What Will Save the Japanese Economy?

The Japanese economy shrank in the third quarter — the first time since last year — prodding the world's third biggest economy into recession and prompting its central bank to announce that it will continue "powerful monetary easing" to boost growth.

What Will Save the Japanese Economy?
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But economists tell CNBC that domestic stimulus is unlikely to bring Japan out of the downturn, with its recovery more dependent on global growth.

"I think the biggest driver for Japan to return to growth is global demand — especially in the U.S., China and Europe," Tokyo-based Masamichi Adachi, senior economist at JP Morgan said. "Of course, without an external demand pickup, I think what the Japanese government or central bank will implement is not enough to prevent the recession."

Izumi Devalier, Japan economist at HSBC in Hong Kong backed that sentiment saying Japan's economic development over the past decade shows that it's been extremely dependent on exports and external demand.

"Sad to say, Japan will have to wait for the overseas economies to pick up before it sees its own economy really lifted," Devalier told CNBC.

Data released Monday showed Japan's GDP (gross domestic product) contracted 0.9 percent in the three months to September from the previous quarter, and resulted in a 3.5 percent drop annually. The contraction was in line with expectations on slowing global growth and heightened tensions with China over disputed islands in the East China Sea.

Economists said they expect further deterioration in the economy in the fourth quarter —marking a technical recession — before growth picks up in the first half of next year.

(Read More: Japan Grapples With Its Fiscal Cliff)

George Boubouras, head of investment strategy and consulting at UBS Wealth Management, said the best thing for Japan's recovery is the expected expansion of the global economy next year.

"There's an awful lot of stimulus in there, led by the U.S. of course and that's the best sort of trade off for Japan and as long as Europe is not a big negative for 2013," Boubouras said.

Impact of Stimulus

The Bank of Japan (BOJ) eased monetary policy for a second month in a row in October by expanding its asset purchase program by $138.5 billion, but that did little to impress markets with the yen rising broadly, putting pressure on exports.

The yen has risen over 3 percent against the U.S. dollar so far this year. A strong yen makes Japanese exports more expensive and hence less competitive.

Exports fell 5 percent year on year in the third quarter — its biggest fall since a 6 percent decline in the second quarter of 2011.

(Read More: Japan September Core Machinery Orders Tumble)

The impact of the stimulus by the BOJ on the economy has been quite limited so far, according to Devalier, who said "I think it's unrealistic to expect the monetary easing measures to immediately lift growth."

She added that a pickup in the global economy — in particular China, as the recent fiscal stimulus filters through its economy — together with a gradual turnaround in consumption in Japan can help pull the country out of a recession.

- By CNBC's Rajeshni Naidu-Ghelani.