China should allow greater flexibility in its exchange rate policy by reducing intervention, as part of its efforts to secure a gradual moderation in growth while pursuing economic reforms, the International Monetary Fund said on Thursday.
"To help deliver durable and balanced growth, China needs reforms that reorient the economy away from excessive reliance on real estate, heavy industry, and external demand," the IMF said in its regional economic outlook for Asia and the Pacific.
Implementation of China's third plenum reform blueprint of 2013, including steps to facilitate corporate deleveraging, strengthen local government financial discipline and reforms to state-owned enterprises, is vital for sustainable growth, the IMF said.
As such reforms are fully implemented, China's growth is expected to moderate to 6 percent by 2017 and then stabilize around there, it said.
In order to achieve a gradual moderation in growth while pursuing reforms, "fiscal stimulus should be the first line of defense, with an emphasis on measures to support private consumption," the IMF said, adding that any further monetary easing in China should be data dependent.
As the economy cools, China's central bank has delivered two interest rate cuts since November, on top of two reductions in the amount of money banks must keep in reserve, and repeated attempts to reduce financing costs.
"Exchange rate policy should continue to allow greater flexibility by reducing foreign exchange intervention," the IMF added.
On Japan, the IMF said an aggressive policy response would be key to achieving "escape velocity" for the Japanese economy.
"Further enhancements to the Bank of Japan's monetary stimulus may be warranted, particularly to the 'qualitative' part of monetary easing, if necessary to achieve the 2 percent price stability target," it said.
The BOJ last week pushed back the timeframe for hitting its inflation target but refrained from expanding its already massive stimulus program, clinging to its conviction that a steady economic recovery will gradually nudge up prices.
The IMF said the BOJ could take steps such as lengthening the maturity of Japanese government bonds it buys, and could also strengthen its forward guidance by committing to maintaining the size of its balance sheet even after exiting its quantitative easing.
"The central bank could consider accelerating qualitative and quantitative easing if the drop in oil prices affects core inflation or longer-term inflation expectations," the IMF added.
While Japan's decision to postpone a second increase in the consumption tax to April 2017 was "appropriate" given the uncertain growth outlook, a credible strategy for medium-term fiscal consolidation is needed, the IMF said.
The IMF also noted that India's economy has made a remarkable turnaround since mid-2013.
India's central bank should "maintain its tight monetary policy stance" the IMF said, adding that elevated inflation expectations and the possibility of supply-side shocks will continue to challenge the achievement of India's medium-term inflation target.
The Reserve Bank of India kept interest rates on hold at 7.50 percent at its policy review in early April, after having cut interest rates twice this year by a total 50 basis points to bolster the economy. But it is widely expected to cut rates again before the end of June.