The acting head of the IMF urged Japan to reduce its massive debt load to boost public confidence in the sustainability of the economy, which the global lender said could be achieved by tripling the 5 percent sales tax.

Japan's economy should bounce back from a slump after the March earthquake and tsunami, the International Monetary Fund said on Wednesday, while urging lawmakers to adopt another emergency budget and start raising the sales tax from next year as the centre piece of long-run fiscal consolidation.

"In the long run, it's clear that Japan requires a process of fiscal consolidation that would eventually begin to reduce the burden of public debt relative to GDP," IMF Acting Managing Director John Lipsky told Reuters in an interview.

"That's an important element, giving confidence to the Japanese people about the long-term sustainability of the outlook and it's also important to Japan's partners."

All three major ratings agencies are ready to pull the trigger on a ratings downgrade of the world's third-biggest economy as it struggles to reduce public debt that is already twice the size of the country's $5 trillion gross domestic product.

The debt has been built up as the government tried to counter years of economic stagnation and the global financial crisis. The earthquake and the still-unknown bill for dealing with the nuclear power crisis it sparked will place further strain on spending.

A vast pool of domestic savings means the Japanese government can fund its debt for now but Finance Minister Yoshihiko Noda has acknowledged fiscal reform cannot be avoided as the fast-ageing society will swell social welfare costs.

In its annual review of the Japanese economy, the IMF urged Japan to raise the sales tax, also known as the consumption tax, to 7 percent or 8 percent from next year to fund reconstruction following the disaster.
Japan should keep raising the tax, currently one of the lowest among major economies, to 15 percent over several years to bring down public debt in the long run, it said.

The March disaster tipped Japan's economy into a recession as GDP fell in January to March, the second quarter of contraction.

The IMF forecast the economy would contract by 0.7 percent in 2011 and then grow 2.9 percent next year.

"The government has responded quickly with supplementary budget and plans for further action. This strikes us as appropriate," said Lipsky, acting IMF head after Dominique Strauss-Kahn resigned on May 18 to defend himself against charges of attempted rape.

"In addition, the Bank of Japan also reacted quickly and stands ready to take further action if needed to support the recovery," Lipsky said.

TAX RISE

IMF economists said a timely adoption of a second extra budget on top of one for 4 trillion yen approved early last month and other bills would help mitigate risks to recovery and spur private spending.

The review forecast steady consumer prices this year and next and said the Bank of Japan could reduce deflation risks and support recovery by boosting its asset buying program.

The Fund acknowledged Japan was not the only developed economy that needs to stabilize its finances. U.S. lawmakers are bickering over how to rein in a federal budget deficit set to reach $1.4 trillion this year and Moody's Investors Service has warned of a small, but rising, risk of a U.S. default.

Europe is in crisis after Greece, Ireland and Portugal sought a financial bailout as investors lost confidence in the countries because of rising debt.

Britain has adopted a tough program of cost cuts to stabilize its finances after the global credit crunch. It raised its sales tax to 20 percent from 17.5 percent.

Japanese Prime Minister Naoto Kan made stabilizing public finances and reforms of the tax and social security systems policy priorities when he took office in June 2010 as Japan's fifth leader in as many years.

A government panel last week recommended doubling the sales tax in stages over the next four years but Kan's looming resignation and divisions in his ruling party cast doubt over whether the policy will be implemented.

In the review, the IMF said more emergency spending was needed and it would have to be financed in part by higher taxes.

"To limit bond issuance, financing of the budget could be supported by a moderate increase in the consumption tax in 2012 when a recovery is underway," the IMF said in the statement.

Lipsky said Japan, like nearly all advanced economies, must ensure confidence about the long-term sustainability of public finances.

There have been tentative signs of recovery in Japan since the disaster. Data showed last week that industrial output rose 1 percent in April after a record plunge in March. Factories reported intentions to raise output further in May-June.

But there are still uncertainties about recovery in Japan's power sector and doubts about external demand, Lipsky said, citing high unemployment in advanced economies as a risk to the global economy.

Lipsky's term expires in August. The top IMF job fell vacant after Strauss-Kahn was arrested and charged last month with the attempted rape of a maid in a New York hotel. He has denied the allegations against him.

French Finance Minister Christine Lagarde and Mexican Central Bank Governor Agustin Carstens are vying to head the organization, although a deadline for nominations is not reached until Friday.