• Kyodo

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The International Monetary Fund urged Japan on Wednesday to end deflation within 18 months with a more aggressive monetary policy and an injection of public funds into viable banks.

In its semiannual World Economic Outlook report, the IMF revised upward its estimate of economic growth in Japan to a contraction of 0.5 percent for 2002 from the 1 percent shrinkage projected in the previous report in April.

It predicted an expansion of 1.1 percent for 2003 from the earlier projected growth of 0.8 percent.

The Washington-based institution said however that Japan needs to fix its bad-loan problems and end deflation to ignite sustainable economic growth. It is vital for Japan to serve as an engine for the world economy amid growing concerns over the sustainability of the U.S.-led global recovery, it said.

The IMF pressed Japan to expand its “quantitative” monetary easing and tackle deflation with a sense of urgency by setting a deadline.

“A more aggressive monetary stimulus is needed to support economic activity, comprising a public commitment to end deflation in no more than 12 to 18 months, backed by further quantitative easing,” the report says.

“The recent appreciation of the yen bolsters the case for further easing, as it will negatively affect activity and prices if sustained.”

In March 2001, the Bank of Japan announced it was easing monetary policy by shifting its operating target from the key overnight bank lending rate — already near zero — to current account balances held by financial institutions at the central bank.

Under quantitative monetary easing, the BOJ has raised the current-account balance target level several times to increase liquidity in the banking system.

The IMF also urged Japan to break the vicious cycle in which unrecognized bad loans make banks unwilling to lend, hurting financial intermediation and corporate activity, and thereby creating new nonperforming loans to replace those being written off.

The Japanese government should “recapitalize viable banks, possibly using public funds, but subject to strong conditionality,” it says.

A resolution of the bad-loan issue is a prerequisite for the planned removal of full government refund guarantees on ordinary bank deposits in April, the IMF said.

The government is considering postponing the refund limit until September.

The IMF criticized the government for lacking decisive action to revitalize the long sluggish economy. and called for drastic reforms.

“Over the last decade, the authorities have adopted a gradualist approach to reform, rather than taking decisive action to solve long-standing structural weaknesses exposed by the bursting of the asset price bubble in the early 1990s.”

While stressing the need to rebuild strained national finances over the medium term, the IMF suggested Japan compile a supplementary budget if the economic situation deteriorates.

Economic reforms could have adverse effects on the economy in the short run, including a rise in unemployment through accelerated corporate restructuring.

The IMF, meanwhile, was less upbeat on the global economy than it was in April.

Citing such factors as sharp falls in global stock markets since the end of March, accompanied with a depreciation of the dollar, the IMF said “concerns about the pace and sustainability of the recovery have risen significantly.”

In particular, the IMF said the recovery in the United States, which has led the global recovery, is now expected to be “considerably weaker than earlier thought.”

The IMF left its estimate of global economic growth in 2002 unchanged at 2.8 percent but lowered its 2003 growth projection to 3.7 percent from 4 percent. The growth estimate for the U.S. economy is now 2.2 percent for 2002, down from 2.3 percent, and 2.6 percent for 2003, down from 3.4 percent.

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