TOKYO (AP) — The International Monetary Fund said Japan's economy is recovering from years of stagnation, but that far-reaching reforms and a "credible plan" are needed to reduce its debt mountain and sustain growth in the long run.
The assessment, in a report released Monday, said the near-term outlook of the world's third-largest economy "has improved considerably" thanks to monetary easing and increased government spending under Prime Minister Shinzo Abe's administration.
It forecasts that Japan's economy will grow 2 percent in 2013, helped by stronger demand at home and overseas, but will expand only 1.2 percent in 2014 as consumers tighten their belts following an expected increase in sales tax.
The IMF's report, based on a consultation with the Abe government last month, echoes earlier comments by the World Bank's lending arm on the "Abenomics" strategy of breaking out of a long spell of debilitating deflation by flooding the economy with money. At Abe's behest, Japan's central bank is striving to generate 2 percent inflation within the next two years.
But the report emphasized the need for "significant adjustments" to help reduce Japan's public debt, which will amount to nearly 250 percent of gross domestic product this year.
A central concern is a potential loss of confidence in Japan's ability to service its debt, given that repaying just the interest on government bonds is consuming a growing share of limited tax revenues. Japan's parlous fiscal situation is compounded by surging health and welfare costs from the fast-expanding share of elderly in the population. Rising inflation would inevitably push interest rates on government bonds higher, adding to the burden.
Uncertainty over the resilience of the recovery has prompted debate in Tokyo over whether the government should follow through on its pledge to raise the sales tax from 5 percent to 8 percent by next April, and eventually doubling it to 10 percent by 2015.
IMF Mission Chief for Japan Jerry Schiff said it would be a mistake to change course on that plan now.
"We think that the plan needs to go ahead as conceived, in other words to move from 5 to 10 percent in two parts," he said on a conference call. The tax hike surely will affect the economic rebound "but we don't think it will knock the recovery off of its rails," Schiff said.
Unlike some other countries facing crushing levels of public debt, such as Greece and Cyprus, Japan's financial system remains generally sound, the report said.
Most public debt is held by Japanese investors and financial institutions, helping to reduce the threat of a rapid and destabilizing exodus of cash. Japan's banks have relatively low levels of debt, while a rally in share prices since late last year has burnished their financial performances.
Over the long run, Japan's economic growth will likely settle near about 1 percent, as government spending on reconstruction from the March 2011 tsunami disaster is wound down, taxes increase and the pool of employable workers ages and shrinks, it said.
Japan needs wide-ranging structural reforms to support growth, encourage investment and improve competitiveness, it said. The report mentioned such priorities as bringing more women into the workforce, relaxing immigration restrictions and opening markets to more trade through participation in the U.S.-led talks on the Trans-Pacific Partnership regional trading bloc.
"Incomplete progress on fiscal and structural reforms could weigh on confidence and undermine the success of the new policy framework," it said.
Inflation, the factor Abe says will underpin growth, should increase from about 0 percent to 0.7 percent by the end of this year, the report said. Much of that will stem from rising costs associated with a weakening in the Japanese yen, which increases costs for imported food, fuel and other commodities. Sales tax hikes will further support inflation.
Schiff said Abe's recovery plan, if properly implemented, should lead to a faster growing and more dynamic economy that will bring the yen back to "equilibrium from its moderately undervalued position."
The IMF expects long term inflation to average 2 percent. The report only indirectly referred to the issue of whether wages will increase enough to ensure Japanese consumers will spend more and not just tighten their belts to cope with rising prices and higher taxes. Consumer spending makes up about three quarters of Japan's economy.
It urged reforms to reduce the growing number of workers, about 70 percent of them women, hired as non-permanent staff, who are paid significantly lower wages than "regular workers" and face limited job security and inferior access to social insurance.
The report said the costs of such a labor market setup were "substantial" and recommended steps to encourage stricter legal standards but more flexibility for employment in general.