Keizo Obuchi became prime minister of Japan in the summer of 1998. A Business section article yesterday had the date wrong. (Published 10/30/1999)

Keizo Obuchi promised speedy overhaul of Japan's ailing economy when he took over as prime minister here this summer. But just as Japan's businesses embrace that task in earnest, Obuchi appears to have lost his nerve.

First it was his new cabinet lineup: Key economic posts were parceled out to old-fashioned party insiders; outspoken reformers got the boot. Then it was his public criticism of Nissan Motor Co.'s decision to eliminate 21,000 jobs as part of its restructuring plan.

Now comes his pledge to "rescue" the nation's small and medium-size enterprises by pushing a $96 billion package of government loan guarantees through the special session of parliament that opens Friday.

"It's a shame," laments Yasushi Kudo, editor of Ronso, a business magazine that has provided a lively forum for the debate about how to revive Japan's economy. "Just as businesses and the public are ready to do things differently, suddenly the government is putting on the brakes."

Some observers offer a more sympathetic view. "I think what you're seeing here is a two-pronged strategy," says John Neuffer, a political analyst for Mitsui Marine Life Insurance. Obuchi and allies in the tripartite political coalition that controls Japan's legislature "are trying to encourage restructuring, but at the same time they want to cushion the blow to traditionally protected industries that have always been their most important constituents."

"It would be political suicide for them to just let the restructuring tiger out of the cage," he said.

That may be true. But even Obuchi supporters express concern that the government's new "go slow" stance on reform has endangered long-term growth prospects for the world's second-largest economy. Close scrutiny of Obuchi's rescue plan for small firms illustrates how efforts to soften the blow of restructuring risk smothering reform entirely.

The $96 billion in new loan guarantees would be added to the $192 billion in guarantees the Japanese government extended to small and medium-size enterprises in August as part of an emergency public works package to jump-start an economy that seemed in free fall. That spending enabled the economy to expand at an annually adjusted rate of 0.9 percent in the most recent quarter.

But opponents of the small-business loan program, including many business leaders and even some members of Obuchi's own party. charge that it has undermined Japan's long-term competitiveness by diverting capital from healthy, well-run ventures to keep inefficient "zombie" companies on life support. They decry it as a symbol of the sloppy, anti-market policies that tipped Japan into recession in the first place.

The small-business proposal prompted Yoshihiko Miyauchi, president of one of Japan's biggest leasing companies and head of a government committee on deregulation, to declare Japan "a state-controlled economy."

"If the economy slips, the government rushes in to fix things up," he complained this week. "If the credit rating of somebody's business gets downgraded, the government compensates with credit guarantees . . . sticking taxpayers with the bill."

Editors of the Nihon Keizai Shimbun, Japan's leading business daily, also have attacked Obuchi's small-business proposals. A recent editorial denouncing the plan was headlined: "Small firms won't grow if all they're fed is candy."

When loan guarantees became available last year, small-business owners and their bankers formed long lines outside the local government offices that administer the program. But officials reviewing the hundreds of thousands of applications lacked the resources and training to make more than a rudimentary check of borrowers' creditworthiness.

The result was the number of corporate bankruptcies declined abruptly from about 1,700 per month in October 1998, to less than 1,000 per month in February of this year, according to Teikoku Databank, a firm that tracks the creditworthiness of Japan's small businesses. But the bankruptcy rate began to rise steadily to more than 1,300 in the months that followed. The rise paralleled expiration of grace periods allowing program beneficiaries to forgo all but a fraction of their normal monthly payments.

Noriyoshi Kobayashi, Teikoku's chief information officer, contends that the program only delayed inevitable failure for many recipients of the guarantees--but with one big difference: When recipients of the guarantees eventually went under, it was Japanese taxpayers rather than firm owners who were left to pick up the tab.

The Obuchi government wants to expand the loan-guarantee program by loosening the official definition of a small business. Under current law, only manufacturers with assets of less than $960,000 and retail or services firms with assets of less than $96,000 qualify as small or medium enterprises. Under the Obuchi proposal, the cutoff would be raised to $2.9 million for manufacturers and $290,000 for retail and service firms.

Under the proposed change, all but 13,700 firms, or 0.3 percent of Japan's 5.1 million companies, would be eligible for small-business loan guarantees, according to the government agency on small and medium-size enterprises.

Doling out more loan guarantees to Japan's small businesses "would create a moral hazard in the extreme," charges Etsusuke Masuda, a senior analyst at HSBC Securities Inc. in Tokyo. "Companies who have resisted easy money from the government and toiled diligently to repay loans on their own would be allowed to die. Companies that made no effort to do so would be saved."

But Mitsui Marine's Neuffer argues that now that big firms such as Nissan, Mitsubishi Motors Corp., and Nippon Telegraph and Telephone Corp. are slashing payrolls, concerns about preserving market discipline have taken a back seat to fears of rising unemployment. Obuchi, who has been slipping in opinion polls of late, must call a lower-house election before October of next year. Some of the biggest beneficiaries of the small-business loan guarantees are construction and property companies that are traditionally the most generous financial contributors to Obuchi's Liberal Democratic Party.

"You can't blame politicians for trying to resist corporate layoffs in an election year," said Ron Bevacqua, senior economist at Commerzbank in Tokyo. "But in the end, they'll only slow things down. The pressures they're fighting have gotten too big for them to control."

Special correspondent Akiko Kashiwagi contributed to this report.

CAPTION: Prime Minister Keizo Obuchi: A retreat, or a "two-pronged strategy"?