The International Monetary Fund (IMF) has advised Japan to persist with raising interest rates and avoid further fiscal policy loosening, cautioning that reducing the consumption tax would impair the nation's ability to handle future economic shocks.

The IMF stated that the Bank of Japan's "sustained independence and credibility" would help stabilize inflation expectations and warned the government against excessive interference in monetary policy.

In a preliminary report on policy recommendations for Japan released Wednesday, the IMF noted, "The Bank of Japan is appropriately exiting from accommodative monetary policy, and gradual interest rate increases should steadily move policy rates toward a neutral level."

"As baseline projections continue to materialize, policy accommodation should continue to be withdrawn, aiming for policy rates to reach a neutral level by 2027."

The IMF emphasized that Japan should refrain from cutting the consumption tax, as such a move would "erode fiscal space and heighten fiscal risks."

While limiting tax reductions to essential items and ensuring they are temporary could help contain fiscal costs, the agency stressed that Japan still needs fiscal discipline to maintain stability in the government bond market.

"Near-term fiscal policy should avoid further easing," the IMF said, calling for the establishment of a credible medium-term fiscal framework.

"High debt levels, combined with deteriorating fiscal balances, leave Japan vulnerable to various shocks," the IMF warned, noting that interest payments are projected to double between 2025 and 2031 as debt is rolled over at higher yields.

One-quarter of Japan's total expenditures rely on debt financing, with approximately half of that debt held by the Bank of Japan.

The IMF indicated that as the Bank of Japan gradually reduces bond purchases and shrinks its balance sheet, close attention must be paid to changes in market liquidity and investor demand.

If heightened market volatility leads to impaired liquidity, the Bank of Japan should be prepared to implement "special targeted interventions," such as emergency bond-buying operations.

Regarding the yen's movement, the IMF welcomed Japanese authorities' "continued commitment to a flexible exchange rate regime," emphasizing that exchange rate flexibility should "help cushion external shocks and support monetary policy's focus on price stability."