Sentiment and spending worse in Japan

Koizumi, here debating in parliament, has popular opinion on his side but keeps seeing business sentiment drop

By CNN's Alex Frew McMillan and wire reports

TOKYO, Japan -- Corporate spending and business confidence have both taken a bashing in Japan, the Finance Ministry showed on Thursday.

The gloomy picture has encouraged several economists to slash their view of Japan's growth prospects this year.

It also reinforces the stiff challenge ahead of new Prime Minister Junichiro Koizumi, as he tries to turn talk of reform into substantive change.

"It's a little bit early to say anything has failed," said Keith Henry, a political analyst with the Massachusetts Institute of Technology in Tokyo. "We have a long hot summer before you have a sense of what's going to pop up in terms of policy."

The bloom on the rose is just blossoming, not off. But the initial "Koizumi effect" has fizzled in Japan's markets. Business sentiment continues to decay.

Henry gives Koizumi a year to produce results before his public popularity turns, too.

Sentiment bad for first time in almost two years

Thursday's business sentiment index showed it had soured significantly. For the first time in almost two years, more of Japan's large companies expect business to get worse than expect it to get better.

The index subtracts the percentage of firms expecting things to deteriorate from those who expect thing to improve. For the quarter through June, it stood at minus 12.1, the first negative number in seven quarters.

In a separate Finance Ministry survey, Japanese companies upped their spending on plants and equipment by 2.5 percent in the quarter through March.

The slight increase showed a marked drop from the previous quarter, when business spending rose 7.1 percent.

"The business environment has deteriorated significantly," said James Malcolm, senior economist with J.P. Morgan. "The business sector is where things are the worst at the moment, particularly in the manufacturing sector."

The investment bank dropped its forecast for Monday's release of first-quarter gross domestic product to 2.3 percent from 3 percent, on an annualized basis. Several other banks followed suit.

Some good news

There was some good news Thursday, as machinery orders for April were surprisingly strong. That could mean business spending picks up later in the year.

But those month-to-month statistics are volatile. With corporate earnings down, Japan watchers are gasping for signs of encouragement.

Koizumi's popularity remains near record levels. The unconventional leader has cut quite a swath, cultivating an image as an outsider pushing change on Japan's rigid political scene.

That and some unconventional cabinet appointments have caught the public's imagination.

"He's taking a populist approach," Henry said.

Turning popularity into results

But the people backing him don't read the economic reports. Koizumi's challenge is to push a political victory into real policy changes and, ultimately, business revival.

The public confidence he instills may keep consumer spending high, economists say. But the persistent decline in Japan's economy, which some believe is in recession, will eventually take a toll on his image.

It also makes it very hard for Koizumi to come through on promises to clean up a massive bad loan problem with Japan's banks. He has also pledged to cap government spending and reduce the deficit.

"The weaker the economy is, it makes it more difficult to push ahead with reforms," Malcolm noted. "Clearing up the bad loan problem and reducing the deficit are deflationary."

Experts commend the reforms in the long term but say they will mean short-term pain, like bankruptcies and unemployment.

And those are never popular, whoever's in charge.