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Why Are Japan's Manufacturers So Bearish?

Olivier Cirendini | Lonely Planet Images | Getty Images

The results of a closely watched business confidence survey in Japan showed that despite a surge in stock prices and a steep fall in the yen, Japanese manufacturers are still largely in a pessimistic mood.

The Tankan survey, Bank of Japan's (BOJ) key economic indicator, came in at minus 8 for the January to March quarter instead of the anticipated minus 7 level. Though the reading was the best in three quarters it was still in negative territory showing that there are more pessimists than optimists among the manufacturers surveyed.

This contrasts with a 34 percent rally in the Nikkei 225 since November when Shinzo Abe, Japan's new prime minister, started pushing for aggressive monetary policy and economic stimulus to end deflation and spur growth.

(Read More: Japan Corporate Sentiment Improves: BOJ Tankan)

"The biggest problem [with the tankan] is the mismatch between the party we've seen in financial markets and what industry leaders actually think. Conditions on the ground are not holding up with market sentiment," said Martin Schulz, senior economist at Fujitsu Research Institute.

"Business leaders remain very careful. They are still preparing for the worst," added Schulz.

Although survey participants forecast an improvement in conditions over the next three months with the index expected to touch minus 1, they remained cautious about capital spending cutting it by 2 percent for the financial year ending March 31 2014.

Furthermore, the participants were not expecting the yen to depreciate any more against the U.S. dollar. They expect the yen to touch 85 to a dollar by the end of the fiscal year, a near 10 percent appreciation from current levels.

(Read More: Ssshh! Why Japan Is Keeping Quiet on the Yen)

Since Abe came to power, policy leaders have succeeded in talking down the yen, which has depreciated near 20 percent from November to mid-March, providing a boost for Japanese companies.

"The result seemed disappointing because it was compared with strong expectations," said Long Hanhua Wang, Japan economist at the Royal Bank of Scotland.

"It shows there are still negative factors for Japanese businesses, such as rise in energy costs. Corporates have had to adapt their assessments to allow for an increase in input prices, which have not been helped by a weaker yen," he said.

All eyes are now on the next BOJ meeting scheduled to start on Wednesday, where new governor Haruhiko Kuroda's first move will be evaluated, with many anticipating bold action through large asset purchases, giving weight to Abe's pledge to turnaround the flagging economy.

(Read More: Japan Just Might Be Set to Open a New Chapter)

Although most analysts agree that the result of the Tankan will not influence Kuroda's policy decision this week, they do say the outcome of the BOJ meeting could substantially turnaround sentiment for these more bearish firms.

"Kuroda needs to push further with easing or expectations might even collapse. Business leaders also need to see the BOJ pushing the government on structural reform, opening up the economy and liberalizing important sectors such as energy, retail, and health care," said Schulz.

The Nikkei 225 sold off over 2 percent to end Monday at 12,135 in reaction to the business sentiment survey.

Contact Asia Economy

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