By Izumi Nakagawa
TOKYO, May 20 (Reuters) - Japanese Prime Minister Shinzo Abe's plan to cut the country's debt pile will rely on the Bank of Japan keeping government bond yields low for years to come, people involved in its crafting say, which could force the bank to maintain its massive monetary stimulus for longer than it wants.
Abe has pledged to come up with plans to fix Japan's tattered finances, but he is reluctant to raise taxes or cut spending drastically for fear of hurting the fragile economy.
The Cabinet Office, a ministry overseeing the government's economic policies, is updating its public finance forecasts in July, and they will serve as the basis for the fiscal reform plans.
It faces a stiff challenge to come up with estimates that will enable Japan's debt burden, which is nearly twice the size of its GDP, to fall.
A particular dilemma is that long-term interest rates may start to rise if the BOJ's stimulus programme succeeds in reflating the economy and accelerating inflation toward its 2 percent target.
To keep borrowing costs as low as possible, since debt servicing takes up nearly a quarter of government spending, the Cabinet Office is considering saying in its forecasts that the BOJ ought to be expected to keep bond yield gains in check, several people involved in the drafting of the forecasts told Reuters.
Any such language could pile pressure on the BOJ to maintain its stimulus programme longer than it would like. The central bank now expects Japan to hit 2 percent inflation in the fiscal year ending in March 2017.
Though many analysts think that timeframe is optimistic, hitting the target would likely prompt the central bank into tapering asset purchases.
Some government bureaucrats and lawmakers want the BOJ to go slow in the tapering process, worried of a possible disruption to bond markets that could lead to a spike in borrowing costs.
"We're not saying that the BOJ shouldn't exit its current stimulus programme even after achieving its price target," one government source said on condition of anonymity.
"But the BOJ should not ignore the effect (of such moves) on long-term interest rates," the source added.
Japan currently aims to return to a primary budget surplus in fiscal 2020 and then steadily lower the debt-to-GDP ratio.
The Cabinet Office, which shares the pro-growth views of premier Abe, wants the government's fiscal reform plans to focus more on reflating growth with stimulus than on spending cuts.
That conflicts with the stance of Japan's powerful Ministry of Finance, which has called for raising tax and cutting spending to rein in debt.
BOJ Governor Haruhiko Kuroda, a former finance ministry bureaucrat, has repeatedly called on the government to speed up reforms, including through raising the sales tax.
In February, the Cabinet Office said it expected the debt-to-GDP ratio to fall to 182.6 percent in fiscal 2023 from 195.1 percent expected in the current fiscal year, but these forecasts were based on the government's best-case assumptions for economic growth. (Writing by Stanley White; Editing by Will Waterman)