By Hideyuki Sano and Kaori Kaneko
TOKYO (Reuters) - The Japanese government upgraded its view of the economy's performance and outlook for the first time in four months on Monday, but disappointing export data showed that the recovery from the March earthquake and tsunami would be anything but smooth.
The cabinet's monthly report cited progress that manufacturers were making in restoring production and supply chains wrecked by the March 11 disaster. The improved assessment of production, exports and consumption -- the first since February -- follows last week's upgrade in the Bank of Japan's view of the economy.
"A recovery from supply constraints and factory production is helping exports and sentiment. This supports the view that the overall economy is moving in an upward direction," said Shigeru Sugihara, director of macroeconomic analysis at the Cabinet Office.
The government, however, stressed that scars left by the disaster that ravaged the nation's northeast, killing up to 23,000 people and triggering the worst nuclear crisis since Chernobyl, were still all too visible.
It also flagged doubts about the strength of the global economy, high energy costs, the euro zone debt crisis and concerns about the stability of power supplies as potential risks.
May trade data published on Monday were a case in point.
While exports edged up 2.5 percent compared with April and a slump against the year-ago period was less pronounced, the improvement fell short of forecasts, a warning sign that overseas demand for Japanese good may prove weaker than earlier thought.
"Overall, the data shows that Japan's economy appears to be bottoming out, but the speed of the recovery will be moderate," said Takeshi Minami, chief economist at Norinchukin Research Institute.
"Emerging economies are tightening monetary policy so they may experience some slowdown, while advanced economies are also seeing very slow growth. That may affect Japanese exports in the coming months."
Exports fell 10.3 percent in May from a year earlier, less than a 12.4 percent drop in April but more than a median forecast for an 8.4 percent decline, and after a 12.4 percent drop in April, keeping the trade balance in deficit for the second month in a row.
The March disaster knocked the world's third-largest economy into its second recession in three years and output is expected to shrink again this quarter.
Yet a combination of domestic activity spurred by Japan's biggest rebuilding effort since the years after the World War Two and solid foreign demand for its exports is expected to help the economy recover in the second half of the year.
Evidence that Japanese carmakers and other manufacturers were ahead of initial targets in fixing supply networks and restoring production spurred talk of a V-shaped recovery and boosted foreign investment in Japanese stocks.
But, addressing a Reuters summit devoted to Japan's reconstruction, a senior manager at a Pimco bond fund warned that it may be hard for the Japanese industry to return to pre-crisis output levels.
"Global manufacturers need to think about diversification of supply chains. Some Japanese parts production could be replaced by other Asian countries," said Tomoya Masanao, managing director at Pimco Japan.
Among key economic areas, the government raised its view on factory output and exports for the first time since February, saying they show "some upward movements" after declining due to the quake.
Another concern is that a political deadlock in a divided parliament is blocking policies needed to revive the economy, get the nuclear crisis under control and start tackling long-term challenges of climbing public debt and social security costs.
The government released the first 4 trillion yen ($50 billion) batch of emergency spending last month and aims to get another installment through parliament in July. But uncertainty over when Prime Minister Naoto Kan will make good on his promise to step down and whether his successor will do better in winning opposition support is clouding the outlook for a reconstruction-driven recovery.
Kan, already Japan's fifth premier in as many years, survived a no-confidence vote earlier this month after promising critics in his own party he would quit. He did not say, however, when and the opposition have declined to cooperate on key bills until Kan goes.
Kyodo news agency reported on Monday that Kan could try to break the impasse by saying that he would quit on the condition that the parliament passed a second extra budget and a bill to issue bonds for this year's budget.
($1 = 80.055 Japanese Yen) ($1 = 80.055 Japanese Yen)
(Writing by Tomasz Janowski; Editing by Kim Coghill)