WASHINGTON (Kyodo) The International Monetary Fund warned Japan on Wednesday against prematurely declaring an end to deflation and raising interest rates, saying there is still a “one-third chance” of a further decline in consumer prices.

In its semiannual World Economic Outlook report, the IMF urged Japan to promote fiscal reforms, including a consumption tax hike “over time,” to deal with problems arising from the aging of its population.

The IMF raised its projection for Japan’s economic growth in 2006, based on “solid” domestic demand.

As for the world economy, the IMF urged global policymakers to pursue a medium-term realignment of exchange rates to send the dollar “significantly” lower than current levels and the currencies of China and other emerging Asian economies higher, to avert the risk of global imbalances.

The report projects economic growth in Japan of 2.8 percent for 2006 in terms of real gross domestic product, revised up by 0.8 percentage point from the September forecast and up from an estimated 2.7 percent growth in 2005. It expects a 2.1 percent growth for 2007, up 0.5 points from six months ago.

Global growth is projected at 4.9 percent for 2006, up 0.6 points from September, and 4.7 percent for 2007, up 0.3 points, the IMF said. It said the global expansion “is becoming more broadly based” compared with the past trend of the United States and China serving as the main growth engines. The 2005 world expansion is estimated at 4.8 percent.

“Japan’s expansion remains solidly on track,” the IMF said, noting growth is increasingly being driven by final domestic demand on the heels of rising employment, buoyant corporate profits and a turnaround in bank credit growth.

The IMF said the solid performance has partly helped Japanese stock prices to rise by some 40 percent since mid-2005 in terms of the Nikkei stock average, by far the most rapid gain among the Group of Seven industrialized nations.

“At this point, the risks are to the upside, especially if private consumption gains momentum in response to rising employment and labor income,” the IMF said. “Most encouragingly, with underlying deflationary pressures easing, there is an increasing prospect of an end to eight consecutive years of declining prices.”

But given the IMF estimate of a one-third chance of further decline in the consumer price index in 2006, “it is still too early to conclude that deflation is conclusively defeated,” the IMF said.

“Given the uncertainties . . . and the large costs of a deflationary relapse, the monetary policy stance is appropriately expected to be kept highly accommodative for the time being; timing of interest rate increases will depend on the extent that incoming data confirm the deflation is decisively beaten and inflationary expectations are solidly established,” the IMF said.

It urged Japan to lay out a “more detailed plan” for fiscal reforms, citing such measures as limiting growth in health-care costs to further curtail expenditures, reducing exemptions to broaden the tax base, and raising the 5 percent consumption tax, which the IMF said “is low by international standards.”

The IMF said Japan also needs to revive its productivity growth by completing the financial and corporate sector restructuring, especially regarding regional banks and some domestic sectors, and by pressing ahead with measures to improve labor market flexibility, downsize government financial institutions, enhance domestic competition, and reduce regulation and trade restrictions.

On the world economy, “risks remain slanted to the downside, the more so since key vulnerabilities — notably the global imbalances — continue to increase,” the IMF said.

“With the risks associated with inaction rising with time, the principle challenge for global policymakers is to take advantage of the unusually favorable conjuncture to address these vulnerabilities.”

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