Japan’s Economy Worsens

Japan’s gloom deepened today as the government reported that the economy contracted at a 3.2% annualized rate in the second quarter, the worst performance in this troubled country since late 1999.

The announcement of a negative 0.8% growth for the April-through-June quarter, combined with recent headlines of a record 5% unemployment level, a 17-year stock market low and weakness in virtually every sector of the economy, heaps more pressure on already beleaguered economic planners.

The contraction also raises the risks for the global economy, with the United States and Europe both mired in sharp slowdowns.

It also makes the political tenure of reform-minded Prime Minister Junichiro Koizumi more vulnerable in a nation in which voter loyalty is notoriously fickle. The deteriorating economy emboldens political opponents who fear Koizumi’s calls to end highways to nowhere and other wasteful public works projects.

“Basically, the numbers show there’s nothing supporting the economy,” said Masaki Kanno, economist with J.P. Morgan Securities Asia Ltd. “If anti-reform people find Koizumi’s public appeal declining, Koizumi’s political life will be at risk.”

One minor saving grace for the administration is that most analysts expected the second-quarter gross domestic product number, the sum total of goods and services produced by the nation, to be even worse. Some predicted a contraction as great as 1.2% compared with the first quarter. “This could give Koizumi a little bit more room,” said Ron Bevacqua, an economist with Commerz Securities Asia.

Personal spending, which accounts for nearly two-thirds of GDP, grew by a relatively anemic 0.5% as Japanese citizens kept a tight grip on their wallets. The quarter saw reduced spending on TV sets, washing machines, refrigerators and other household appliances following a rush to stores in March in advance of a new, more costly appliance recycling law.

Also undercutting their spending was the weather. The summer was cooler than expected, capping spending on air conditioners, fans and beverages. And the parade of bad news in recent weeks has depressed confidence.

“The most worrying news for most ordinary people are the rising unemployment levels since it’s closest to their daily lives,” said Ayako Mitsui, an economist with UBS Warburg.

Eichi Maekawa, a 30-year-old mobile telephone salesman, needs a new car but said it’s a pipe dream as he tries to scrape by on his salary. No one is buying cell phones these days, undercutting his commission and forcing him to limit out-of-pocket spending to $8 a day, barely enough for lunch and a can of soda.

“I’ve been looking for a new job, but it’s very difficult to find anything,” he said. “And I just got married and we’re expecting a baby, so I’m trying to save even though my salary won’t let me.”

The current numbers come after years of spotty performance. International trade and spending by companies, two other major contributors to GDP, proved to be a drag on the economy at negative 0.1% and negative 2.8% in the quarter, respectively.

“These were the two factors towing the Japanese economy last year,” said Shinichiro Kawasaki, chief researcher at Daiichi Life Research Institute, affiliated with a life insurer. “And they’re both out of breath.”

Exports were hard hit as U.S. and European consumers tuck away their charge cards and other Asian countries stop ordering components. And many Japanese companies have stopped or slowed investment in factory modernization.

The outlook among smaller companies is even bleaker. “Many noodle shops in my neighborhood have gone bankrupt,” said Kikuko Kawasaki, a 49-year-old office worker living in western Tokyo’s Shinjuku area. “People aren’t even spending $4 on ramen anymore. Things are really tough.”

Even government investment was extremely weak at negative 4.1% for the quarter, far worse than expected. This suggests public works spending enacted late last year has contributed little to overall growth. It also undermines hopes that future stimulus packages will help at a time when government coffers are depleted. Japan is already the most indebted nation in the industrialized world. “We really can’t expect much in the way of stimulus,” said Taro Saito, a researcher at NLI Research Institute.

Economists see only one ray of hope for the Japanese economy in the near term: the possibility of a faster-than-expected turnaround in the United States. This has become something of a “Waiting for Godot” mantra in Japan and other Asian nations.

“If that continues to be delayed, it will be very negative for Japan,” said James Malcolm, an economist with J.P. Morgan Securities. “There’s very little else on the horizon I can pin much hope on.”

Furthermore, although the Japanese economy is in no great shakes now, several dangers could worsen the economic outlook in coming months. One of the biggest icebergs ahead is the prospect of another banking crisis, with its potential to undermine consumer and business confidence.

Bad loans are mounting, and bank profits are disappearing. So far the government has failed to act decisively in tackling this growing problem, insisting that the debt levels are manageable. Given near-zero interest rates, it’s difficult to engineer rates to help out the banks.

This increases the chances that Japan will have to inject more taxpayer money into the financial system. Future instability in this area, along with an expected rise in unemployment, could further undermine business and consumer confidence.

All the while, Japan’s political outlook is getting more dicey. There has been a growing chorus of calls for Prime Minister Koizumi to abandon his reform plan and revert to the old policies of stimulus spending until the economy recovers.

This leaves Koizumi a bit cornered. If he doesn’t open the government spending taps, the economy could sink further. If he backtracks on his campaign pledge to resist old-style special interest spending, he risks losing public trust--essentially his best weapon against his many political opponents. Some are even predicting a repeat of 1998, when then-Prime Minister Ryutaro Hashimoto stuck to his tight purse strings pledge in the face of a recession and was forced to resign.

“Politicians and bureaucrats sense blood,” J.P. Morgan’s Malcolm said. “Everyone has the sense that Koizumi is close to making all the mistakes [former Prime Minister Ryutaro] Hashimoto made.”

The benchmark Nikkei-225 stock index was off 1.7% to 10,467.98 in afternoon trading today.

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Hisako Ueno in The Times’ Tokyo Bureau contributed to this report.