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TOKYO — The global economic slowdown is battering Kunio Yanagisawa's small business manufacturing industrial plastics, sending sales tumbling 50% in October as his major clients stopped making orders. But his local government isn't about to let his business go under.

This month, Tokyo's Ota ward threw Mr. Yanagisawa a lifeline: a 10 million yen ($105,000) interest-free loan that will help him cover operating expenses until the economy improves.

This is the first time the Tokyo ward, which houses more than 4,800 small factories, has resorted to such drastic measures. But never before has the economic climate been so severe and the future so uncertain, the government says.

"Usually we can guess when the conditions will get better. This time we can't," says Yoshi Ishii, director of Ota ward's economic development division, which pays the interest on the business loans.

Economists disagree over whether Japan will report its second consecutive quarter of contraction — which would put the economy in recession, under a widely used measure — when the government on Monday announces gross domestic product for the July-September quarter. What isn't in dispute is the grim forecast for Japan in the longer term.

Japan's sudden economic downturn has focused primarily on the damage to its large multinational corporations like Toyota Motor Corp. and Sony Corp., both of which suffered steep profit declines in the most recent quarter.

But the economic slump is being felt more deeply, if less visibly, by millions of small businesses — from neighborhood vegetable shops to small high-tech firms like Mr. Yanagisawa's — that form the backbone of Japan's economy, accounting for 99.7% of all business enterprises and 70% of all employment.

The number of companies that failed in Japan jumped 13.4% in October to 1,429, of which 1,415 were small or medium-size businesses with 300 or fewer employees. The Bank of Japan's closely watched tankan survey of business sentiment released last month found that small businesses have a far more pessimistic outlook for this year than large corporations. The survey also found that small businesses are having a harder time getting access to credit than larger firms.

Assistance to small firms through tax relief and help in obtaining loans are two of the top items in Japanese Prime Minister Taro Aso's new $51.5 billion stimulus package to shore up Japan's economy. Given the vast impact of small businesses, the government views companies like Mr. Yanagisawa's as the driving force behind Japan's recovery.

To be sure, economists question whether interfering in market forces by propping up vulnerable businesses makes sense for the economy.

"If you are a free-market person, you would say they shouldn't do it if they are not strong enough to survive," says Akira Maekawa, an economist for UBS Securities Japan. But, he adds, "to try to help the small companies not go bankrupt would help underpin the economy."

Good idea or bad, Ota ward's interest-free loans have been in high demand. In the first five days since the program started Nov. 4, 217 small-business owners applied and were approved from the program. The government is expecting many more applications in the months ahead.

Normally filled with the sounds of honking delivery trucks, hammering and drilling, Ota ward's narrow alleyways are now filled with silence. At Mr. Yanagisawa's plastics company, Sinano Sangyo, a half-dozen workers kept busy dusting plastic shards from drilling and molding machines, preparing for the day new orders will start arriving. Business has slowed to a trickle for November, as orders for parts from the semiconductor and pharmaceutical industries ground to a halt.

Mr. Yanagisawa, 55 years old, started the business 18 years ago and has survived downturns before. But this time is different, he said. "I can't see when it's going to end. I'm worried," he said.

Nearby, Shinichiro Yokota, 39, was also fretting about the future. Since taking over his father's metalworking business in April, plummeting sales have pushed his business to the brink.

Pushed up against a wall, he has started manufacturing steering wheels and equipment for sports cars, developed a driver's training course to sell to the disabled and is experimenting with a wheelchair for two.

"I can't say I'm enjoying what I'm doing," he said. "But we are in a time when we need to change."

Write to John Murphy at john.murphy@wsj.com