Asia Economy

Hope for Abe's 'virtuous cycle' as Japan spends on technology

Japanese Prime Minister Shinzo Abe
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Japanese manufacturers, flush with cash but loath to spend it at home since the global financial crisis, are finally shedding their deflationary mindset and splashing out on the new plant and equipment crucial to sustaining a nascent economic recovery.

Creating a "virtuous cycle" of expansion that boosts wages and in turn lifts consumer spending is central to Prime Minister Shinzo Abe's strategy to unshackle the Japanese economy after two decades of stagnation.

A year-and-a-half after the launch of "Abenomics" - a mix of fiscal and monetary stimulus and structural reforms - economic data, which tends to lag actual spending, has in recent months begun to show a broad-based pick-up in capital expenditure.

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Anecdotal evidence from smaller firms in the industrial heartland suggests the upturn is continuing to spread beyond the prosperous automotive sector that led the pack, as companies gain confidence in the economy and vie to develop and deploy cutting-edge technologies at their domestic factories.

"Until now, we just couldn't take the plunge," said Takashi Nanki, director and general manager at Shima Seiki, whose knitting machines make sweaters and knitwear for the likes of Gucci, Prada and Benetton.

The company, located south of Osaka, is doubling its domestic capital expenditure for the financial year to March to 2.7 billion yen ($26.6 million), while boosting production capacity by 10 percent.

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Shima Seiki, which barely eked out an operating profit in the latest financial year after a 500 million yen loss the year before, was encouraged by the brighter outlook for its export business, Nanki said, as Abe's reflationary policies reversed years of yen strength.

Cash piles

Capital spending in Japan has been anemic for years, a result of deep-rooted pessimism that deflation - which encourages firms to put off expenditure for as long as possible - would persist and the economy would remain in the doldrums.

As a result, corporate Japan sits on a cash pile of some 232 trillion yen ($2.27 trillion), according to Bank of Japan data.

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"Japanese firms have long been sitting on ample cash reserves but they were cautious about boosting investment due to uncertainty over the economic outlook," said Taro Saito, director of economic research at NLI Research Institute.

"Companies have grown confident about the outlook since last year as the economy showed clearer signs of recovery."

Japanese manufacturers boosted overall domestic capital spending 6.8 percent in the first three months of this year, finance ministry data shows, the first rise of more than 1 percent in nearly two years and joining a pick-up since early last year in the service sector.

The automotive sector took an early lead, with double-digit spending increases in three of the four quarters through March, but other mainstay sectors such as electronics and office and industrial equipment have only just started to pick up.

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The Bank of Japan's tankan survey released last week showed that large firms plan to raise capital expenditure 7.4 percent in the fiscal year to March 2015, more than initially expected.

Machinery orders data, a volatile leading indicator for capital spending six to nine months ahead, is expected to have risen modestly in May data due for release on Thursday after sliding in April.

Part of that rebound can be explained by years of restraint that left Japanese manufacturers with ageing facilities.

But the economic recovery is also finally taking up much of the slack left in the wake of the global financial crisis.

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Government estimates now indicate that the output gap, which measures spare capacity in the economy, shrank in the first quarter to its narrowest since 2008.

"The narrowing output gap could mean that companies need to either refurbish production facilities or make fresh investments, which is supportive of capital spending," Saito said.

Virtuous cycle

Investment in new technology is particularly useful in creating Abe's virtuous cycle, because it has more growth-spurring potential than the one-hit boost that comes from spending that simply replaces existing capacity like-for-like.

There are signs that is starting to happen, with the auto sector again in the driving seat.

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Aisin Seiki, a supplier to the Toyota Motor group and the world's biggest maker of automatic transmissions, is boosting its domestic capital spending by 11 percent this year to 113.5 billion yen.

Some of that will go towards a 10 billion yen plant to be completed next April that will make next-generation automatic transmissions, as the industry competes to boost fuel efficiency. The plant will develop technology that the group hopes to introduce across its global production network.

"The Okazaki East plant will be our foothold for taking this overseas," Aisin Executive Vice President Makoto Mitsuya said at the company's latest earnings briefing in April.

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Denso Corp, the world's second-largest auto parts maker, is also raising domestic capital expenditure to its highest since the financial crisis after focusing on operations abroad, in part to bolster output in Japan of fuel-injection parts for diesel engines.

Back in the Osaka area, the heart of Japan's struggling electronics sector, Sumitomo Electric Industries is boosting capital spending by 5 percent to 74.9 billion in the year to next March, its first increase in three years.

A major project is to increase output capacity for undersea power cables, a high-tech business where it anticipates rising demand from offshore windfarms. The company has received a piece of a 400 million euro ($540 million) order from Italy's Terna SpA for a high-voltage cable linking Italy with hydropower output in Montenegro.

But economists warn that, without a corresponding pick-up in domestic consumption or exports, the improvement in capital spending is unlikely to be sustained.

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Across town, cash-strapped display maker Sharp Corp is not anticipating the kind of big-ticket, multibillion dollar spending on new factories that used to power Japan's once-mighty electronics sector.

"If you're talking about large-scale investments around 300 to 400 billion yen, we definitely won't do it," Sharp President Kozo Takahashi told a roundtable for reporters last week.