Japan reports economy grew at 3.5 percent annual pace last quarter, beating expectations

TOKYO – Japan's economy enjoyed a stronger than expected recovery last quarter, growing at a 3.5 percent annual pace as the government stepped up public works spending and eased credit to encourage investment.

The data for January to March showed the world's third-largest economy grew 0.9 percent on a quarterly basis, the fastest pace in a year, compared with revised 0.3 percent growth in the final quarter of 2012, as Japan inched its way out of recession. The figures were reported by the Cabinet Office on Thursday.

Prime Minister Shinzo Abe took office in late December vowing to help the economy recover from two decades of deflationary malaise. His policies have helped push share prices to their highest levels in over five years, fueled by strong liquidity and expectations of improved profitability for listed companies.

The benchmark Nikkei 225 stock index rose to 15,139.56 early Thursday before falling back slightly on profit taking. It has gained about 75 percent since November in a rally linked to high hopes for Abe's policies, which have been dubbed "Abenomics."

A sharp decline in the value of the Japanese yen, brought on both by monetary easing and by expectations of further easing, has helped some exporters and provided a windfall in yen terms for companies repatriating overseas earnings. But it is also raising costs for many companies that depend heavily on imports of natural gas and other commodities.

Apart from share prices, Japan's manufacturing and employment showed slight improvements in March, buttressing hopes that the economy may be headed for a moderate recovery.

The central bank, which is committed to 2 percent inflation within two years, says it expects a moderate recovery by midyear but has warned that uncertainties in the domestic and global economies could foil those hopes.

Abe needs fast results as ammunition in an election for the upper house of parliament in July, a vote that will determine his Liberal Democratic Party's chances for pushing through with other policy priorities, such as revision of Japan's war-renouncing constitution.

Critics of the Abenomics strategy question whether the extra funding pumped into the economy will foster sustainable growth or just push up prices for shares and other assets.

Key to the success of the policies will be increased spending by households and corporations, partly due to expectations that prices will rise. So far, increases in spending have been attributed mainly to luxury purchases by share investors splashing out after seeing gains in their portfolios.

Analysts had generally forecast a 2.7 percent to 2.8 percent increase in GDP in January-March and slightly lower quarter-on-quarter growth.

Much of the growth in the first quarter of the year came from public demand: government spending on reconstruction from Japan's March 2011 tsunami disaster and other public works. Private demand has been fueled by a recovery in housing investment, which has picked up sharply as purchasers rush to beat expected increases in sales taxes in the coming two years.

Exports grew 3.8 percent, helped by the weaker yen and improved demand in the U.S. and other key markets.

The sales tax increase, while needed to help reduce Japan's massive public debt, will amount to a "major fiscal tightening," Capital Economics economist Julian Jessop said in a commentary before the growth figures were released.

"Overall, Abenomics surely represents the right mix of policies to tackle Japan's problems," he said. The government, however, faces a challenge in carrying out fiscal and structural reforms — such as changes in labor, education and tax policies and administrative deregulation — to help improve Japan's long-term competitiveness and adapt to its aging and shrinking population.

In the near term, if companies do not boost wages to help improve household purchasing power, inflationary policies could just discourage consumer spending, he and other economists warn.

"On these points at least, the jury is still out," he said.

Data released Wednesday showed consumer confidence fell slightly in April, though it has improved since late last year.