TOKYO - Japan needs a credible plan to reduce its debt to contain the risk that the Bank of Japan's quantitative easing could cause inflation expectations to spike, the Organisation for Economic Cooperation and Development said on Tuesday.
The government's decision to delay a sales tax increase scheduled for next year will help growth, but it also means the government will not meet its deficit reduction target for fiscal 2015, the OECD said in its economic outlook report.
The BOJ's surprise expansion of asset purchases last month was warranted, but it is still unlikely to meet its 2 per cent inflation target sometime next fiscal year, the OECD said.
"Even if inflation expectations are currently below the inflation target, the de facto monetisation of government deficits could raise such expectations abruptly," the OECD said in its report.
"To contain the risk of potential instability, it is essential to produce a detailed and credible long-term consolidation plan."
Prime Minister Shinzo Abe decided last week to delay a sales tax increase next year after an earlier hike to 8 per cent from 5 per cent in April pushed the economy into recession.
The tax hikes were part of a plan to earn more revenue for welfare spending.
Delaying the second increase has eased concerns about the economic outlook, but it has also raised worries Japan is not doing enough to control its debt burden, which is the worst in the world at more than twice its $5 trillion economy.
Another reason some investors are worried is that the BOJ last month expanded its quantitative easing by increasing annual government debt purchases to 80 trillion yen (431 billion pounds) from 50 trillion yen previously.
The BOJ's purchases are so large it virtually monopolises the secondary market and could keep yields low even if the government increased spending, some economists say.
The BOJ is buying debt and some riskier assets in a bid to put an end to 15 years of deflation and guide consumer inflation stably to its price target.
The central bank's monetary policy has helped improve inflation expectations, but meeting the BOJ's price target could take more time, the OECD said.