(Updates with Moody’s, official comments, market reaction)
* Industrial output up in April, bigger gains in May-June seen
* Moody’s puts Japan on downgrade watch
* Moody’s cites faltering growth prospects, weak policy action
* PM Kan refuses to quit in face of no-confidence vote
* Policy drift feared as result of political stand-off
By Stanley White and Linda Sieg
TOKYO, May 31 (Reuters) - Japan’s economy offered more signs of recovery from the deadly March earthquake on Tuesday, but Moody’s ratings agency warned both growth and government action may fall short of what is necessary to bring Tokyo’s ballooning debt back under control.
Industrial output rose 1 percent last month after a record plunge immediately after the magnitude 9.0 quake and a tsunami it set off, and companies said they planned to crank up output further in May-June, bringing it close to pre-disaster levels.
The upbeat outlook spurred talk that the world’s third-largest economy could be poised for a V-shaped recovery after the disaster knocked Japan back into its second recession in three years and a third downturn in a decade. [ID:nL3E7GU0JC]
Tokyo stocks rose 2 percent , buoyed by the forecasts, which were backed by a manufacturing survey showing a turnaround in May. The yen dipped after the Moody’s warning provided shares of exporters some extra support, while government bond yields inched up.
However, manufacturers’ optimism failed to impress Moody’s which on Tuesday put Japan’s sovereign debt on a watch for a possible downgrade. It cited huge costs of dealing with the quake’s aftermath and concerns that the government’s response to economic challenges may prove inadequate. [ID:nL3E7GV112]
“The much larger than initially expected economic and fiscal costs of the March 11 earthquake are magnifying the adverse effects imparted by the global financial crisis from which Japan’s economy has not completely recovered,” Moody’s said.
The rating agency cut Japan’s outlook to negative in February and moved one step closer to a possible downgrade by putting its Aa2 rating on review.
Japan has been mired in economic stagnation for much of the past two decades and its repeated efforts to jolt the economy back to life with stimulus spending propelled public debt to twice the size of its $5 trillion economy.
Moody’s voiced doubts the Japanese economy could grow fast enough to bring down fiscal deficits and warned political infighting could scupper tax and social security reforms needed to stabilise public finances.
Prime Minister Naoto Kan, who has been sharply criticized for his handling of the crisis at the crippled Fukushima nuclear plant, faces a no-confidence vote and a deepening rift in his own party and analysts are more pessimistic than ever that any substantial reforms were possible.
“The government intends to introduce a comprehensive tax reform program in June. However, Japan’s divided Diet...and the intensifying level of political challenges to Prime Minister Kan together continue to threaten to bog down such efforts,” Moody’s said.
Although Tokyo faced no immediate risk that borrowing costs would spike up, the buildup of debt could not go on forever and at some point would reach a tipping point where markets would start demanding much higher premiums for lending to Japan, Moody’s said.
Kan told parliament he would stay on to resolve the worst nuclear crisis in 25 years and most political commentators think he will survive the vote.
But he needs opposition votes to pass spending bills and other legislation in a divided parliament and the looming face-off bodes ill for any form of cooperation between the ruling party and the opposition. [ID:nL3E7GV0BU]
Economics Minister Kaoru Yosano said he was not happy about Moody’s move, but that the government had no choice but act to preserve fiscal discipline. [ID:nT9E7GC01O]
Kan was having trouble forging consensus around his reform plans even before the disaster struck, wiping out whole communities in Japan’s northeast, leaving around 24,000 dead or presumed dead. The quake exacerbated his problems, forcing the government to juggle aid to quake-hit areas, controlling the nuclear crisis, securing funds for reconstruction and drafting tax reforms.
The Bank of Japan eased monetary policy just days after the disaster, but it has stood pat on policy since then on the view that the economy will resume a moderate recovery before the end of the year, helped in part by spending on reconstruction.
It has signalled, however, that it stands ready to loosen policy further if the damage from the quake proves bigger than expected.
Recent data and news from manufacturers such as carmakers Nissan Motor Co and Honda showed companies were making progress in restoring supply networks torn apart by the disaster and managing their energy needs in the face of possible electricity shortages.
Economists, however, pointed to still subdued consumer demand as reason for caution about the economy’s longer-term prospects.
Underscoring lingering weakness in consumption, household spending fell 3.0 percent in April from a year earlier, after a record 8.5 percent annual drop seen the previous month, while wage earnings fell 1.4 percent in the year to April 1.4, the sharpest decline since 2009. (Additional reporting by Rie Ishiguro and Yoko Nishikawa; Writing by Tomasz Janowski; Editing by Vidya Ranganathan & Kim Coghill)