The Bank of Japan should ease monetary policy further to support its still-fragile economy as it has room to take unconventional steps, a senior International Monetary Fund official said, warning that a lack of action could deepen deflation.
Naoyuki Shinohara, the IMF's deputy managing director, also said the global economic outlook remained highly uncertain with the biggest risk posed by possible renewed market strains from Europe's debt crisis.
His comments come ahead of the Bank of Japan's closely watched policy meeting next week where sources say it may ease monetary policy further in a show of its determination to achieve its 1 percent inflation goal.
Looking at Japan's economy, I don't see any fears of inflation. Rather, there's a risk deflation may worsen given its demographics and weak economic growth, Shinohara told Reuters in an interview on Thursday.
Japan, with little room for additional fiscal stimulus, needs to rely more on monetary policy, he said, adding that the central bank has room to boost asset purchases and expand quantitative easing.
But Shinohara, a former top Japanese financial diplomat, said the lack of a credible road map by the government to fix the country's tattered finances may make the central bank hesitant to ease policy further.
The BOJ has nudged interest rates to virtually zero and bought assets ranging from government bonds to corporate debt in an effort to beat more than two decades of grinding deflation.
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The government is struggling to get Japan's fiscal house in order due to strong political opposition toward tax hikes that analysts say is crucial to rein in the country's fiscal deficit, at double the size of its economy the biggest among advanced nations.
BOJ Governor Masaaki Shirakawa said the central bank will continue its powerful monetary easing, signalling its readiness to offer further stimulus if needed to support the economy. But he warned that fiscal reforms were needed to ensure Japan does not lose market confidence over its finances.
Shinohara said that while Japan's economy is expected to perform relatively well due to spending for reconstruction from last year's earthquake, time was running short to tackle structural woes hampering growth such as persistent deflation, a shrinking labour force and worsening public finances.
Still, he said Japan was unlikely to run a current account deficit in the years to come because income gains from overseas investments would make up for any deficit in the trade balance.
Shinohara said Japan's pledge to contribute $60 billion to the IMF to boost its firepower was a welcome move that led to many other countries either announcing or preparing to offer their own commitments.
Some emerging economies are expected to examine contributing funds to the IMF, even if they do not go as far as making firm commitments at this weekend's G20 and IMF meetings, he said.
No country does not see the need to strengthen the IMF's resources, regardless of whether they put up money or not, he said.
The IMF's bid to win a big boost in funding to handle the euro-zone debt crisis hit a speed bump on Thursday when Brazil demanded more power at the IMF for emerging economies as a condition for lending it extra cash.
(Reporting by Leika Kihara; Editing by Tim Ahmann and Jonathan Hopfner)