Japan needs exit strategy from stimlus

TOKYO, July 24 - Japan needs an exit strategy from its record fiscal stimulus so that it can reduce its huge outstanding debt, a government report said on Friday.

The government cannot dismiss the risk of Japan returning to a period of prolonged deflation and must quickly take measures to increase demand, the annual white paper on the economy said.

But it stressed the need to have a long-term strategy of cutting costs and reining in huge long-term public debt which, at 170 percent of gross domestic product, is the worst among major economies.

Prime Minister Taro Aso's 15 trillion yen ($157.8 billion) stimulus package has added to concern about Japan's long-term fiscal health as it has contributed to a record amount of new government bond issuance.

"Previous studies have shown that cutting government spending and transferring spending are effective ways to lower outstanding debt and reduce the budget deficit after a crisis has subsided," the report said.

"Japan should use such examples as a springboard to develop its own strategic fiscal policy going forward."

The report urged the Bank of Japan to do its most to return the nation to sustainable growth, a statement which is likely to be interpreted as suggesting that the central bank should maintain its ultra-easy monetary policy for the time being.

The report comes amid worries that the spending plans of the opposition Democratic Party, which could wrest control of the government from Aso's Liberal Democratic Party in an election on Aug. 30, will inflate already huge public debt and push up government bond yields.

Policy makers in the United States and Europe are also struggling to find the best exit strategy from increased fiscal spending, with some politicians in the United States saying more stimulus is needed.

The government said last month it aims to stabilise the debt-GDP ratio by the mid-2010s and lower it steadily by the beginning of the 2020s, abandoning a more difficult target as it seeks to avoid cutting welfare spending.

Japan's economy suffered a record contraction in January-March but growth is expected to turn positive in the second quarter as a pickup in global demand supports exports and output.

But the country has fallen into its second bout of deflation in a decade as weak demand and lower prices for oil and grains weigh on overall prices.

The BOJ is already forecasting two years of declines in consumer prices, though it does not expect deflation to spiral out of control. Price expectation data are already showing signs that deflation could persist and price falls could accelerate further should the output gap widen further from a record of minus 8.5 percent logged in the January-March quarter, the report said.

The output gap shows how much actual GDP deviated from potential GDP, or the volume of activity when the economy is running at full capacity.

Japan's economy likely expanded 0.6 percent in April-June from the previous quarter, a Reuters poll showed, after a record 3.8 percent contraction in January-March due to a collapse in demand for cars and high-tech goods. The data is due on Aug. 17. (Editing by Edwina Gibbs)