The world's second-largest economy slipped into its first recession in seven years by shrinking in the second and third quarters, buffeted by a global financial crisis that has hit Japan's biggest export markets.

The Bank of Japan expects the economy to grow 0.1 per cent in the fiscal year that ends in March 2009, followed by a 0.6 per cent expansion in the next fiscal year.

Mr Yosano appeared to suggest such a forecast, made two weeks ago, was too optimistic.

'I can hardly be confident that (next fiscal year's growth rate) will be positive,' he told a news conference on Tuesday.

'The reality is that when we look at all the external and domestic factors affecting the economy, it's hard to find anything that would contribute positively to growth.'

The euro zone is also in recession and the US economy shrank in the third quarter. Japan's recession is all the more worrying because the country escaped the worst of the global financial crisis triggered by US mortgage defaults until Oct.

The 0.1 per cent contraction in July-Sept gross domestic product barely captured the impact of the financial fire-storm that began on Wall Street in mid-Sept, triggering a stock market crash in Tokyo and a yen rally that may hit exporters even harder.

'The Oct-Dec quarter and the following one will be the most crucial stage for the Japanese economy in the current downturn,' said Mr Kyohei Morita, chief economist at Barclays Capital Japan.

'If Japan takes a really severe hit, consumer spending could start to fall and that would in turn put the country's economy back in deflation.'

Japan suffered a decade of deflation until 2005 after a stock and real estate price bubble burst in the 1990s.

Mr Yosano's bleak assessment suggests the government may predict an economic contraction for the next fiscal year when it issues its annual forecast in Dec. The report, used to draft the budget, has never contained a forecast for a contraction since it was first published in 1955.

Some analysts say the Bank of Japan may revise down its economic forecast when it reviews its twice-yearly outlook report early next year.

Several economists expect Japan's slump to last well into next year.

'Exports have fallen pretty far, so the focus next year would be on domestic problems, such as whether capital spending will fall further,' said Mr Takeshi Minami, chief economist at Norinchukin Research Institute.

Mr Minami said the economy was unlikely to return to steady positive growth until the third quarter of next year.

JPMorgan Securities expects economic growth to remain negative until the second quarter of next year, before picking up in the third quarter.

A long contraction would hit tax revenues and derail plans to rein in government debt, which at nearly 150 per cent of gross domestic product is already the biggest burden on any developed country.

Tax revenues for this fiscal year could fall as much as 7 trillion yen (S$110.6 billion) short of the initial forecast due as corporate profits slide, the Nikkei business daily reported last week.

As a result, new debt issuance for this year is likely to exceed the government target of 30 trillion yen, the paper said.

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