Japan should expect stronger growth as the global economy improves but the government and central bank must work harder to end deflation and fix the banking system to ensure a sustained rebound, the OECD said Thursday.

Gross domestic product was forecast to expand 1.0 per cent in 2003, up 0.2 percentage points from a projection made last November, according to the Organisation for Economic Cooperation and Development.

"Although the outlook for domestic demand remains weak, a rebound in world trade growth in the second half of

2003 may prompt a mild recovery," it said in its half-yearly economic report.

The world's second largest economy would grow 1.1 per cent in 2004, up from 0.9 per cent seen previously, the OECD predicted.

But this anaemic revival would fail to reduce near-record high unemployment levels or fight persistent deflation, which has curbed corporate profits and consumer demand.

"Indeed, a possible strengthening of deflationary pressures poses a downside risk to the projection, as do continued financial sector fragility and the strains associated with a further rise in public debt," the Paris-based

grouping of developed countries warned.

Measures have been implemented in the past six months to help the economy -- such as a move by the Bank of Japan to buy shares from banks and the establishment of a governmentrun body to purchase some bad loans -but they do not go far enough.

"More aggressive liquidity provision (by the BoJ) combined with a decisive restructuring of the financial sector is advisable," OECD chief economist Jean-Philippe Cotis said in the report.

A clean-up of Japanese banks, buried under billions of dollars in non-

performing loans, was a top priority, the OECD said.

The government should be ready to boost banks' capital with public funds as they offload bad loans and struggle against a plunge in stock prices, which has eroded the value of their shareholdings.

Japan's financial authorities have instructed major banks to halve the ratio of NPLs to total loans by March 2005.

At the same time, Japan, which has the highest national debt of all industrialised nations, needs to control extra budgetary spending.