Japan's economy shrinks 2.3 percent in 4Q

TOKYO — Japan's economy shrank 2.3 percent in the fourth quarter as manufacturers were battered by the strong yen, weak export demand amid the European debt crisis and flooding in Thailand.

A drop in public investment during the quarter, due largely to political bickering delaying parliamentary approval for a 12 trillion yen ($156 billion) extra budget for tsunami reconstruction, also contributed to the year-on-year decline reported Monday.

The world's No. 3 economy should get a boost once that rebuilding money kicks in, but the outlook for the country's vital exporters remains unclear, said Masayuki Kichikawa, chief Japan economist at Bank of America Merrill Lynch.

"This should be viewed as temporary setback," Kichikawa said. "To what extent will the European crisis continue to affect overseas demand — that is the big question."

Japan's major manufacturers, such as Sony Corp. to Honda Motor Co., were hit badly during the fourth quarter by a drop in export demand and flooding in Thailand, a regional factory and supply base, which disrupted their production.

Those problems arose just as many exporters appeared to have recovered from the March 11 earthquake and tsunami, which interrupted their manufacturing at home.

Japan last month reported its first trade deficit since 1980, reflecting broader changes in its economy as manufacturers shift production overseas to escape the strong yen and be closer to their markets. But the Thai flooding underlined that basing production overseas also has risks.

The drop in gross domestic product was worse than expected. Economists polled by Kyodo News agency projected a 1.4 percent decline.

Compared to the previous quarter, October-December GDP fell 0.6 percent, the Cabinet Office said. That comes after 1.7 percent increase in the July-September quarter, reflecting some recovery after the tsunami disaster.

Domestic private consumption, which accounts for over half the economy, edged up 0.3 percent from the previous quarter, the data showed.

Corporate capital investment rose 1.9 percent, while private housing investment fell 0.8 percent and public investment declined 2.5 percent.

Along the tsunami-battered coast, most of the debris has been cleared away, but rebuilding has yet to begin in many towns and communities as local leaders finalize reconstruction plans. Reconstruction is expected to stimulate economic growth, although export demand still appears weak.