JAPAN RETURNED to growth in the second quarter after a year of contraction, but economists warned that the recovery remained vulnerable to any faltering in export demand or tightening of the government’s fiscal stimulus scheme.

Preliminary data released yesterday showed gross domestic product (GDP) expanded a seasonally adjusted 0.9 per cent quarter on quarter between April and June, its first rise since the first quarter of 2008 and the equivalent of 3.7 per cent growth on an annualised basis.

Japan’s embattled prime minister, Taro Aso, welcomed the rebound, which comes less than two weeks before a general election that polls suggest could mark a historic defeat for his long-ruling Liberal Democratic Party (LDP).

Yet with unemployment still rising and deflationary pressures growing, Mr Aso acknowledged the world’s second-largest economy was far from a return to real health. “We are only halfway there,” he said.

While the second-quarter data means Japan has beaten the US and UK to recovery and has been expanding faster than Germany and France, it also highlighted the economy’s failure to find a domestic replacement for its worrying reliance on external demand.

Net exports offered a 1.6 percentage point boost to the GDP growth rate – half of that generated by a robust 6.3 per cent quarter-on-quarter growth in exports reported, and half from the much less cheerful 5.1 per cent fall in imports.

Growth in the second quarter was also shored up by the effects of a series of huge economic stimulus packages ordered by Mr Aso’s government, with public investment growing 8.1 per cent in the period. A Y2,000 billion (€15 billion) government cash handout in recent months will also have been a factor in rising private consumption during the quarter, although overall private demand including investment fell sharply.

Grant Lewis, head of research at Daiwa Securities, said rising unemployment and falling wages were set to put pressure on domestic demand for the foreseeable future. “The Japanese economy will therefore remain very vulnerable to any hiccups in the recovery in global demand.”

Some economists expect a slowing flow of fiscal stimulus towards the end of the year to lead to weakening growth in 2010.

But victory in this month’s election for the opposition Democratic Party (DPJ), which is far ahead of the LDP in polls, could mean new sources of spending will be kicking in by then. The DPJ is campaigning on a platform that includes generous child allowances, tax cuts and other spending, but many analysts are sceptical about its plans to fund such largesse by “eliminating” government waste and reining in construction spending.

Despite last quarter’s relatively rapid growth, economic activity will remain far below pre-slump levels for some time, suppressing corporate profits. – Copyright The Financial Times Limited 2009