(Adds details from IMF staff papers)
By Lesley Wroughton
WASHINGTON, July 15 (Reuters) - The International Monetary Fund said on Wednesday there were signs of stabilization in Japan's economy, but warned that the outlook was still highly uncertain and hinged on global trade and financial conditions.
In an annual assessment of Japan's economy, the IMF said a sustained recovery in the world's No. 2 economy was likely sometime during 2010 although deflation is likely to remain until 2011.
The IMF maintained its forecast for a record 6.0 percent contraction in Japan's economy this year, with growth resuming to 1.7 next year. In May, it projected Japan's economy would shrink by 6.2 percent, but then revised it up slightly to 6.0 in its World Economic Outlook released last week.
"Policy stimulus will provide a much-needed boost to the economy but a sustained recovery will ultimately depend on an upturn overseas," an IMF staff report noted.
Meanwhile, the IMF praised the authorities for a "well-calibrated" response to stabilize the economy, and said current stimulus appeared to be adequate although additional measures may be needed next year if the recession persists.
At roughly 5.0 percent of gross domestic product, stimulus spending in Japan is larger than most Group of 20 nations, and is expected to bolster the economy by 2.0 percent in 2010.
The IMF said fiscal policy in Japan should remain flexible to address further downside risks but urged the authorities to clarify fiscal plans once the recovery takes hold.
Japan's net public debt could rise to about 140 percent of gross domestic product, or 240 percent in gross terms, by 2014, according to IMF staff estimates.
"The sizable fiscal stimulus is judged to be appropriate given the depth of the slump, but the large buildup in public debt from an already high base requires that attention be paid to the medium-term strategy to secure fiscal sustainability," the IMF added.
Turning to monetary policy, the IMF said further credit easing may be necessary should risks materialize or financial pressures resurface.
For now, monetary policy is "appropriately accommodative" in the wake of a significant widening output gap and downward pressures on prices, the fund added.
The IMF said its analysis of the yen showed that the current value of the currency was "consistent with medium-term fundamentals."
As the crisis eases, the IMF said the authorities should ensure that government support to shore up its financial and corporate sectors is withdrawn in an orderly fashion.
"Public financial support to corporations and regulatory forbearance, if sustained for too long, could hinder market discipline and needed balance sheet adjustments," the IMF cautioned. "The sizable increase in (small and medium-sized enterprises) credit guarantees raises the risk of large fiscal costs while slowing the pace of restructuring," it added.
To address these risks, the authorities should implement a transparent exit strategy that preserves financial stability, the IMF said.
(Reporting by Lesley Wroughton)