TOKYO -- Last week got off to a miserable start for Prime Minister Keizo Obuchi when the Economic Planning Agency reported Japan's GDP contracted a worse-than-expected 1% between July and September after two encouraging quarters of growth. Given that Obuchi must hold a lower house election by October 2000 and that his popularity is on the wane, you'd think he needed the grim news like a hole in the head. Well, that's not really so. For starters, despite the fact that private domestic demand dropped dishearteningly in the third quarter, many economists in Tokyo remain optimistic about Japan. Richard Jerram, chief economist at ING Barings, believes there are plenty of indications that the country is powering into a cyclical recovery. Jerram points to surging industrial production, improving business confidence and strengthening labor demand. And the markets seem to agree. In a show of confidence that Obuchi's getting this economy back on track, investors shrugged off the negative figure released last Monday. Influenced instead by the record-setting close of the Nasdaq the previous Friday, they plowed money into the Nikkei Index, which closed up nearly 140 points. Market concerns over the negative number were also diminished because the government's upward revision of the GDP in the second quarter exaggerated the contraction. Perhaps more importantly, the negative GDP number gives Obuchi even greater justification for throwing additional taxpayer money at the economy to get it back on its feet. Importantly, one of the primary reasons the economy shrank in the third quarter is that public investment fell 8.5%, the result of a tapering off of earlier pump-priming measures. The 6.8 trillion yen supplementary budget passed in parliament last Thursday to fund the latest 18 trillion yen stimulus package is intended to plug the public-spending gap. After this session of parliament adjourns, probably on Dec. 15, the three parties in the ruling coalition will hit up the Ministry of Finance for the fiscal 2000 budget. From the looks of it, that spending package will equal, and probably even surpass, this year's 82 trillion yen budget, the biggest in Japanese history. Unsurprisingly, lawmakers are drooling over the prospect of loading up that budget with plenty of vote-getting pork, including more expensive bullet trains and roads to nowhere. They are also angling to give companies greater tax incentives to restructure and to reduce Japan's onerous inheritance tax. What of Japan's ballooning budget deficit? The Organization of Economic Cooperation and Development estimates government sector debt will reach a staggering 114% of GDP next year, putting Japan on track to become the most debt-ridden member of the 29-nation OECD by 2001. For Japan's lawmakers, this is a post-election problem. Another troubling aspect of the last week's negative GDP figure: It gives old guard members of the ruling coalition more ammunition to claim that deregulation and corporate restructuring have gone too far in Japan. Last month, a large flock of lawmakers in Obuchi's Liberal Democratic Party, the coalition's biggest member, established a group called the Forum to Reconsider Deregulation. Headed ironically by the LDP's pointman for administrative reform, Kabun Muto, this group is seeking relief for small companies feeling the pinch of deregulation. Small firms, by the way, employ roughly three-quarters of Japan's workforce and traditionally provide strong electoral backing to the LDP. The antideregulationists have friends in high places, including the LDP's policy affairs chief Shizuka Kamei. Nine days ago, Kamei ordered several key committees in his party to investigate how deregulatory reforms already in the pipeline will hurt small firms, which have borne the brunt of Japan's economic hard times. While the corporate giants have announced lots of restructuring plans, most of their cuts in personnel have and will continue to be achieved through attrition. The little guys, however, have been forced to simply fire employees to reduce costs or shutter their doors. Kamei says that by year's end, he'll submit proposals to the LDP including measures that call on the government to protect small companies from the evil hand of deregulation. He and his nervous band of recidivists won't be able to derail deregulation. But with last week's negative GDP figure -- and with an election on the horizon -- you can bet they'll work harder to slow the process. In the end, the lousy GDP figure released last week wasn't so bad for Obuchi after all. The markets were unfazed and he's now got a stronger mandate to continue his fiscally robust economic policies. Problem is, his ruling coalition might be tempted to use the contraction as an excuse to pump up next year's budget with even more useless public works projects and drive the nation deeper into the red. The bond market, already skittish about the country's burgeoning budget deficit, would just love that. It also emboldens lawmakers, worried about losing their seats in the next election, to slow the pace of deregulation. If they make any headway, you can bet the markets won't continue being so kind to Japan's prime minister. Investors don't care about elections; they just want this country to start turning a profit.