Analysis: Is Japan winning its war on deflation?

By Jason Szep

TOKYO, April 16 (Reuters) - Machiko Takeda has found something unusual in her local store - rising prices.

After three years of profit-crushing deflation, some prices in Japan are leveling out or even beginning to rise.

It's early days yet, and the deflation that Prime Minister Junichiro Koizumi blames for crippling the financial system and stifling corporate profits remains far from vanquished.

But as Japan pulls out of its deepest recession since World War Two, convenience stores, clothing shops and restaurants are finally feeling confident enough to stop marking prices down.

"We found the bottom of prices last autumn," said Kazuko Itakura, a spokeswoman for Ito-Yokado Co Ltd, Japan's biggest retail group, which owns 50 percent of the country's largest convenience store chain, Seven-Eleven.

For 22-year-old Takeda, a resident of Tokyo's Shibuya district, the change has translated into a 40 percent price hike for one of her favorite snacks - rice balls, or "onigiri".

For others, its clothing or fish burgers at McDonalds.

And for the retailers themselves, the change is expected to mean stronger profits for the business year that started on April 1, a factor that has driven up some stock prices in recent weeks.

"I wouldn't say that deflation is gone, but prices in the stores are stabilizing," said Toshiko Binder, an analyst who tracks Japan's retail industry for British investment bank HSBC.

Binder says a good example is clothing retailer Shimamura Co Ltd, which last week unveiled a bullish profit forecast and announced plans for new stores at home and in Taiwan.

"Every year, Shimamura would hold a conference and say 'yeah prices will go down by 10 percent'. Now this year they are saying they won't go down anymore," Binder said. "That doesn't mean they will go up by five percent. They're just levelling off."

Since mid-March, Shimamura's stock has leapt 14 percent, compared to a 1.9 percent drop in Tokyo's Nikkei average.

STILL ENTRENCHED

Economists say deflation is still entrenched in the world's second-biggest economy, even if it is easing in some sectors.

In February, as a slide in stock prices to 18-year lows threatened to ignite turmoil by choking banks on big losses on their huge shareholdings, Koizumi announced a crusade against deflation, saying it was the root of Japan's economic problems.

Falling prices discourage consumer spending - the biggest chunk of the economy at 55 percent of gross domestic product - because buyers expect prices to be cheaper in the future.

At the same time, the real cost of huge corporate debts increases, squeezing companies who are also unable to raise prices or cut wages enough to offset their rising costs.

But since Koizumi's unveiled his anti-deflation weaponry, including a crackdown on brokers who benefit from stock price falls, Japan's economy has shown signs of turning around, giving consumers more confidence and feeding into some price rises.

In March, for example, Japan's wholesale price index was unchanged from February when it rose for the first time in six months, while Tokyo core consumer prices gained 0.3 percent.

"Some preliminary congratulations may well be in order in the efforts to counter deflation," Glenn Hubbard, U.S. President George W. Bush's chief economic adviser, said in early April.

"The increase in Tokyo consumer prices in March, the first in seven months, is a positive development," he said in a speech.

NO CHAMPAGNE JUST YET

Private economists, however, say far more work needs to be done to lick it once and for all.

Hundreds of inefficient companies in the retail, real-estate and construction sectors - industries that form a powerbase in Koizumi's ruling party - need to be shuttered.

"I think prices will continue to decline, although perhaps not as quickly this year as they did last year," said Robert Feldman, chief economist Morgan Stanley.

His view was echoed by an official at Aeon Co Ltd, Japan's second-largest retail group, who said he expected deflation to continue although at a slower pace.

"For some merchandise there may be a slowdown in the speed of price falls. However, it's not a complete stop," said Kahori Miyake, an Aeon spokeswoman. "We believe that this trend in deflation will still continue some more."

But Feldman noted some encouraging signs.

In some industries, such as telecommunications and utilities, the impact of deregulation appears to be wearing off, slowing the pace of decline in the consumer price index, he said.

Also, the type of products that are seeing price increases reflect a new trend, retail industry analysts say - many companies are introducing higher prices in tandem with new, more attractive products, rather than simply jacking up the price.

Rice balls are a case in point.

Japan's second-biggest convenience store chain, Lawson Inc, recently upped its price tag on rice balls to 110-150 yen (83 cents-$1.14) from 80 yen (60 cents).

But the new balls are a different breed with more ingredients.

"This is also happening elsewhere," said Binder at HSBC.

"It's not like raising the price. They are increasing the range of the higher end products."

Still, the change does little for 22-year-old Takada, a part-time worker and art student.

"They are not such a good deal now," she said.

($1=132.03 yen)

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