Hold On, Japan Still Missing Key Pillar of Growth

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While growth in the world's third largest economy, Japan, surpassed expectations in the first quarter, expanding at its fastest pace in a year, an important pillar of growth was missing: revival in capital spending.

Japan's economy grew 0.9 percent in the first quarter of 2013 from the previous three months - above forecasts for 0.7 percent growth - helped by robust consumption growth and a pick-up in exports.

However, the improvement in export demand has failed to translate into investment, with capital expenditure (capex) falling 0.7 percent - the fifth straight quarter of declines - compared with estimates for a rise of 0.7 percent.

"The capex figure is a concern. Core machinery orders - a strong leading indicator - have been down in the first quarter versus the fourth quarter. And so I think capex spending is going to continue to be a drag despite the improvement in corporate profits," Izumi Devalier, Japan economist at HSBC told CNBC Asia's "Squawk Box" on Thursday.

(Read More: Why Weak Yen Remains Wild Card for Japan's Growth)

Capital spending, which accounts for around 15 percent of the country's gross domestic product (GDP), is an important indicator of business confidence.

"Companies are still cautious about ramping up investment and you really need to see a higher level of export growth that pushes companies to invest," she said, highlighting the importance of the "third arrow" of "Abenomics" - structural reforms to counter demographic headwinds and raise productivity - to improve the domestic corporate environment and encourage spending.

'Abenomics' Showing Up

Nevertheless, the remaining two arrows - bold fiscal and monetary stimulus - have proved to be effective in supporting growth in recent months, said economists.

(Read More: Jack Lew's Gamble on Japan's Monetary Policy)

Expansionary monetary and fiscal policies have helped weaken the yen and drive equities to a five and a half year high - which in turn has provided a significant boost to consumer spending.

Weakness in the yen, which has declined almost 18 percent against the dollar since the start of 2013, has provided a major boost to the country's equity market that has emerged as the world's best performer this year - up nearly 44 percent over the same period.

Private consumption, which accounts for 60 percent of GDP, rose 0.9 percent from the previous quarter, as higher asset prices and expectations of wage growth boosted consumer confidence.

(Read More: Capital Flight From Japan: Has the Yen's Downfall Just Begun?)

"This is Abenomics showing up in the economy. The wealth effect of the strong stock market is pushing up consumer confidence," said Long Hanhua Wang, Japan Economist at RBS.

Going forward, however, analysts said it is unlikely the strong pace of consumption growth will be sustained.

Higher import costs as a result of weakness in the yen could force companies to pass on higher prices to consumers, which could dampen demand, said Harumi Taguchi, principal economist at IHS.

Another risk to consumption is if wages rises do not meet the expectations of workers, she added. Wage growth has remained sluggish this year, with scheduled cash earnings for full time employees declining 0.2 percent in March from a year earlier, from a 0.7 percent fall in February.

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While Yoshiro Sato, economist at Credit Agricole agrees that the pace of consumption growth will slow, he added that the execution of large-scale fiscal stimulus package "would more than compensate" for the consumption slowdown.

In January, the government unveiled 10.3 trillion yen ($101 billion) in fresh spending targeted at infrastructure and disaster prevention following the earthquake and tsunami of March 2011.

"GDP growth would be even stronger for a coming couple of quarters than that for January-March," Sato wrote in a note.