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TOKYO (Reuters) - The International Monetary Fund urged the Japanese government on Tuesday to raise the country's sales tax and reform its welfare system to demonstrate a commitment to fiscal reform.
Prime Minister Yoshihiko Noda has staked his political life on the plan's fate, aiming to pass the tax and social security bills during the current session that ends on June 21.
Japan's ruling and opposition parties launched talks on tax and welfare reforms last week, aiming to strike a deal by June 15 to secure parliamentary approval of a plan to raise the sales tax to 10 percent by 2015 to fix tattered public finances.
"Passage of legislation to double the rate to 10 percent in stages by 2015 is crucial to demonstrate a commitment to fiscal reform and sustain investor confidence," the IMF said in a statement following its annual review of Japan's economy and economic policies.
Investors and rating agencies see progress on the tax hike plan as a test of Tokyo's resolve to tackle its public debt that is twice the size of its $5 trillion economy, the highest among industrialized nations.
Ratings agency Fitch cut Japan's credit rating last month, citing scant progress in coping with ballooning social security costs and describing Tokyo's fiscal consolidation plans as "leisurely.
The IMF also said the yen is moderately overvalued, and the chance of further yen appreciation due to Europe's sovereign debt crisis poses a risk to Japan's outlook.
The government will need to take additional measures to reduce public debt and the Bank of Japan could easy policy further by increasing asset purchases to help end deflation, it said.
Reporting by Stanley White and Tetsushi Kajimoto; Editing by Michael Watson & Kim Coghill