Japanese companies are braced for a slump in spending as the government has put up sales tax from five to eight percent.
It is the first increase in 17 years and is part of moves to reduce Japan’s massive public debt.
VAT is due to rise further to 10 percent from October next year.
The Tokyo government has said it is ready to roll out more fiscal and monetary stimulus, as needed, if the sales tax rise proves more damaging to growth than expected.
The closely watched tankan survey of companies carried out by Japan’s central bank showed business sentiment barely improved in the three months to March.
Prime Minister Shinzo Abe is trying to get the country out of the economic stagnation and deflation it has endured for the past 15 years.
Soon after the consumption tax was put up from three to five percent in 1997, the country slid into recession.
Japan’s economy posted the strongest growth among industrial powers in the first half of 2013, spurred by Abe’s reflationary policies, but has slowed to less than a 1.0 percent annual rate since then.
Policymakers and private-sector analysts expect the economy to dip in the April-June quarter before rebounding in July-September.
“The combination of a major tax hike and modestly contractionary spending policy will both lower growth and leave the economy vulnerable to negative shocks,” Morgan Stanley’s MUFG Research Japan said in a report, noting that this year’s extra budget was smaller than last year’s.
“Unlike in 1997 when the consumption tax was lifted from three percent to five percent, however, the risk of the Japanese economy sliding back into full-blown recession is limited.”