UPDATE 1-BOJ's Kuroda: Economy can handle sales tax increase
* BOJ: Tax hikes necessary step for fiscal discipline
* Doubts growing whether PM Abe will go through with hikes
* BOJ battling to end 15 years of deflation
TOKYO, July 29 (Reuters) - Bank of Japan Governor Haruhiko Kuroda said a planned increase in the sales tax rate would not hurt the economy and was needed to repair public finances, amid growing signs on Monday the prime minister could delay or even water down the policy.
Kuroda, appointed by Prime Minister Shinzo Abe earlier this year, said fiscal discipline was important because long-term yields could rise if investors thought the central bank's purchases of government debt were aimed at financing spending.
Abe has ordered a study of alternatives to a plan to double the sales tax to 10 percent, government sources said, raising concerns that a rise in bond yields could undermine efforts by the government and central bank to escape deflation.
"I do not think that raising the sales tax as currently planned will do any great harm to the economy," Kuroda said in a speech in Tokyo.
"The BOJ is purchasing debt for price stability. If people think this is financing government spending, long-term yields could raise, rendering monetary policy less effective."
The BOJ's expanded quantitative easing, which it launched in April, is making great progress towards pulling Japan out 15 years of deflation, Kuroda said.
Inflation was likely to approach the central bank's 2 percent target as Japan's economic growth exceeds its potential, which would narrow a negative output gap, he said.
Overseas economies posed the biggest risk to this outlook, with Europe's debt crisis unresolved and China shifting its economy away from excessive fixed-asset investment, he said.
The sales tax is due to rise to 8 percent in April 2014 and then 10 percent in 2015, and Abe has said he will decide in autumn whether to go ahead with the first increase.
His finance minister last week supported the tax increase, saying it was needed to show Japan was serious about fixing its finances.
Reneging on fiscal reform could hit investor confidence, which has allowed Japan to borrow money cheaply even though its debt burden is the worst among major economies at more than twice the size of its $5 trillion economy.