GDP shows Japan likely in recession

By CNN's Alex Frew McMillan and wire reports

TOKYO, Japan -- Japan is likely in recession, after its economy went backwards in the most recent quarter.

The stagnation poses a serious problem for Prime Minister Junichiro Koizumi. He could stifle Japan entirely, economists say, if he pushes ahead with his vaunted reform plans too quickly.

Koizumi's key platforms -- trimming the budget and banking reform - are likely very positive in the long run. But they'll hurt when they happen.

"If you do both of those at the same time in an economy that is already contracting, you do run a serious risk of pushing the economy over the edge," said Jeffrey Young, economist with Nikko Salomon Smith Barney.

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Japan's stock market ended 1.5 percent lower Monday at 13,226.48, a loss of 203.74 points.

GDP disappoints, dips 0.2 percent

The Cabinet Office on Monday reported Japan's gross domestic product (GDP) dipped 0.2 percent for the March quarter, compared with the previous quarter. Economists had expected a 0.2 percent gain.

"It seems everything has weakened slightly. I'm a bit worried," Finance Minister Masajuro Shiokawa said.

The bad quarter meant Japan missed a government forecast of 1.2 percent growth for the fiscal year, instead coming in at 0.9 percent.

Japan's economy will almost certainly miss the government forecast for the current fiscal year of 1.7 percent. Most experts are cutting projections, which were already well below that.

"I think the real question is whether growth in 2001 is positive or negative," said Richard Jerram, chief economist with ING Barings in Tokyo. "And the way things are going, it's looking increasingly likely there's going to be a negative number."

Western recession not good yardstick

Japan's dismal GDP showed business investment was the biggest detractor, down due to a slump in exports to key markets such as the United States and Asia. Consumer spending also stalled and prices fell.

Using the Western definition, Japan will technically enter recession if it posts a second quarter of negative growth. It only emerged from a year-long recession in April 1999.

But experts say GDP is too unreliable and erratic an indicator. Other indictors show that Japan is already in recession, according to Yasushi Okada, chief economist at Credit Suisse First Boston.

"To apply the Western standard of recession is not appropriate in Japan," Okada said, adding that Japan entered a severe slowdown after the dotcom bubble burst in the United States.

The government's diffusion index, the broadest measure of business activity, has shown recession-level readings. Technology, the only bright spot on Japan's radar, has already collapsed.

"The recession is here," agreed Jesper Koll, chief economist at Merrill Lynch.

Koizumi at a crossroads

That leaves Koizumi caught at a crossroads. Normally the government would respond to a weakening economy with a supplementary budget and tax cuts.

But Koizumi has promised to curb government spending and trim the deficit. He promises to tackle Japan's biggest issue, a vast amount of bad loans sitting on its banks' books, over the next three fiscal years.

Economists worry he may be underestimating the stagnation in Japan, pushing ahead too quickly when Japan needs bolstering. Over the weekend, Koizumi again said his reforms would require Japan to "bear pain."

Okada said Koizumi has been sending out mixed signals. Reforms require a certain amount of creative destruction, he noted.

The Japanese public is very opposed to using public funds to prop up its banks. Koizumi has gone along with that. But risking bank failures when unemployment and bankruptcies are rising could damage the public's confidence.

"If they have to lose their job and also face severe uncertainty of their asset value, then the combination of the two would be very negative for consumer sentiment," Okada said. "We would see a very severe spiral, a vicious spiral. So I'm very concerned about this possibility."

Japan watchers fear a repeat of 1997, when then-Prime Minister Ryutaro Hashimoto's Big Bang reforms came too quickly and precipitated a disastrous economic slump.

Jerram said there is a difference between propping up the worst-off banks and making Japan's problems greater.

"It's really rather worrying that six weeks into the job, he still hasn't figured out the difference," Jerram said. "It does suggest there's quite a nasty policy mistake coming our way and quite a nasty recession."

Reuters contributed to this report.