Japan's Abe vows flexible steps in case of downside economic risks

By Tetsushi Kajimoto and Leika Kihara

TOKYO (Reuters) - Japan stands ready to take all possible steps flexibly and without hesitation when downside risks to the economy emerge, Prime Minister Shinzo Abe said, as a simmering Sino-U.S. trade war clouds the outlook for the export-reliant economy.

Speaking on Monday after his ruling coalition kept a solid majority in upper house elections, Abe pledged to continue to make the economy his top priority, to put a decisive end to roughly two decades of deflation.

China's slowing economy, its trade war with the United States and spreading protectionism have led to a seventh straight monthly fall in Japan's exports and weakened factory output, threatening to derail the world's third-largest economy.

"Uncertainty remains over the global economic outlook such as trade frictions and Britain's exit from the European Union," Abe told a news conference. "We'll respond to downside risks without hesitation and take flexible and all possible steps.

"Based on a stable political basis, the Abe cabinet will take more aggressive and bold economic measures than ever."

Japanese policymakers are counting on solid domestic demand to offset the external headwinds, but a scheduled hike in sales tax, to 10% from 8% now, threatens that scenario, analysts say.

Abe has twice delayed the planned hike since the previous tax increase to 8%, from 5%, dealt a severe blow to private consumption, which accounts for about 60% of the economy, and triggered a deep economic downturn.

To prevent a repeat of the tax hike pain, Abe's government has earmarked 2 trillion yen ($18.53 billion) in stimulus measures in this fiscal year's budget including free education, shopping vouchers, tax breaks on car and housing purchases.

"We will underpin domestic consumption which accounts for the bulk of the economy by taking sufficient measures," Abe said.

Late on Sunday, Abe said he would take economic stimulus steps if there was a risk of the economy faltering.

With monetary policy stretched, after more than six years of easy money has dried up the bond market and squeezed banks' profit margins, analysts say Japan must fight the next recession with fiscal stimulus through a combination of monetary easing.

"If the economy falls into a recession, Japan would resort to a large-scale fiscal stimulus with the Bank of Japan effectively financing debt through its yield curve control," said Ryutaro Kono, chief economist at BNP Paribas Securities.

($1=107.9300 yen)

(Reporting by Tetsushi Kajimoto and Leika Kihara; Editing by Chang-Ran Kim and Clarence Fernandez)