Hard times are not getting any softer in Japan.

Recovery from the global recession has stalled. Economic growth, minus 1.2% in 2008 and down 5.2% in 2009, is forecast by the World Bank at only 2.5% this year and 2.1% in 2011. Meantime, public debt has swollen to twice the size of Japan’s economy.

What’s more, unemployment is near a record high. Deflation is whittling down consumer spending, and there were shock waves when the labor ministry revealed almost one in six Japanese were living in poverty in 2007. No surprise, then, that China recently passed Japan as the world’s second-largest economy.

“My task is to rebuild this nation,” says Naoto Kan, after taking office in June as the third Japanese prime minister in less than a year.

Yet, political leaders continue to founder, unsure about how to revive the country’s fortunes.

A recent government survey of 102 companies reveals 40% would move their factories and development facilities outside Japan if the yen remains near its 15-year high of ¥85:$1, up 26% since 2007.

The finance ministry on Sept. 15 intervened in currency markets to weaken the yen for the first time since 2004, but experts doubt it will impede market forces and have a lasting effect.

For Japan’s automotive industry, the outlook is as unclear as the political climate. But, at present, major car companies are recovering lost ground and performing far better than the economy. The country’s top-3 auto makers all are projecting growth for the current fiscal year, ending March 31, 2011.

Toyota Motor Corp. is forecasting a 1.9% uptick in global sales to 7.38 million units and a more than twofold jump in operating profits to ¥330 billion ($3.88 billion). Honda Motor Co. Ltd. expects a 6.6% increase to 3.61 million global deliveries and a 23.7% increase in operating profits to ¥450 billion ($5.29 billion).

Nissan Motor Co. Ltd. foresees global sales rising 8.1% to 3.8 million units and operating profits of ¥350 billion ($4.11 billion), up 12.3%.

Although the forecasts are encouraging, the results still will fall well below 2007 peaks, and the momentum may not be sustainable. “The current situation is very tough,” Toyota CEO Akio Toyoda admitted in September.

The soaring yen threatens to dull the competitive edge of Japanese auto makers, sour their sales and profits and force significant changes in what they produce.

For every ¥1 gain in the exchange rate against the dollar, the loss in operating profits is about ¥30 billion ($353 million) for Toyota, ¥17 billion ($200 million) for Honda and ¥15 billion ($176 million) for Nissan (computed at ¥85:$1).

“There will be over 60% negative impact from the currency on the operating profits of Japan’s Big Three this fiscal year,” says Kota Yuzawa, a senior analyst with Goldman Sachs Japan.

Analysts believe the yen could continue to strengthen to ¥80, ¥75 or even ¥70:$1, although opinions differ on how severe the impact might be.

“The breakeven point of major Japanese auto makers has dramatically declined from the 2007 peak,” says Yuzawa. “Even at ¥80, most Japanese auto makers will be profitable, and I don’t think Nissan or Honda would be in the red at ¥70.”

But Mitsuru Kurokawa, senior market analyst-Japan at IHS Automotive, is less confident. “Japanese car makers cannot manage a rate less than ¥85:$1,” he says.

Koji Endo, managing director-Advanced Research Japan, agrees. “At ¥85, most Japanese auto producers won’t be able to make hardly any money from exports,” he says. “On expensive models, profit margins are minimal and on small cars there are no profits.

“If the yen becomes even stronger, many will have to change their business model, which up to now has been to use roughly half their production in Japan, around 5 million units, for exports.”

Endo points out an additional 1 million units of capacity are excess because domestic demand is fading. That’s because the Japanese population is aging and the younger generation tends to regard a car as basic transportation, rather than a source of pride and joy.

After peaking in 1990 at 7.7 million units, domestic vehicle sales dropped to 4.6 million units in 2009. The decline is expected to continue, despite a rise this year to about 4.9 million deliveries triggered by a cash-for-clunkers program.

A production shift overseas to replace exports has been under way for decades. Even in lean and mean 2009, for example, 10.1 million Japanese vehicles were built offshore, compared with 7.9 million units in Japan that included 3.6 million for export.

The economic realities today for Japanese auto makers are more obvious than ever before. Growth is in overseas markets, especially the emerging nations, and the strong yen is making vehicle exports from Japan less viable.

“Shifting more production overseas is quite logical,” Yuzawa says. “Currency fluctuations are a continuing concern, production costs in Japan are high and the aim of all auto makers is to produce where they sell.”

Endo calculates some 3 million units of export production, which reached 6.7 million in 2008, eventually will have to be moved from Japan and transferred overseas. “That is easy to say but difficult to implement, and a very costly, lengthy operation,” he says.

Because the economic and social consequences of closing plants and dismissing workers will be brutal, such moves are likely to be slow and measured – and postponed for as long as practical.

Current strategy favors building new assembly plants in growth centers, new and old, such as China, India, Thailand, Indonesia, Brazil and Russia, as well as the U.S.

For example, Nissan, in a joint venture with Dongfeng Motor Group, now is the leading Japanese auto maker in China. The JV recently opened a new plant in Zhengzhou to make SUVs and will nearly double capacity to 1.2 million units by 2012.

Guangqi Honda Automobile Co. Ltd. plans to expand production 33% to 480,000 units. Dongfeng Honda Automobile (Wuhan) Co. Ltd. will build a second plant with 60,000-unit capacity and Sichuan FAW Toyota Motor Co. Ltd. will construct a third plant with 100,000-unit capacity.

Toyota’s first Entry Family Car for emerging markets will be made in India, not Japan. Production of the new entry-level compact Etios will begin this year, with annual sales in India set at 70,000 units and exports planned as well. And a third Toyota plant under construction in Brazil, with a 70,000-unit annual capacity, may begin making the Etios in mid-2012.

Yet, Tokyo analysts believe the reduction in vehicle output in Japan cannot be ignored indefinitely, and Nissan is showing how it can be done.

“Nissan was the first major Japanese manufacturer to close plants in Japan and is the first to shift production of a mass-production model overseas. Production of the March/Micra has been completely transferred from Japan,” Endo says.

The all-new global compact is being built in Thailand, China, India and Mexico and eventually will be sold in 160 markets, including exports to Japan that began in July and are targeted at 4,000 per month.

Endo expects many other auto makers to take similar measures, as exporting low-priced, entry-level cars has become profitless.

Another prime target for production shifting is North America, where one third of the vehicles Toyota sells there, along with 20% of Nissan deliveries and 10% of Honda sales, still are imported from Japan.

But what’s notable is that emerging markets are becoming as important as the traditional mainstays, the U.S., Europe and Japan.

Toyota’s game plan this year calls for sales of 1.97 million vehicles in North America: including 1.77 million in the U.S.; 1.84 million in Asia, including 800,000 in China; and 760,000 in Europe.

Vehicle exports from Japan are recovering from a 27% drop last year, but competition is stiffening, especially from Hyundai Motors Co. Ltd. and Volkswagen AG. Costs are being cut in every way possible.

“Many Japanese auto makers are putting extra pressure on suppliers this year to cut their prices 3%, instead of a more normal 1% or 2%,” Endo cites as an example.

The analysts agree Japanese auto makers will continue to dominate the global market for hybrid, plug-in hybrid and electric vehicles, which Yuzawa forecasts will make up 20% of total vehicle sales of 100 million units in 2020.

“They are developing more fuel-efficient gasoline-driven cars, too, which deliver about 30 km/L (71 mpg),” adds Kurokawa.

Yuzawa estimates Japanese auto makers’ share of total global vehicle sales, 27.7% in fiscal-2009, will be 28.2% this fiscal year and 27.4% in fiscal-2011.

“(The Japanese) will regain share in the U.S., which will still be their No.1 market,” he says. “No.2 will be China. And this will be a super year for them in Thailand and Indonesia.”

Adds Yuzawa: “The yen is likely to bottom at ¥80:$1, and we foresee an upside to the currency impact, which would offer Japanese auto makers huge opportunities.”

But Endo is not as optimistic. “For Japanese auto makers” he says, “the future is going to be stormy.”