CRISISBOOM

By TOMOKO A. HOSAKA

TOKYO — Japan confirmed Monday that China’s economy surpassed its own as the world’s second largest in 2010 and said a late-year downturn was Japan’s first quarterly contraction in more than a year.

Japan’s real GDP expanded 3.9 percent in the calendar year in the first annual growth in three years, but it wasn’t enough to hold off a surging China. Japan’s nominal GDP last year came to $5.4742 trillion, less than China’s total of $5.8786 trillion, the Cabinet Office said.

Gross domestic product shrunk at an annualized rate of 1.1 percent in the October-December quarter, a sharp reversal from a revised 3.3 percent expansion in the third quarter, the government said.

A slowdown in exports and weaker consumer demand at home led to the unsurprising downturn, which is expected to be temporary. The result was better than Kyodo news agency’s average market forecast of an annualized 2.2 percent decline.

China was acknowledged last year as having grown to the world’s second-largest economy, but the Japanese data confirming it were not available until Monday. The switch underscores the nations’ stark contrasts: China is growing rapidly and driving the global economy, while Japan is struggling with persistent deflation, an aging population and ballooning public debt.

Prime Minister Naoto Kan has pledged to revive the economy and make major reforms in the country’s tax and social welfare systems. His approval ratings are eroding quickly, however, as voters question his government’s ability to lead the country through its pressing problems.

The fourth-quarter figure translates to a 0.3 percent fall from the previous three-month period, according to the Cabinet Office’s preliminary data. Consumer spending, which accounts for some 60 percent of GDP, fell 0.7 percent. Auto sales slumped during the quarter after government subsidies for “green” vehicles expired in September.

Exports fell 0.7 percent from the previous quarter amid a strong yen and waning global demand. A rise in the Japanese currency reduces the value of exporters’ profits overseas and makes Japanese goods pricier in foreign markets.

The road ahead looks brighter, with economists saying GDP will expand this quarter in tandem with global growth. The head of Japan’s central bank, Masaaki Shirakawa, said last week that that recent signs indicate Japan is emerging from the “pause” and performing at par with other advanced economies.

Ryutaro Kono, chief economist at BNP Paribas ( BNPQY.PK – news – people ) in Tokyo, says exports and production have escaped their “soft patches.”

“The economy seems to be recovering again from December, so the negative growth in (the fourth quarter) need not become the basis for pessimism about Japan’s cyclical outlook,” he said in a report this month.