Economy worsening, says Japan

Koizumi answers questions at a budget hearing Monday, as investors wait for reforms

In this story: A tough summer ahead Looking to reign in spending Mixed signals in both U.S. and Japan RELATED STORIES

By By staff and wire reports

TOKYO, Japan -- Even the Japanese government admits its economy keeps worsening. That spells tough times ahead for Prime Minister Junichiro Koizumi as he tries to push for promised reforms.

On Monday, economic and fiscal policy minister Heizo Takenaka downplayed the government's 1.7 growth forecast for this fiscal year.

"Whether we reach 1.7 percent this year does not really have much meaning," Takenaka said. Since taking office last month, Takennaka has frequently stated that the forecast is too optimistic.

On Friday the Japanese government downgraded its assessment of the economy for the fourth straight month, the worst string of downgrades since February 1998, when it completed a string of six monthly downgrades.

"The economy is increasingly weakening," the Cabinet Office said in its May report.

"Reflecting the slowdown of the U.S. economy, Japanese exports have faltered, with the result that industrial production started to fall and inventory increased."

A tough summer ahead

The situation is unlikely to improve quickly. Experts predict Koizumi will move slowly in pushing reforms as a result.

"At least for the next half a year the situation is likely to remain tough," said Tomoko Fujii, director of economic and market analysis for Nikko Salomon Smith Barney.

The new prime minister's main focus is likely to shift to Japan's Upper House elections in July. Koizumi was picked for his record public popularity, and a strong showing would bolster his support within the Liberal Democratic Party.

Japan watchers have been encouraged by the prospect of change that Koizumi represents. The benchmark Nikkei 225 index has come off the 16-year low it hit before Koizumi's unpopular predecessor, Yoshiro Mori, stepped down.

But investors have been watching for any sign that Koizumi has backed off his more-ambitious ideas since taking office. Some say it's inevitable.

"Ultimately he's likely to be forced to compromise more," James Malcolm, senior economist with J.P. Morgan. So far, though, " there hasn't been very much in the way of backing down."

Looking to reign in spending

The stock market is as nebulous as Japan's politicians about what it really wants from reform. Koizumi has been vague about his plans, some believe deliberately.

He has often pledged to cap total government spending at 30 trillion yen in the fiscal 2002 budget. But a lagging economy would mean less tax money than the government predicted when it set its target.

Members of Koizumi's own cabinet have hinted the cap may not be concrete.

On Monday, Koizumi reiterated his pledge to reign in government spending. The government needs to lead a push toward greater self-help and self-restraint, he said.

He has also promised to continue with a government-led program to encourage banks to write off non-performing loans.

How fast he can push those changes depends on the Japanese economy. Koizumi has suggested real reform will require pain and suffering from Japanese business and a rise in unemployment.

To offset the pain, a supplementary budget may be necessary later this year, some economists say. Capping government spending will be tough if the slump persists.

Mixed signals in both U.S. and Japan

Right now, though, the economic data is muddled. After an undoubtedly poor start to the year, there are some encouraging signals. And there are as many signs the economy is getting worse.

On the positive side, the outlook for machinery orders was better than expected when it came out last week. Consumer spending looks reasonably firm. On the negative, industrial production is poor, unemployment is rising and job offers are down.

Inside Japan, the focus is mainly on Koizumi's plan to cap government spending. Outside Japan, investors are keen to see him push banks to write off a vast amount of bad loans.

How far he gets with either remains to be seen.

"Mr. Koizumi remains willing to pursue structural reforms, so long as the economy permits," Fujii said. "He's not going to abandon reforms. However, realistically it's also difficult to assume very quick progress."

Reuters contributed to this report.

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