Japan's Happy SMEs?

In Japan, large companies and their SME suppliers co-exist in a symbiosis which is traditionally deeply uncomfortable for the smaller party. And so it continues.  In calendar 2013, large companies (Y1bn+ in capital) accounted for 43% of Japanese sales and, with OPM of  4.8%, took for 55% of corporate profits.  Meanwhile, small companies (Y10-100mn in capital) accounted for 38% of sales, but with OPM of 2.8%, took only 29% profits.  Because small companies form the the protean industrial substructure which support Japan's giant companies, they also are first to know when conditions change. This is why the Shoko Chukin SME business confidence index tends to be closely watched.  

In March the index jumped 2.9pts to the highest levels seen since 1989. On the face of it, this is extraordinary: in the very near future consumption taxes will rise to 8% from the current 5%, and although there has been no noticeable rush to shop before prices rise,  there is nevertheless a common worry that demand will take at least a temporary hit after prices rise.  And yet not only did the index for non-manufacturers rise 3.7pts (vs 2.2pts for manufacturers), but in addition, the biggest bounces in sentiment came precisely from retailers (up 5pts), wholesalers (up 4.5pts) and truckers (up 6pts). These are exactly the sectors which stand to be worst hit if tax rises bite into domestic demand.

At this point, the most important thing to realize is that this index is not seasonally-adjusted, and that SME confidence always jumps in March, which is the end of the fiscal year.  I do not know why the end of the fiscal year cheers SME spirits so much, but the track record is unequivocal: in the last five years, the monthly gain in March has averaged 3.8pts – rather more, actually, than was achieved this year. The chart below shows that regular March bump.  It also shows that it doesn't usually last – we can expect to see most if not all of the gain reversed in April.

Nevertheless, if March's bounce is a fiscal year-end phenomenon, it has peaked still higher than any since 1989.  And when one looks at how the various aspects of corporate experience and expectations are changing, it does seem that SMEs perceive real improvements in their operating environment, measured on a yoy basis. One particularly striking result is that SMEs now see the capacity situation as favourable (albeit by the narrowest of margins). For an economy which has routinely reported excess capacity for decades, this is rather startling. In addition, financing conditions, which have historically also always been seen as unfavourable, have nudged up to nearly neutral.  The profits situation is still seen as marginally unfavourable, but this is a far better reading that in March 2013.  Finally, SMEs are also seeing the first signs that the margin squeeze imposed by the depreciation of the yen is beginning to relax very slightly.  

Conclusion? March's reading isn't the breakthrough it seems, but nevertheless the index is grinding higher on the back of a slow improvement in business conditions:  maybe Japan's SMEs are catching some trickle-down from the gains finally being enjoyed by exporters as the J-curve impact of the yen devaluation  finally begins to emerge.