Japan: Tankan Suggests Strong Recovery

• Today's Tankan survey suggests that the recovery remains in place and GDP growth will be strong in the early recovery phase. Tankan suggests GDP growth around 5% q/q AR in Q3 and only slightly slower growth in Q4.
• Financial markets mainly focused on the weak capital expenditure plans in the Tankan survey. In our view Tankan still suggests Q2 was the trough for capital expenditures.

Tankan suggests early recovery phase is strong

The Tankan business survey compiled by Bank of Japan suggests the recovery remains in place and the early recovery phase is likely to be quite strong. Both manufacturers and non-manufacturers report that conditions have improved in Q3 and they expect further improvement in Q4. Not surprisingly the improvement has been most pronounced for large manufacturers on the back of the recent strong recovery in exports.

While the level of the survey remains depressed, the development in Tankan in our opinion suggests that the early recovery phase will be strong. GDP growth is closely correlated with changes in Tankan, not with the level of Tankan. As can be seen in the second chart to the right, the development in current conditions in Tankan for all enterprises has historically tracked GDP growth quite closely. At the moment it suggests GDP growth around 5% q/q AR in Q3 and based on enterprises' outlook for Q4 it suggests there will only be a slight slowdown. Hence, today's Tankan is consistent with our current forecast of GDP growth substantially above potential in both Q3 and Q4 (see chart).

Worst is over for capital expenditures

Market focus today was mainly on weak capital expenditure plans for FY 2009 (from April 2009 to March 2009). According to the survey large enterprises now plan to cut capex by 10.8% compared to 9.4% in the previous edition of the survey. However, in our view the larger planned cut in capex for FY 2009 mainly reflects that capex has already been cut substantially. When we take a closer look at the details it appears that large enterprises have cut their capex plans for H1 FY 2009 by about 3% while capex plans for H2 have been left largely intact. Importantly, smaller and medium-sized companies have actually stepped up their capex plans for H2 FY 2009 compared to the previous survey.

In our view the worst is over for capex and Q2 will most likely prove to be the trough, which view is supported by today's Tankan. Both the overall business sentiment outlook and the inventory component have historically tracked business investments closely, and both suggest that Q2 was the trough for business investment.

According to our latest forecast, business investment will be broadly flat in H2 2009 and will start to recover substantially next year. Based on this forecast capex should drop by about 15% in FY 2009. According to the Tankan survey all enterprises (including all sizes and industries) plan to cut capex by 13.2% in FY 2009. This suggests that we are not far off the mark on business investments at the moment.

Danske Bank
http://www.danskebank.com/danskeresearch

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