Bank of Japan warns of recession

Mr Koizumi is under pressure to accelerate reforms

The Bank of Japan has acknowledged the world's second largest economy will shrink this year by cutting a growth forecast for 2001 that many economists have long viewed as unrealistic.

The recession forecast coincided with the release of industrial production data showing a worse-than-expected slump of 2.9% in September.

And the Bank attracted fresh criticism for leaving monetary policy unchanged.

Meanwhile, finance minister Masajuro Shiokawa warned of the urgency of sticking to austerity targets for government borrowing.

'Risk to government'

If Japanese government bond (JGB) issues continue at the present pace they could spark chaos in international financial markets and bring down the government, he said.

"We should not depend on easy issuance of government bonds to finance this supplementary budget," he said, stressing that a planned 2 trillion yen of extra spending on job training and IT firms this year must not breach a ceiling on borrowing.

The Bank of Japan forecast the economy would contract by between 0.9% and 1.2% in the fiscal year to March 2001.

'Discipline is crucial'

This reverses a prediction of growth of up to 0.8% growth made in May.

"Greater uncertainty than usual exists," the Bank said in its twice-yearly report.

It highlighted economic pain "stemming from the terrorist attacks in the United States" - but also "the content and pacing" of Japan's economic reforms.

The poor economic news comes as Japan enacted a controversial bill to allow its military to go abroad to back up US-led strikes in Afghanistan, posing a further strain on the budget.

It called on reforming Prime Minister Junichiro Koizumi to step up the pace and tackle the huge government debt because "market confidence in fiscal discipline is crucial".

A further sign of Japan's economic problems came as the bank toughened its deflation forecast, saying consumer prices will fall by up to 1.1% in the year to March 2002, compared with a maximum of 0.8% expected previously.

Zero interest rates

But economists expressed suprise that the bank failed to tighten its relaxed interest rate policy, keeping a key lending rate at 0.1%, the level set at its 18 September meeting.

Coupled with other monetary measures, this is effectively a zero interest rate policy. The bank hopes that this will support the cash flow to commercial banks.

"They lowered their [growth] forecasts, but they're not doing anything about it," said Yashushi Okada of CS First Boston Securities.

The finance minister weighed in to the row, saying "There are companies that are borrowing from banks that haven't paid any dividends to shareholders for some years, who debts have been forgiven, but are still unable to recover. Banks should be able to foreclose on such firms", he said.

Mr Shiokawa complained that "this is not really my territory, it's not an area where I'm allowed to comment".