Japan should emphasize developing its IT infrastructure to allow for sustainable growth and only embark on fiscal reconstruction after ensuring an economic recovery, the Economic Planning Agency said in its annual report released Friday.

The agency said the government should tackle debt reduction by making governmental expenditure more efficient only after it is certain that a full-fledged recovery is in place.

While the economy started gradually improving in spring 1999, it is "still in the process" of achieving a self-sustaining recovery, with consumer spending in particular still weak in June, it said.

The EPA also for the first time officially admitted it erred in advocating fiscal rehabilitation in fiscal 1997, describing the policy as "ill-timed."

The report meanwhile says IT innovation appears likely to offer a major impetus to the economy comparable to that provided by steam engines, electricity and automobiles in the past.

IT investment, which accounted for 18.5 percent of corporate capital investment in 1999, has been a factor in the recent improvements in productivity and in the economy as a whole, it says.

In the years to come, IT will assume a more important role in the economy, the report adds, noting that with the population aging and about to decline, a qualitative improvement in the labor force is needed.

But the agency said Japanese universities have not been meeting demand for providing specialized knowledge and abilities that students will require for work after graduation, although Japan boasts a high rate of high school students moving on to university -- 49.1 percent in fiscal 1999.

The report also notes that schools have been slow to promote IT, with only 35.6 percent of Japanese elementary, junior high and high schools hooked up to the Internet in 1999, compared with 89 percent in the United States in 1998.

In the report, the agency pointed out that Japan has the highest fiscal deficit as well as the highest balance of outstanding public debt among the 29 mostly industrial member states of the Organization for Economic Cooperation and Development.

The fiscal deficit of Japan's central and local governments, including social security funds but excluding government-run corporations, grew to an estimated 7.6 percent of the gross domestic product in 1999.

The balance of outstanding debts is projected to swell to around 645 trillion yen at the end of fiscal 2000, equal to 129.3 percent of GDP.

The agency said these deficits -- generated by economic stimulus measures -- have not yet had a serious impact on the economy, thanks to huge private-sector savings of 1.377 quadrillion yen as of the end of 1999 as well as Japan's big current-account surplus.

But since the debt is unlikely to be reduced substantially over the short run, once interest rates start rising, it could be a major threat to the economy, as the government will have to bear increasing debt-servicing costs.

The agency thus proposed reducing the debt but only over the mid- to long-term, drawing a lesson from fiscal 1997, when the government, also alarmed by huge public deficits, pushed through fiscal rehabilitation even though the economy was not in a robust state.

The fiscal reforms of fiscal 1997, coupled with the Asian currency crisis and the collapse of major domestic financial firms, crippled the economy. Negative growth led the government by the end of fiscal 1998 to freeze fiscal reforms.

"In this sense, as we look back at the results, it can be thought that (the attempt at fiscal reform then) was ill-timed," the agency admitted in the report.

On the current state of the economy, the EPA is still cautious about declaring a full-scale recovery because of weak personal spending but notes improvements since spring 1999 and even a recovery in corporate capital spending since late 1999.

The agency attributed the improvements to brisk housing construction, underpinned by the government's offer of low interest rates for home buyers, as well as increased public spending projects and strong overseas economies.

Besides weak consumer spending, the agency cited as concerns for the economy a certain level of downward pressure on prices and the problem of nonperforming loans, which it said could still make small financial institutions, if not major ones, reluctant to lend because of their weak capital bases.

Given these adverse factors, the agency suggested that it is opposed to recent calls by Bank of Japan officials for the ultraeasy monetary policy to be terminated.

"As for monetary policy, it is expected that appropriate management is implemented by taking into account prices and the state of the economy" to fully ensure a full-fledged recovery, the report says.

The current report is the last annual white paper published by the EPA, which will be integrated into the Cabinet Office after a major organizational reform of the central government scheduled for January.