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Driven by deep recession at home and a cloudy economic outlook abroad, a key government panel said Monday it will postpone the target year of an expected economic recovery by about two years.

According to a revised version of a five-year outlook by the Council on Economic and Fiscal Policy, chaired by Prime Minister Junichiro Koizumi, the economy will emerge from its deflationary funk around fiscal 2005.

The previous report, issued a year earlier, says Japan will see an end to deflation and achieve slight positive growth in fiscal 2003, when the government’s structural reform programs take effect.

The latest version of the report is expected to be approved by the Cabinet on Friday.

“Harsh situations remain due to the deflationary trend,” it says.

The report predicts the economy will nearly attain a full recovery in fiscal 2005 or 2006, later than its original outlook of fiscal 2004.

Real growth is expected to mark 1.3 percent in fiscal 2005 and nominal growth of 2.2 percent in fiscal 2006. This compares with expectations of 0.6 percent real growth and minus 0.2 percent nominal growth in fiscal 2003.

The report also notes that the level of banks’ bad loans remains high after sharply increasing in the business year that ended March 31, 2002.

“Economic uncertainty is heightening amid concerns over prospects of the world economy, as well as global setbacks in stock markets,” it says. “This will be a negative factor for the Japanese economy for the time being.”

The report comes after the government lowered its economic assessment Friday for the third straight month, citing the slowing of production activities, which had been fueling a fragile recovery.

The panel’s gloomy economic outlook also casts a shadow over how the government’s budget will be funded.

In calculations provided by the Cabinet Office, overall government bond issues will stand slightly above 40 trillion yen in fiscal 2004 and the following three years, compared with 36.4 trillion yen in fiscal 2003, even if the country goes ahead with a controversial increase in the sales tax of 1 percentage point to 6 percent in October 2004.

This is because the government plans to raise the financial burden for the basic public pension program to 50 percent from the current 33.3 percent in fiscal 2004. Any revisions to the pension program usually take effect in October.

The report also postpones by one year the end of the so-called intensive adjustment period, during which the economy is predicted to suffer nearly zero growth. The period was originally expected to span fiscal 2002 and 2003.

Also emphasized is the need for the government and the Bank of Japan to make every effort to put an end to deflation.

However, the panel stressed it will stick to its original target of securing a primary balance surplus in the early 2010s.

The primary balance is a gauge of a government’s fiscal soundness that shows state expenditures and revenues, excluding bond revenues as well as interest and principal repayments on bonds.

A primary balance surplus means the government has tax revenues sufficient to finance public services.

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