TOKYO Mazda Motor Corp (7261.T) has returned to profit as the falling yen has rewarded the carmaker's export-heavy strategy. Mazda's response? Move some production to Mexico.
Investing in plant abroad is hardly an endorsement for Prime Minister Shinzo Abe's strategy to revive the fortunes of the world's third largest economy, and one driven by exports.
"Companies are not that interested in expanding capacity in Japan," said Kaori Yamato, senior economist at Mizuho Research Institute. "This is a problem for exports."
With companies making less goods at home, it has become structurally difficult for exports to rise, even with the yen at multi-year lows as a result of Abe's policies, economists say.
It is not just Japan's big exporters that find it makes less sense to manufacture at home. Japan's manufacturing capacity is at a 28-year low and the number of firms planning to raise capacity has halved from before the global financial crisis, a Development Bank of Japan survey shows.
An aging and falling population makes the home market an unattractive prospect for many manufacturers, while building production capacity near overseas markets has cost advantages. It is also reduces risks posed by exchange rate volatility.
The decline of Japan's manufacturing sector has been a long term trend, whereas Abe's policies to end deflation and revive the economy, known as "Abenomics", have only been in place since his election in late 2012.
But going by manufacturers' capital investment plans, and a stubbornly weak export performance, despite the yen's 27 percent decline since late 2012, analysts say the signs are that Japan Inc has not bought into Abe's strategy.
Two years of a weak yen hasn't been enough to convince many manufacturers to rebuild capacity in Japan.
Announcing plans to sell 200,000 Demio sub-compact cars annually, Mazda's chief executive Masamichi Kogai explained that the abiding risk that the yen could rise in the long term meant Mazda cannot rely on making cars in Japan.
The redesigned Demio will be manufactured for the first time in Japan, Thailand and a new plant in Mexico.
"The Demio underscores our business model of continuing to manufacture cars at home while accelerating overseas production," Kogai told a news conference last week. "We're going to make our business foundation more resistant to currency moves."
Many executives at other firms harbor similar sentiments.
Mitsubishi Motors Corp (7211.T) announced on Tuesday that it is setting up a factory in Indonesia to make vans for Southeast Asia, while Toyota Motor Corp (7203.T) has been considering opening a plant in Mexico.
MISSING EXPORT GROWTH
Trade data set to be released on Thursday is expected to provide further evidence of the weak yen's failure to ignite export growth, with exports seen falling for the first time in two months.
"I think structural factors have played some part (in the export weakness) but they have been around for years," BOJ Governor Haruhiko Kuroda said last month.
"I therefore think the underlying weakness in exports was due more to cyclical and one-off factors," he said, referring to a slower than expected recovery in emerging markets and how a particularly severe winter hurt demand in the United States.
Some economists remain hopeful that a strengthening U.S. economy will eventually lift Japan's exports. But BOJ optimism over prospects for economic recovery has plenty of critics.
Abe was counting on the yen's decline from a record high in 2011 to boost exports and offset the blow from a sales tax hike in April this year, but the export recovery never materialized.
Now consumption and factory output are struggling after the April sales tax hike. If exports remain weak, Abe could be persuaded to delay a planned second increase in the sales tax to 10 percent from 8 percent, scheduled for October next year.
He has few policy options for boosting the economy.
The government could increase fiscal stimulus again, but it would heighten concerns about a record public debt that stands at more than twice the size of Japan's $5 trillion economy.
And there could be resistance within the BOJ to further monetary easing, as central bankers could argue it was not needed so long as annual inflation was rising toward its target of 2 percent.
If the Bank of Japan's unprecedented quantitative easing and the yen's sharp depreciation are not enough to convince companies to make more goods in Japan, analysts say there would seem little value in policymakers offering more of the same.
Japan's production capacity really started to fall after the 2011 earthquake and nuclear disaster, shrinking almost 5 percent, as damage to supply chains and a soaring yen rattled manufacturers already frustrated with the sluggish home market.
Economists say the lost production may never come back.
Real exports have risen only 1.4 percent since late 2012 despite the yen's plunge during the same time, according to Masaki Kuwahara, senior economist at Nomura Securities.
"For companies that are operating on a global scale, they have decided to adopt a strategy that does not depend on or respond to fluctuations in currencies," said Kuwahara.
Manufacturers made a record 20.6 percent of their goods at plants abroad in fiscal 2012, most recent Cabinet Office data shows. Firms expect this ratio to rise to 25.5 percent in fiscal 2018, suggesting it will become even harder for exports to grow.
Abe's government was also betting that an increase in capital expenditure, a planned corporate tax cut and special economic zones will expand the shrinking manufacturing base.
Policymakers regularly cite a survey by the state-backed Development Bank of Japan that shows manufacturers plan to increase domestic capex this fiscal year by a buoyant 18.5 percent, an about face from a 1.7 percent fall last fiscal year.
However, drilling into the survey results finds a far less encouraging story. Only 20.9 percent of firms surveyed want to expand domestic capacity, down from 42.8 percent in fiscal 2007.
And 40.0 percent of firms surveyed want to invest to merely to replace old capital stock or streamline operations, up from 26.6 percent in fiscal 2007.
This type of investment will quickly fade, and economists expect domestic production capacity to fall further.
(Additional reporting by Yoko Kubota and Leika Kihara in Tokyo and Dave Graham in Mexico City; Editing by Simon Cameron-Moore)