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Strong yen stirs pessimism among major manufacturers in BOJ's Tankan survey

Business confidence slumped among Japanese companies in the Bank of Japan (BOJ)'s quarterly Tankan survey announced on April 1, a result likely to put the spotlight on the central bank's future decisions on monetary easing and the government's planned sales tax hike.

The central bank's key diffusion index (DI) among large manufacturers fell from 12 in the previous survey in December 2015 to 6 -- the first drop in two quarters. Among major companies in the nonmanufacturing sector, the index sank three points to 22 -- the first decline in six quarters.

The index is calculated by subtracting the percentage of companies that say business conditions are favorable from those that say the business environment is worse. The latest figures underscore the negative impact of a slowdown in emerging economies, a stronger yen and falling stock prices, together with a slump in consumer spending.

At a ceremony for 2,239 new employees on April 1, Toyota Motor Corp. President Akio Toyoda underscored rapid changes in the economic environment, stating, "We cannot count on lasting growth in the future based only on our experience of past success."

The weakening of the yen seen after the inauguration of the second Abe Cabinet at the end of 2012 boosted the automobile industry. But since the beginning of this year, the industry has faced a rising yen. In the latest Tankan survey, the DI for automakers sank 6 points to settle at 5, while the outlook for June stands at minus 1.

Toyota envisaged an exchange rate of 115 yen to the U.S. dollar for the January to March period this year, but from mid-February the yen strengthened, falling below 115 yen. When Japan's currency strengthens by one yen against the dollar, Toyota's yearly operating profit falls by 40 billion yen. Speaking to labor union members during wage negotiations for fiscal 2016 in mid-March, Toyoda went as far as to warn them, "We're setting sail on a course where a storm lies in wait." An official at another major automaker commented, "There's no shortage of matters of concern, from the slowdown in the Chinese economy to sudden changes in the exchange market and the terrorist attacks in Europe."

Diminishing demand in China stemming from the country's economic slowdown has resulted in falling oil and steel prices, which has a direct impact on the Japanese material production industry. Major Japanese steel manufacturers Nippon Steel and Sumitomo Metal Corp. and JFE Holdings, Inc. have both revised their consolidated earnings forecasts for the fiscal year ending March 2016 downward. In the latest Tankan survey, the diffusion index for the iron and steel industry fell from 0 to minus 22.

During a ceremony for new employees at Nippon Steel and Sumitomo Metal on April 1, President Kosei Shindo declared, "The iron and steel market finds itself in a very difficult environment." An official at one major chemical company also commented, "Retail prices have dropped sharply due to excessive supply from China, and this has had no small effect on business performance. We can't predict our future prospects at all."

A "Tankan shock" hit Tokyo stocks April 1 after the BOJ announced the survey results, with the Nikkei 225 average at one stage shedding 600 yen from the previous day's closing price.

The level of revenue of major exporters in the manufacturing sector, benefitting from a weaker yen, was at an all-time high by the end of fiscal 2014. It had been hoped that capital investment would increase and small- and mid-sized enterprises would see increased orders. But major manufacturers have now changed their tune, with concerns that the positive economic cycle envisioned under the "Abenomics" economic policy mix may be broken.

The latest Tankan survey showed that planned investment spending by major companies in fiscal 2016 was down 0.9 percent from the previous survey -- around the same level as the 1.2 percent drop recorded in the Tankan survey a year earlier. This was apparently because they recorded high profits the previous year, but there appears to be a smoldering risk of companies postponing capital investment projects due to worsening business sentiment.

It is feared that small- and mid-sized companies could be adversely affected. Masao Namiki, 75, chairman of Namiki Kanagata Ltd., a manufacturer of molds in Tokyo's Ota Ward, says he is wavering over whether to replace core equipment -- a move that would cost his company about 20 million yen. He has seen the worsening sentiment firsthand, with a manufacturer he knows recording a drop in transactions due to the slowdown in the Chinese economy. He worries whether he will see work continue to match the level of investment. There are thus concerns that the benefits of Abenomics could wilt without extending to small- and medium-sized companies.

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