A woman looks on as a vendor works on a calligraphy at a stall in Chinatown in Yokohama, Kanagawa prefecture, Japan. The IMF said it was essential Japan went ahead with a scheduled two-stage doubling of its sales tax from next year amid signs the government is reconsidering the plan out of concern it may derail economic recovery.

Reuters/Tokyo

The International Monetary Fund said it was essential Japan went ahead with a scheduled two-stage doubling of its sales tax from next year amid signs the government is reconsidering the plan out of concern it may derail a nascent economic recovery.

The IMF also called for the Bank of Japan to be ready to expand its asset-buying scheme or change what it bought if inflation did not pick up as envisaged, or if government bond markets became volatile again.

With Japan’s huge public debt leaving it with little room to offer additional fiscal stimulus, monetary policy should be the first line of defence against risks to growth such as weakening exports to China, the IMF said in a detailed report on its annual consultations with policymakers released yesterday.

Japan is due to raise its 5% sales tax to 8% next April and to 10% in October 2015. The IMF said this was an “essential first step” to fix Japan’s fiscal problems.

“The absence of credible fiscal and structural reforms could weigh on confidence and undermine the success of the started reforms. This would not only be detrimental to Japan, but also for the rest of the world,” the IMF said.

“As Japan’s debt would remain unsustainable, a global tail risk of a spike in yields and volatile capital flows would remain on the table.”

The central bank has unleashed an intense burst of stimulus to end 15 years of deflation, promising to double the supply of money to achieve its 2% inflation target in two years.

Its strategy rests on buying around ¥7.5tn ($76bn) of long-term government bonds per month, as well as risky assets like corporate bonds and trust funds investing in stocks and property.

The BoJ should stand ready to boost asset purchases, or shift the composition of purchases to buy more risky assets than government bonds, if risks to Japan’s recovery heightened and prevented inflation from picking up, the IMF said.

Japan’s public debt is the largest among major industrialised nations at more than twice the size of its ¥500tn economy, and the sales tax hike is considered a test of the government’s commitment to reform.

Sources have said Prime Minister Shinzo Abe has ordered a study of alternatives to the planned increases to avoid derailing an economic recovery he has tried to foster through a policy mix that has been dubbed “Abenomics”.

The IMF has backed Abenomics, which combines aggressive monetary easing and fiscal stimulus with structural reforms. But it has also said Japan must eventually increase the sales tax rate to at least 15% and craft a credible fiscal consolidation plan as soon as possible to reduce its debt.

Yesterday’s report estimated that if the sales tax was not increased, Japan’s net public debt would rise to around 245% of GDP by 2030, compared with 210% if the tax hikes were implemented as scheduled.

Still, there are disagreements even within the IMF on the feasibility of the two-stage tax hike plan, according to a statement issued by the IMF’s decision-making Executive Board.