The March Tankan only showed a modest improvement in business sentiment, which stands in sharp contrast to the sharp rise in stock prices in Q1 2013. Companies revised up their profit forecast, but this was not translated into more fixed investment. The survey dampens expectations of a quick recovery of the Japanese economy.

The March Tankan survey was much weaker than expected. Large manufacturers reported improved business conditions – the division index (DI) gained 4 points – thanks to the depreciation of the yen and the gradual strengthening of the global economy. This was especially the case for the large car industry, where the DI gained 10 points. However, the situation for medium-sized and small enterprises deteriorated owing to higher import prices and the sluggishness of domestic demand. Overall, sentiment was unchanged compared with three months earlier. Manufacturers expected a modest improvement in Q2 2012.

In the non-manufacturing sector, the improvement in business conditions was more widespread in terms of size and sectors. In the construction sector, the diffusion index gained about 5 points, thanks to the fiscal stimulus and increased housing construction ahead of the VAT rate hike on 1 April 2014 from 5% to 8%. Also retailers were more upbeat, thanks to brisk consumer spending underpinned by substantial capital gains on stocks. By contrast, sentiment in the transport sector deteriorated due to rising petrol prices.

The modest improvement in business sentiment stands in sharp contrast to the sharp rise in stock prices. In Q1 2013, the Nikkei gained almost 20% on the back of anticipations of looser monetary and fiscal policies. Corporate managers are clearly not as upbeat as the financial sector.

Companies revised up their profit growth for FY2012 (ending 31 March 2013). They expect much stronger profit growth for the coming fiscal year. In particular, profit margins in the manufacturing sector are likely to improve thanks to the depreciation of the yen. The worrying aspect of the Tankan is that this has not affected capital spending. In FY 2012, fixed investment growth was revised downwards compared with the previous Tankan, in particular in the manufacturing sector, and for the coming fiscal year, enterprises expect even to reduce their capital spending. One of the reasons for the sluggishness is the persistent overcapacity, which has hardly diminished since the previous survey. In the manufacturing sector, firms also reported to be overstaffed, although slightly less than in the December Tankan.

Financial conditions remained very easy, in particular for large enterprises. These also reported that lending conditions had eased and that interest rates had come down. Business conditions in the financial sector substantially improved in Q1. That was especially the case for non-banking institutions such as hedge funds.

The March Tankan dampens expectations on a quick emergence of the Japanese economy out of deflation. In particular, it shows that that yen depreciation does not benefit all the sectors of the economy. It also cast doubt on the authorities’ strategy to revive the economy by more aggressive monetary easing as according to the survey, monetary conditions are already extremely loose. More should be done to stimulate capital investment, for example by improving the functioning of product markets.