WASHINGTON (Kyodo) The International Monetary Fund warned Thursday that Japan will remain under a destabilizing bout of deflation until 2012 and called for efforts to spur domestic demand to achieve a full-blown recovery.

In its twice-yearly World Economic Outlook report, the institution also said global growth will recover to 3 percent in 2010 after contracting in 2009 under the weight of the worst financial crisis in generations.

“In Japan, after a sharp first-quarter fall, activity is expected to contract by 5.4 percent in 2009 as a whole, although a sizable fiscal stimulus and a modest increase in exports will support growth in the second half of 2009 and will lead to a recovery of 1.7 percent in 2010,” it said.

“Given the significant slack in the economy, inflation will remain negative until 2012,” it predicted, alluding to concerns that deflation be a drag on economic recovery.

Consumer prices continued record-breaking falls in August, with the key index marking its sharpest yearly decline — 2.4 percent — due mainly to lower energy costs.

The IMF urged the government to pursue a recovery driven by domestic demand rather than by exports, saying fiscal support should encourage private consumption within the country.

“To complement efforts to repair the supply side of economies, there must also be adjustments in the pattern of global demand in order to sustain a strong recovery,” it said.

“Specifically, many economies that have followed export-led growth strategies and have run current account surpluses will need to rely more on domestic demand.”

The IMF raised its growth projection for Japan in terms of real gross domestic product to minus 5.4 percent for 2009, up 0.6 percentage point from its previous forecast in early July, and maintained its outlook for the country at 1.7 percent for 2010.

It indicated Japan’s recovery could be slow “because of the recent appreciation of the yen,” a phenomenon that hurts exporters by eating into their yen-based earnings once repatriated from foreign markets.

While noting high debt levels in Japan, the IMF warned that the government should not repeat the same mistake it made in the late 1990s, when it hiked the consumption tax to 5 percent from 3 percent before a nascent recovery took hold.

“Premature tax hikes in 1997, along with an unfavorable external environment, were among the factors that seem to have contributed to pushing Japan into recession,” it said.

In other parts of the report, the IMF put its global economic forecasts at minus 1.1 percent growth for 2009 against a previous prediction of a 1.4 percent fall, and plus 3.1 percent for 2010 compared with an earlier forecast of 2.5 percent.

“After a deep global recession, economic growth has turned positive, as wide-ranging public intervention has supported demand and lowered uncertainty and systemic risk in financial markets,” it said.

Even so, the IMF said the world still faces risks, and that governments should not move too early to withdraw the massive stimuli they have put in place to tackle the global crisis that erupted last year from the U.S. subprime-mortgage crisis and housing meltdown.

“Risks to the outlook remain on the downside. Premature exit from accommodative monetary and fiscal policies is a particular concern because the policy-induced rebound might be mistaken for the beginning of a strong recovery,” it said.

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