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The Improvement in Corporate earnings and Its Implications for the Japanese Economy*1

November 10, 2005
Research and Statistics Department
Bank of Japan

Click on ron0511a.pdf (630KB) to download the full text.

ABSTRACT

  1. Corporate earnings have been greatly increasing in Japan since FY 2002 as business conditions continue to recover. This ongoing improvement in corporate earnings has the following distinctive characteristics: (a) earnings have risen to a high level across a wide range of industries; (b) fixed expenses were greatly reduced and have subsequently remained suppressed overall; and (c) a gradual decline in prices has been coexisting with increases in both sales and earnings.
  2. The following three points are believed to be important as the fundamental background to this increase in corporate earnings with these characteristics: (a) enterprises have seriously pursued full-scale restructuring following their experience of financial crises and with growing market discipline over management; (b) enterprises have benefited from a good global economic environment overall; and (c) there have been signs of a growing recovery in domestic demand as the "three excesses", namely excess of debt, capacity and employment have receded.
  3. Because overseas economies will decelerate somewhat and it will become difficult to suppress fixed expenses as much as to date, the predictions for FY 2005 are that it will become difficult to achieve the kind of large-scale profit growth seen through FY 2004. Regardless, corporate earnings which have already reached a high level are expected to support capital investment for the time being, and their positive effect on employee income is gradually becoming clear. The return of funds to shareholders via dividend payments and share repurchases has also begun to advance. Against the background of these developments, domestic demand is becoming increasingly firm, and a virtuous cycle whereby domestic demand then comes to support corporate earnings is becoming firmly established, albeit little by little.
  4. Nevertheless, considering the scale of the problems facing the Japanese economy such as the declining fertility rate, aging of society and fiscal deficit, it would be desirable to make the earnings power and growth potential of Japanese enterprises, which are the very sources of national income, even stronger. Whether or not Japanese enterprises can further enhance their value by agilely responding to developments in the global market, which offers many earnings opportunities but is severely competitive, has important implications for the future of the Japanese economy.
  • *1This is a translation of the Japanese original, which was released on September 20, 2005. The original paper was mostly prepared by the following staff of Economic Assessment and Projection. Analyses were mainly conducted by Sohei Kaihatsu (presently at Brown University), Yusuke Inomata and Masato Higashi. Supplementary analyses were conducted by Tomohiro Shigemoto, Tetsuma Arita (presently with the International Department), Yoshimitsu Shimizu (presently at the University of London), Tetsuya Yamada, Toru Hirasawa and Masayuki Sakata. Charts were prepared by Naoko Igawa and Yuko Koyama. Kazuo Momma put together all the analyses.