The Economic Planning Agency announced that it now expected the overall economy measured by the gross domestic product to contract by 1.8 per cent for the fiscal year ending next March.

That was a sharp reversal from its previous much-maligned claim that the world's second-largest economy would grow 1.9 per cent.

Prime minister Keizo Obuchi told his ministers to consider stimulus steps and one suggested increased government spending, but there was no immediate consensus on what new steps could be taken.

Industrial output and capital spending will fall, the government now says, personal spending will dip, unemployment will hover near record levels, the trade surplus will surge and consumer prices will barely budge.

Under the forecast, the tumble would eclipse that of the 1970s "oil shocks" and mark its first postwar string of twofiscal years of decline. GDP slipped 0.7 per cent in 1997-98.

The government's about-face follows recent admissions that the economy is on the brink of a deflationary spiral, with manufacturers retrenching from decades of over-production, a shaky banking system bloated with bad loans, global markets in turmoil and consumers left shell-shocked.

A deflationary spiral is a cycle of price falls leading to cuts in output, which in turn hurts employment, causing households to cut spending and prompting more price cuts.

"The latter half of this fiscal year and the start fiscal 1999-2000 represent the moment of truth for the revival of the Japanese economy," EPA chief Taichi Sakaiya told the cabinet.

"Fiscal 1999-2000 must be the year for a turnaround from two consecutive years of negative growth and for establishing the basis for recovery," Sakaiya said.

Sakaiya said the prime minister called for consideration of measures to improve corporate housing and capital spending and boost jobs, but "he did notorder the compiling of a specific economic stimulus package."

Trade minister Kaoru Yosano said an additional 10 trillion yen ($74.6 billion) in fiscal spending was needed to help fill the gap between Japan's productive capacity and slumping demand.

Yosano was apparently referring to expanding the direct fiscal stimulus component of a second supplementary budget, which Obuchi has promised will total more than 10 trillion yen.

But Sakaiya said there was no direct discussion in the cabinet meeting of accelerating or expanding the extra budget.

Financial markets did not react to the GDP forecast revision, but share prices and government bond yields rose on Yosano's suggestions of fresh government spending.

EPA officials said they had not calculated the effects of the extra budget, seven trillion yen in promised tax cuts or the record 16.7 trillion yen stimulus package announced in April into their revised forecast.

But they said they indirectly factored in some improvement in business and householdsentiment from the announced measures.

The revision included some major caveats -- the EPA said it had assumed there would be no "failures of large-scale (Japanese) financial institutions" or any "major turmoil of financial and currency markets in the global economy" during the fiscal year.

EPA head Sakaiya, a former economic commentator and the only non-politician in the cabinet, vowed upon taking office in July to change the government forecast, which he said was "impossible" to meet.

A check by Reuters of eight private Japanese think-tanks found an average forecast of a 1.9 per cent GDP decline, ranging from minus 1.2 per cent to minus 2.3 per cent.

Under Tuesday's revision, the government expects the GDP to fall to 495.4 trillion yen this fiscal year from 519.7 trillion yen in 1997/98. A boost worth 0.6 per cent of GDP from net expors would be swamped by a 2.4 percentage-point drag from the domestic economy.

Personal spending, a main engine for the economy, is seen falling a real 0.9 per cent,against the initial forecast of 2.5 per cent growth. Another traditional source of growth, corporate spending on plant and equipment, will drop 10.1 per cent, the agency said, revising a 3.5 per cent growth projection.