UPDATE 2-Japan eyes end to decades long deflation
* Govt expects mild price rises this year and next
* Says economy recovering but warns of risks
* Expects real GDP growth of 2.2 pct in FY2012/13
* Forecasts real GDP growth of 1.7 pct in FY2013/14
* FY2013/14 nominal GDP growth at 1.9 pct, above real growth
By Leika Kihara
TOKYO, Aug 17 (Reuters) - Japan on Friday offered its strongest indication yet it sees a way out of deflation next year, after being mired in a corrosive mix of falling prices and weak economic growth for much of the past two decades.
The assessment, part of the government's mid-year economic forecasts, could ease political pressure on the central bank for imminent policy easing to nudge prices higher.
But economists still expect the world's third-largest economy to struggle in coming quarters if global demand continues to falter.
"Japan's economy is expected to recovery moderately on robust private demand," the government said in the forecast, while warning that any further yen rises and the global slowdown posed risks to the export-reliant economy.
The government expects real gross domestic product (GDP) to expand 1.7 percent in the fiscal year beginning in April 2013, from an expected increase of 2.2 percent in the current business year after no growth last year.
The forecasts matched the BOJ's projection issued last month and are roughly in line with the median estimate of analysts polled by Reuters this month.
With activity seen picking up, albeit modestly, the government expects Japan's overall consumer price index to rise 0.2 percent this fiscal year, which would mark the first increase in four years, and by around 0.5 percent in fiscal 2013/14.
Since a massive property bubble burst in the early 1990s, Japan's consumer prices have been largely flat to negative apart from blips up in 1997 and 2008, which were due to hikes in the sales tax and higher commodity prices, respectively.
However, some analysts said the government's latest projections were optimistic, adding that the central bank would likely face renewed calls for further monetary stimulus if economic performance did not improve as expected.
"The government has set a pretty high goal for itself by projecting strong nominal GDP growth," said Yoshiki Shinke, chief economist at Dai-ichi Life Research Institute in Tokyo.
"Its forecasts look close to that of the Bank of Japan. But once the economy begins to undershoot the forecasts, the central bank will surely come under pressure to ease policy again."
NOMINAL GROWTH TO EXCEED REAL GROWTH
On a nominal basis, which is not adjusted for inflation, the government predicted economic growth would exceed real growth in the next fiscal year for the first time since 1997 as prices start to rise.
The GDP deflator, a broad measure of price trends, will likely rise 0.2 percent in fiscal 2013 after declining 0.3 percent this business year, as a domestic demand-driven recovery helps narrow the country's output gap, the government said.
Japan will thus achieve nominal GDP growth of 1.9 percent in fiscal 2013, exceeding real growth for the first time in 16 years, it said, signalling that an end to deflation is in sight.
But the nominal GDP growth forecast was much higher than private-sector forecasts of around 1.4 percent, and may reflect the government's hope of convincing the public the economy was strong enough to weather a planned sales tax hike, analysts say.
EXPORT RECOVERY KEY
Economics Minister Motohisa Furukawa said the government would not rule out the possibility of compiling a supplementary budget to support new areas of growth, such as green technology, to ensure that the recovery momentum is sustained.
"Now is a good chance to pull Japan out of deflation as soon as possible. It's important to take various steps for this," Furukawa told a news conference.
The government's real GDP estimate for the current fiscal year, ending in March 2013, was unchanged from its previous estimate made late last year, and is in line with the latest Reuters poll.
Prime Minister Yoshihiko Noda's government, which last week pushed through a plan to raise the sales tax to 10 percent by 2015, is keen to convince voters that the economy will have enough momentum to withstand the tax hike's impact.
In budget guidelines approved on Friday, the government set its focus on promoting its growth strategy as it aims to strike a balance between efforts to prop up the economy and rein in snowballing debt.
But it also set spending and borrowing caps to prevent Japan's debt, already worth twice its GDP, from growing too much, leaving it with little room to offer huge fiscal support if the economy weakens and putting the onus on the BOJ.
Robust private consumption, driven by government subsidies for low-emission cars, and reconstruction spending from last year's earthquake have so far made up for weakening exports.
But analysts expect the world's third-largest economy to struggle in the coming quarters as the stimulus effect begins to fade, even before overseas demand for Japanese goods pick up.
In the latest Reuters poll, analysts trimmed their growth forecasts for the current quarter and the next to a consensus 0.2 percent, from 0.3 percent in the previous poll, after news that the economy expanded by just 0.3 percent in April-June, half the pace expected.
The government expects external demand to add just 0.3 percentage point to real GDP growth in fiscal 2013, against a 1.4 point contribution expected from domestic demand.