Japan's Economy Shrinks: Posts 1.2 % Slump

Decline in the Gross Domestic Product (GDP) coupled with a sharp fall in the capital expenditure raised serious concerns about the efficacy of corporate-led recovery. For the quarter April-June, Japan’s GDP declined 1.2 percent on an annual basis. Capital expenditure, on the other hand, contracted 1.2% from the previous quarter.

The information aggravated the negative sentiment and sent the Tokyo shares plunging. The benchmark Nikkei 225 index finished down 2.2 percent Monday on the Tokyo Stock Exchange.

Some analysts, although few in numbers, rubbished this 1.2 per cent drop in real economic growth as a "blip" and were confident that the GDP would look north again as corporate capital spending rose again.

Referring to the weakening trend in exports and the fact that the capital expenditure has declined in three of the past four quarters, Hiroshi Shiraishi, chief Japan economist said, "The risk that the corporate-sector recovery peters out before wage growth starts picking up appears to be on the rise. The outlook for exports seems to be deteriorating, with the U.S. economy slowing and the yen appreciating."

The current scenario has raised apprehensions about the fundamental strength of the Japan’s economy. This decline suggests that the world's second largest economy may be suffering a slowdown in its pace of growth.

Given the state of affairs, Bank of Japan is likely to refrain from raising the interest rates in the near future. Kenichi Kawasaki of Lehman Brothers said, "The Bank of Japan’s basis for taking a forward-looking approach on raising rates early was its assumption that the economy will keep growing. But the assumption may be about to crumble."

In order to play down the worries, a government said that consumer spending and business investment reflected a slowdown in motivation for investment, primarily because of the subprime mortgage problems in the U.S.

Lehman Brothers' Shiraishi echoed this sentiment, "Overall demand for funds appears to remain weak, which is reflective of lacklustre domestic demand and subdued domestic sentiment about the outlook."