Q+A-Japan capex bottoming out; may affect BOJ exit policy

Thu Sep 17, 2009 1:44am EDT

By Rie Ishiguro

TOKYO, Sept 17 (Reuters) - A slump in Japan's capital spending -- long seen as the country's biggest economic weak spot -- is showing signs of bottoming out, supporting a Bank of Japan forecast the economy will pick up moderately by early next year.

However, any recovery in capital spending will be slow and patchy, analysts say. Companies are saddled with excess output capacity and their earnings are weak as Japan emerges from its deepest recession since World War Two.

As a heavily industrialised country, capital spending is a key measure of the health of the economy and so an important indicator for the Bank of Japan (BOJ) in setting monetary policy.

Following are questions and answers about Japan's capital expenditure outlook.

IS THE SLUMP IN CAPITAL SPENDING OVER?

Possibly. Companies slashed spending on plant and equipment in January to March by a record 25.3 percent from a year earlier, Ministry of Finance data shows. It carried on falling in the April-June quarter, but at a slower pace of 21.7 percent.

More forward-looking figures support the view that the worst is over. Falls in core machinery orders, an indicator of capital spending in the coming six to nine months, have slowed. A three-month moving average of orders fell 1.2 percent in July, against a decrease of 6.9 percent in December. [ID:nT105569]

Capacity utilisation is also recovering. While that means companies are edging closer to the point where they might need to invest to boost output, utilisation remains a long way below pre-crisis levels.

Utilisation rose to 77.2 percent of capacity in July from a record low of 60.5 percent in February.

Analysts say the utilisation figures suggest capital spending will not start growing again until the second quarter of next year. Typically, capital spending recovers two quarters after capacity utilisation.

WHICH SECTORS ARE SEEING CAPITAL SPENDING?

An annual survey by the Development Bank of Japan (DBJ), a government bank that extends loans to companies for their operating capital, found that nearly half of manufacturers are directing capital spending into energy conservation and environmental protection, rather than into machinery.

Electrical machinery makers are increasingly counting on rising demand for rechargeable batteries, solar cells and flat-panel displays and automakers on hybrid and low-emission cars, the August survey showed.

Take midsize auto-parts maker Keihin Corp (7251.T: Quote, Profile, Research, Stock Buzz). It cut capital spending by 34 percent this fiscal year, but the money it is spending is being directed into equipment for producing parts for electric vehicles and hybrid cars.

WILL THERE BE A SUSTAINED RECOVERY IN CAPITAL SPENDING?

There are risks. There is little need for companies to invest in boosting output when capacity utilisation is so low.

The Bank of Japan's tankan survey in June showed the production capacity index, which measures the excess capacity that companies feel they have, hovered around a 30-year high hit in the previous survey in March.

In addition, a lot of the capital spending that is taking place is in industries benefiting from global government stimulus, such as low-emission cars.

The danger is that when demand for these products or the stimulus support fades, so will capital spending in these areas.

The Development Bank survey showed that more than 60 percent of manufacturers believe sales won't recover to pre-crisis levels until the year to March 2012 or beyond. So companies will be reluctant to boost capital spending until they are confident about their sales prospects.

WHAT ARE THE IMPLICATIONS FOR BOJ POLICY?

The BOJ believes that the sharp fall in capital expenditure has run its course. But it also expects corporate appetite for capital spending to be curtailed by weak earnings.

That supports expectations that the BOJ will keep interest rates near zero until 2011. [ID:nLAG003674]

The BOJ brightened its economic outlook on Thursday by saying there are signs of recovery. Previously, it had said economic conditions had stopped worsening.

The outlook for capital spending may influence the BOJ's decision on whether to extend its special steps to support corporate funding, which currently expire in December. A pick up in capital spending will be crucial for a broader economic recovery and so confidence to end the special funding steps.

BOJ officials focusing on improvements in credit markets, such as board member Miyako Suda, have warned against keeping the measures, which include buying commercial paper and corporate bonds from banks, in place for too long. [ID:nL9153370]

But others warn ending corporate fund support when economic activity is still low would hurt already weak corporate spending.

The key is the BOJ's next tankan quarterly business survey, due on Oct. 1.

If it shows business confidence and spending forecasts improving not just for big firms but for smaller companies too, the BOJ may be inclined to end some of the unconventional steps it has used to fight the global financial crisis. (Additional reporting by Leika Kihara; Editing by Neil Fullick)