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Japan struggles to charge consumers more, Tankan shows

Investment plans still robust, but material and labor costs cloud outlook

Rising prices of raw materials such as oil are weighing heavily on companies that cannot easily pass those costs on to customers.

TOKYO -- Japanese companies are growing pessimistic as consumers refuse to shoulder rising materials and labor costs, raising questions about whether the businesses will make planned investments in technology to increase efficiency.

In the Bank of Japan's latest quarterly Tankan survey for June, an index of business sentiment at large manufacturers fell to 21 -- down 3 points from the March survey, when it also declined. This marked the first time since late 2012 that confidence has declined two quarters in a row.

Rapidly climbing costs, coupled with a lull in sales prices, appear to be the main cause. Among large manufacturers, the share of those that say input prices are rising, minus those that say prices are falling, comes to 30 percentage points, up from 26 points in March. But a similar "diffusion index" representing whether companies actually raised prices climbed only 1 point to 5.

This pinch is acute in the chemical sector, where surging oil prices have made their mark. Japan's Tokuyama forecasts its first decline in operating profit in four years for the year ending March 2019, calling rising materials costs the main factor. Increases in the price of naphtha, used in such key products as polyvinyl chloride, will deal a roughly 5 billion yen ($45 million) blow to the company's balance sheet. It is difficult to stand out on quality in such commodity-grade materials as PVC, making raising prices a challenge.

In such industries as food, a shortage of truck drivers is driving up shipping costs. "Consumers tend to shop based on affordability," and "unless you add value to products, it is difficult to pass on rising costs," a representative of food producer Kagome said. Five food companies including Kagome and seasonings maker Ajinomoto will integrate logistics operations next April, aiming to bring down costs and improve earnings.

On the retail side, food sellers face competition from drugstores, which are cutting food prices to draw in customers who would otherwise shop online. To raise prices in this environment "would only drive shoppers away," a supermarket executive said. This makes markets unwilling to accept price hikes from producers.

Nonmanufacturing companies appear to have an easier time passing on costs, primarily that of labor. The diffusion index indicating price hikes at small companies in that sector rose 3 points to 4 in June, its highest level since 1991.

Growing trade friction between the U.S. and the rest of the world is also cause for concern. American levies on steel and aluminum, together with follow-up measures, have led to upheaval in global markets. Sentiment has taken a dive in such industries as automobiles, where the U.S. has threatened additional action, suggesting that managers are bracing for a trade war.

The index of current business sentiment in the auto sector dropped 7 points to 15. Its forward-looking counterpart forecasts a 2-point decline in that measure in the next three months. Automotive tariffs the U.S. has proposed "would create anxiety for U.S. customers and employees of the auto industry," said Akio Toyoda, chairman of the Japan Automobile Manufacturers Association and president of Toyota Motor.

"There would be a negative impact on the global economy if various countries were to go on raising tariffs," said Tatsuo Yasunaga, president of trading house Mitsui & Co.

Yet while pessimism may be rising, companies' capital investment plans for fiscal 2018 remain fairly robust. Large companies across all sectors expect to spend 13.6% more on fixed investment this fiscal year than last as of the end of June, the largest anticipated jump in records going back to fiscal 1983. Manufacturers expect 17.9% investment growth, up from just 4.9% in March's survey, while nonmanufacturing companies see 11.2% growth, up from 0.8%.

This seems to include both expansions to meet brisk demand and the introduction of labor-saving technology to improve productivity and absorb rising costs. The BOJ believes that once the latter form of spending runs its course, companies will start passing additional cost increases on to customers.

Moreover, this appetite for investment suggests a key mechanism for economic growth is functioning well. While the economy "is in a temporary lull, it remains strong overall -- there is no need to worry too much," said Satoshi Osanai of the Daiwa Institute of Research.

But whether companies follow through on their investment plans depends heavily on the state of the global economy. Historically, companies' investment outlooks have been at their strongest in the June Tankan, only to decline across the latter half of the year. Rising resource costs stand to weaken the trading position of such major resource importers as Japan, while increasing U.S. interest rates threaten to disrupt emerging economies as investors flee to America.

In Japan, "the manufacturing sector's appetite for investment could shrink if U.S. trade protectionism grows stronger," said Kazuyuki Inoue, president of general contractor Shimizu. Auto tariffs, in particular, could sink business sentiment across the economy, causing investment to wither, and with it prospects for investment-driven growth.

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