There will be no growth without reform

Heizo Takenaka Economy Minister

"Although a slowdown was expected, the deceleration has been surprisingly rapid," the OECD warns.

It is forecasting negative growth for Japan of -0.75% this year and -1% next year, and says the best Japan can expect in 2003 would be an anaemic 0.75% increase in GDP.

And if "Immediate prospects do not look bright," future "risks are weighted to the downside," the report adds.

Japan's Economic Growth

2001: -0.75% 2002: -1% 2003: 0.75% Source: OECD

It says the slowdown is "symptomatic of the failure to adequate address structural problems in the past."

"After a decade of lost opportunities, it is now urgent for Japan to move ahead with fundamentally reforming its economic structure," the OECD adds.

"What is needed now is for the government to rapidly redress these weaknesses, even at the cost of temporary negative growth," it adds.

After a decade of lost opportunities, it is now urgent for Japan to move ahead with fundamentally reforming its economic structure

OECD

The most urgent problem is the disposal of bad loans which are weighing down the banking sector, and the OECD warns that there are further risks if banks are forced to report heavy capital losses on their stock market holdings due to falls in the Nikkei stock index.

Japan's heavy government debt burden - the largest among OECD members - is also criticised, and the report says that Japan will have to run a budget surplus of 4% of GDP just to stabilise the situation.

Credit fears

But credit agencies fear that Japan's politicians have little appetite for reducing that debt.

Moody's has become the latest rating agency to downgrade Japan's government bonds. Moody's said there was little hope of a quick turnaround in Japan's fortunes whatever the policies adopted by the government.

"Neither current macroeconomic policies nor new reform initiatives offer much tangible hope for an early turnaround in economic performance," the US-based agency said.

It has downgraded Japan's domestic government bonds, but left international bonds unchanged.

Japan government debt amounts to 130% of GDP, compared to 30% in the UK, and Moody's said that "fiscal strains were likely to persist owing to the country's ongoing economic weakness and the elusiveness of effective policy measures."

Foreign investment falling

Foreign direct investment in Japan fell by 18.7% in the first half of the year, as investors fled from the troubled financial sector.

Total investment was $12.3bn, but investment in financial sector firms dropped by 40%, with only investment in the telecoms sector holding up.

Meanwhile, the government admitted that Japan would officially fall into recession when the latest figures for GDP are released on Friday.

A Cabinet report said that Japan would only grow by around 1% a year at best until economic reforms are completed.

It's a recession

Last month, the Japanese government said it is expecting the economy to shrink 0.9% for the fiscal year ending in March, rather than the initial target of 1.7% growth.

Japan's economy was caught up in a "negative cycle" that is preventing growth and both consumers and companies are searching for hope for the future, the report said.

The report defended the policies of Prime Minister Junichiro Koizumi, who has promised to clean up the bad debts in the banking sector and rein in public spending.

"There will be no growth without reform," said Heizo Takenaka, the economy minister.

But it is clear that the cost of reform will be a further prolonged slowdown in the Japanese economy, already suffering from a ten-year slump.