March 23 (Bloomberg) -- Japanese Prime Minister Taro Aso’s next stimulus package may need to exceed 10 trillion yen ($104 billion) to bolster an economy heading for its worst recession since World War II, analysts said.

Finance Minister Kaoru Yosano said yesterday that a new package of as much as 20 trillion yen is “not out of line” after the economy contracted at the fastest pace in more than 30 years last quarter.

“The domestic economy might really tank and there’s basically no way out of it except if the government helps,” said Martin Schulz, a senior economist at Fujitsu Research Institute in Tokyo. “It is absolutely necessary for Japan to keep the domestic economy going.”

Yosano’s remarks helped the Nikkei 225 Stock Average advance 3.4 percent. Aso, whose approval rating has plunged ahead of elections that must be called by September, this month called for fresh spending to add to 10 trillion yen pledged since October.

“It’s not a situation where new fiscal spending of 2 to 3 trillion yen would be enough of a remedy,” Yosano said on TV Asahi’s “Sunday Project” television program yesterday.

Economists are using the nation’s output gap, a measure of the balance between supply and demand in the economy, as one indication of how large the package will need to be. Fujitsu’s Schulz estimates the nation’s domestic demand shortfall is about 2 percent, which would require about 10 trillion yen in spending to fill.

‘Substantial Impact’

Spending of that scale may be needed to have “a substantial impact” on the economy, said Seiji Adachi, a senior economist at Deutsche Securities Inc.

The stimulus may need to be even larger when taking into account the unprecedented slump in overseas demand, according to Junko Nishioka at RBS Securities Japan Ltd. in Tokyo.

“The government should spend about 20 trillion yen at least to fill the supply-demand gap as Japan’s recession is deepening and facing the risk of falling back into deflation,” Nishioka said.

The output gap widened to 4.1 percent in the three months ended Dec. 31, the Cabinet Office said last week, the biggest since the first quarter of 2003.

Business leaders including Japan Business Federation Chairman Fujio Mitarai and Japan Chamber of Commerce and Industry Chairman Tadashi Okamura called on the government to pass a stimulus package worth 30 trillion yen once the main budget has cleared parliament, according to an official broadcast of the meeting, which took place on March 21.

Urging Aso

Ruling Liberal Democratic Party lawmakers are urging Aso to devote money to public works, including spending in rural areas and maintenance of roads, airports and harbors as well as development of magnetic-levitation train line projects.

“Spending on public works could be a quick remedy for the economy, but money shouldn’t be used in a conventional way on roads and buildings,” said RBS’s Nishioka. “The government should spend more on growth areas including environmental projects,” such as alternative energy, solar panels and hybrid automobiles, she said.

Fujitsu’s Schulz said lower-tech projects such as insulating buildings might be more effective at supporting employment in the short run. “Money should be spent as fast and as efficiently as possible,” he said.

More Debt

The government may need to borrow more to finance any extra spending, adding to the public debt, which at more than 170 percent of gross domestic product is the world’s largest. That may put more pressure on the central bank to increase its purchases of government bonds from banks.

“The government has no other choice but to issue a huge amount of bonds, not only to launch a large-scale stimulus package but also make up for a plunge in tax revenues,” Deutsche Securities’ Adachi said. “The Bank of Japan will be asked to pitch in on this front by buying more bonds.”

The central bank last week raised its monthly government bond purchases to 1.8 trillion yen from 1.4 trillion yen. Bank of Japan Governor Masaaki Shirakawa said the increase was to help stabilize financial markets and not to fund stimulus measures.

To contact the reporter on this story: Keiko Ujikane in Tokyo at kujikane@bloomberg.net

Last Updated: March 23, 2009 02:36 EDT