up 0.3 point to 8.5 percent in Asia and Oceania, implying
that profits from the main overseas regions is still modest at 13.9
percent of total global profits. This in turn implies that incremental
cost savings from domestic rationalization could easily absorb the
impact that the strong yen is having on their US businesses, while the
expected acceleration of GDP growth in Europe will also be an
offsetting factor.

In 2003, Japan's economy showed surprising strength, but the
recovery is widely recognized to be a fragile one that could
be derailed by a significant change in the economic picture in
China and other overseas markets. While individual Japanese
companies may now be better able to withstand a significant
appreciation in the yen, it is a different matter should the yen
surge through 100-yen/US$ and stay there for an indefinite time.
Moreover, the net impact would be to reduce Japan's GDP growth
rate by a significant amount, given that there is not much growth
to work with in the first place.

In this regard, the economic indicators announced last week
contained a warning that Japan's economic planners should not get
too sanguine about the current recovery and start trying to jack
up taxes to plug revenue shortfalls, nor should they move too quickly
to sell off more of their holdings in NTT or the old JR companies. The
November coincidental indicator was 77.8 percent and represented the
seventh straight month above the boom-bust line of 50 percent.
However, the leading indicator fell to 44.4 percent and dropped
under the 50 percent boom-bust line for the first time in seven

In January 2002, the Japanese economy hit a trough and thereafter
entered the 14th economic expansion in the postwar period. Like the US
economy, Japan's economic recovery has so far been a "jobless"
recovery with little positive knock-on effects for the domestic

The current recovery already looks better than the prior aborted
recovery, which became Japan's shortest postwar economic recovery
(21 months). The current recovery is already 22 months old,
compared to the median postwar expansion period of 28 months. If
this is an "average" cyclical recovery, the economy will begin to
peak sometime in June. Since the median lead time in which the stock
market has historically "read" these peaks is four months, the stock
market could completely discount this "normal" recovery (if it is
indeed normal) by February. Consequently, the last thing Japan's
economy needs at this juncture is overzealous bureaucrats pushing for
higher taxes to squeeze more blood from a turnip.

In the first half of 2003, business and investor sentiment was
still bearish, and stock prices were too low for holders of large
blocks of strategic and cross holdings to unload their positions,
even though they would have liked to. But given the brighter
economic and market outlook, the major banks are again moving to
unload large positions in stockholdings ahead of the September
2006 deadline to get their stockholdings to within the level of
their reported capital positions. UFJ Financial Group (8307) had
previously planned to unload 710 billion yen worth of stock by fiscal
2007, but has accelerated this plan by three years. The bank plans to
reduce stockholdings to under 7 trillion yen, or 40 percent below
levels prevalent last September. Sumitomo Mitsui Group had planned to
unload 560 billion yen worth of stock in fiscal 2003, but is
accelerating its sales in the second half of the fiscal year to
March 2004, as are the remaining core banking groups.

UFJ plans to pare its stockholdings to less than half of its core
capital by the end of fiscal 2004, and the major banks as a whole
now expect to be able to reduce their stockholdings to a level less
than half that at the end of fiscal 2001, a level equal to 60-70
percent of their core capital. In order to prevent further downward
pressure on the stock market, the banks plan to sell these holdings to
the Bank Stock Purchasing Corporation. This is a massive change in
ownership of listed Japanese shares. In the early 1990s, financial
institution holdings of listed Japanese company shares had risen to
almost 50 percent. Since 1997, Japanese financial institutions (city,
long-term and prefectural banks as well as insurance companies) have
sold 17 trillion yen worth of Japanese equities.

The other supply factors that will cloud the supply-demand picture
in 2004 are the revival of new issues by companies that have been
waiting for better market conditions to list and the issuance of
a large block of NTT (1 million shares) and Japan Tobacco (330,000
shares) that are expected to net 500-600 billion yen for the tax
revenue-starved Japanese government.

As the unwinding of strategic and cross-held shares has accelerated,
Japanese companies have increasingly looked to individual investors as
a possible source of demand for their stock. But while individual
investors are again actively trading stocks, mainly over the Internet,
they actually remained net sellers during 2003. Since 1997, they too
have been net sellers of over 8 trillion yen of Japanese stock and
have sold over 1 trillion yen worth of stock in 2003 alone, even as
they accounted for roughly 30 percent of total trading value.

Consequently, the fate of the Japanese stock market will again in
2004 be largely determined by how actively foreign investors continue
to purchase Japanese stocks. During the last several months of 2003,
foreign investors were accounting for over 50 percent of trading value
and were essentially the only net buying demand. Of this, US-based
investors accounted for over 60 percent of net purchase value. In
short, how bearish US investors remain regarding their home market and
the US dollar will continue to have a large impact on the price
formation of Japanese stocks again in 2004.

As previously stated, surveys of global fund managers at the end
of 2003 indicated that they continue to view Japan as one of the
most attractively valued of the developed markets, which implies
continued foreign fund inflows in 2004. Thus the risk to the Japanese
equity market in 2004 is a major shift in sentiment regarding the US
dollar and relative valuations of the US market.

A common feature of those companies expected to record historically
high earnings in fiscal 2003 is that they can grow their revenues. In
other words, it is not enough just to get costs under control and
profit margins up if in the process you are sacrificing future growth.

In fiscal 2004, we believe the following themes will continue to exert
a significantly favorable influence on the revenue growth of Japanese

1) Rapid Diffusion of Digital Consumer Electronic Products

Toshiba's (6502) Yokkaichi semiconductor plant is operating at full
capacity on strong orders from digital consumer electronic products.
Renaissance Technologies, a joint venture between Hitachi (6501) and
Mitsubishi Electric (6503), plan to spend 33 billion yen to boost
production capacity of large-memory-capacity flash memories by 80
percent by the fall of 2004. These memories are used to store video
data for digital consumer electronics. Matsushita (6752) will be
spending 130 billion yen to build a new system LSI plant that should
be operational by the fall of 2005.

According to Japan's CIPA (camera video equipment association),
global shipments of digital cameras (an area that Japan still
dominates) for the first 11 months of 2003 reached 1.52 trillion yen
and will increase by 50 percent this year, or roughly 10 times that of
film camera shipments during the same period. Digital cameras first
arrived on the scene in 1999, which means they have exploded into a
1-trillion-yen market in just four years. Thus, despite the strong
yen, growth in main products such as digital cameras for Canon (7751)
is expected to drive the company's profits to historical highs for the
fourth straight year, as net income surges by 42 percent from a year
earlier. Consequently, the company has announced a dramatic increase
in its annual dividend from 20 to 50 yen per share. Nitto Denko Corp.
(6988) expects its consolidated operating profit for the year ending
March 31 to surge 47 percent on the year to more than 50 billion yen
on robust sales of its film for liquid crystal displays.

A recent survey of semiconductor and electronic parts manufacturers
found that 95.7 percent believe their industry is in a recovery trend
and that 90 percent have already boosted production from the previous
year. Seventy-six percent of these respondents said they were
increasing production in Japan, while 61 percent were increasing
production in China, and 37 percent were increasing production in
Asia. In addition, 89 percent of those that are spending more than
originally planned on capital expenditures are investing in facilities
in Japan. Driving electronic component demand is strong demand
for flat-panel TVs, DVD recorder/players and mobile products.
Eighty-seven percent of the respondents to the Nikkei survey name
thin/flat-panel TVs as the industry's driving force for 2004 and
beyond; 76 percent cited DVD players.

Some basic materials producers such as JSR (4185) are in the process
of transforming themselves into producers of high value-added
electronic and optical materials from "rust bowl" industries. Thanks
to strong demand for LCD materials sparked by growing sales of
flat-panel TVs, the company expects 29.5 billion yen in consolidated
pretax profit for the current fiscal year ending in March, up 43
percent from a year earlier and an all-time high for the second
straight year. The pace of growth is exceeding management's
expectations, as new diversified businesses now account for 80 percent
of total operating profits.

The way forward for Japanese producers of flat-panel TVs and other
displays, however, is less clear. The long-expected shift from large,
bulky Braun tubes to TFT liquid crystal, plasma and other
flat-panel-display technologies is finally upon us. While these
screens are enjoying almost unlimited demand, only firms in Japan,
South Korea and Taiwan produce them. At a recent international
conference held in Tokyo, it was estimated that Japanese companies
would hold only 20 percent of the global flat-panel market by 2008,
with South Korean firms accounting for 40 percent, Taiwan 30 percent,
and Chinese companies 10 percent.

This year, Japanese producers are expected to hold 50 percent, versus
40 percent for Korea. The Japanese producers of color filters,
polarizing plates and other key LCD display components should be able
to hold their ground. Considering that materials and components
account for an impressive 50 percent of the total manufacturing cost
of a flat panel, component producers would seem to be the area to
focus on to best leverage growing demand for digital consumer
electronic products.

2) Soaring China Demand

Polypropylene and other plastics used in automobile components are
increasing 20 percent year on year on strong exports to China, where
the increase in demand is expected to continue until the 2008 Beijing
Olympics. Smaller companies like Osaka Organic Chemical (4187), along
with Nippon Steel (5401), Hitachi Construction Machinery (6305) and
even shipping firms like Mitsui OSK (9104) and Kawasaki Kisen (9107)
are benefiting from China demand.

Nippon Yusen, Mitsui OSK and Kawasaki Kisen are expected to invest
more than ・1 trillion combined over the next four to five years to
significantly expand their shipping capacities. During most of the
1990s, these companies kept a lid on capital expenditures as the
rising yen and intense price competitive from Asia rivals ravaged
earnings. However, the business environment has improved noticeably on
China-related demand and the forecast for a significant recovery in
world trade.

Mitsui OSK, for example, has received an order from JGC (1963) for the
shipping of massive machinery to be used in construction of the
largest petrochemical plant in China, and Mitsui will be shipping
equipment from both Japan and South Korea.

Last year, Japanese companies sent 20 percent of their exports to
China and Hong Kong. Though the percentage is still lower than to
the US, exports to greater China (including China, Hong Kong and
Taiwan) are expected to surpass exports to the US in the near future.
In addition, the fact that foreign investment in China currently makes
up over 40 percent of China's GDP is beginning to set off warning
bells at the Bank of Japan, as it remembers that this figure is almost
on par with the levels seen in Southeast Asia before the regional
currency crisis in 1997-1998. The BOJ fears there currently are no
effective measures in place in China to prevent the economy from

Consequently, any serious problems in China's economy would
undoubtedly have ripple effects on the Japanese economy, as exports to
greater China for the first 11 months of 2003 were 24.5 percent of
total exports, versus 24.7 percent for exports to the US. Moreover,
exports to China are rapidly growing while exports to the US are

-- Darrel Whitten

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Written by Darrel Whitten

Edited by J@pan Inc staff (


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