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Japan Downgrades Its Assessment of the Economy

Amid worrying signals that Japan's recovery is in danger, the government has downgraded its economic assessment for the first time in a year. There is a strong belief that Japan's near-term economic fate depends on what happens in the next few months in the United States and China.

After years of stagnation, the Japanese economy has recorded six straight quarters of growth. But there is increasing evidence that even modest growth over the next few quarters could be tough for the world's second largest economy.

The yen has surged to its highest level against the dollar in nearly five years - making exports more expensive in world markets.

Gross domestic product growth was nearly flat from July through September. Industrial production dropped 1.6 percent in October from September, surprising economists who had predicted a rise. Another concern - unemployment crept up a tenth of a percent in October to 4.7 percent.

Economy Minister Heizo Takenaka says the government is carefully watching whether expectations of a continuing modest recovery can still be met. Mr. Takenaka, trying to put the best spin on the recent data, says the economy is "moving sideways within a mild uptrend," but he does acknowledge there are weaknesses.

One of those weaknesses is sluggish exports - which contributes to the drop in industrial production. Economists say shipments to China and the United States, especially of high-technology items, have leveled off in recent months.

Mamoru Yamazaki is the chief economist in Japan for Barclays Capital. He says that if Chinese factories and consumers cut purchases of Japanese goods, then the economy could suffer.

"Industrial production and corporate profit still depend on both U.S. and Chinese demand," he said. "That's a major reason for such a relationship between the expectation for the global economy, in particular U.S. and China, and the Japanese domestic economy."

Despite the export slowdown, the Finance Ministry and the Bank of Japan have remained relatively optimistic about the resilience of the recovery. Housing starts and domestic demand are both up.

Barclay's Mr. Yamazaki says there are also signs business investment is rising - and the most recent government data shows that corporate capital expenditure rose more than 14 percent from July through September.

"I'm also not pessimistic about the future course of the economy because the background of the economic expansion has not changed significantly," Mr. Yamazaki added. "Corporate profit is expanding sharply. That means corporations can increase private capital investment."

But a specter on the horizon is the rising yen, which has been trading near five-year highs. There are some Japanese companies that theoretically benefit from the rising yen - such as importers and airlines. The president of All Nippon Airways, Yoji Ohashi, agrees a stronger yen helps offset soaring fuel prices and the costs of purchasing foreign aircraft, and might prompt more Japanese tourists to venture overseas in search of bargains. But he says the disadvantages eventually will outweigh the benefits.

The airline president says if the yen rises more or persists at its present level then it will damage Japanese corporations. And because Japanese businessmen are primary customers for his airline then it will also suffer from the high yen.

The past six quarters of growth had given hope that Japan had finally clawed its way out of more than a decade of stagnation and recession. Many international economists and businesses have been counting on continued Japanese growth to help shore up world trade and add strength to the global economy.

Japan's governing coalition is beginning to think about what can be done if the economic slowdown persists, such as additional government spending.