Sales tax hike is vital and will hurt Japan, says IMF

Japan's upcoming consumption tax hike will hurt growth, but it's a necessary sacrifice to inject investor confidence in the country's ability to address its colossal debt pile, said Jerry Schiff, mission chief for Japan at the International Monetary Fund.

Japan is due to raise its sales tax in April to 8 percent from 5 percent, and to 10 percent in October 2015, in a move that will help the economy cut its fiscal debt of over 200 percent of GDP.

(Read More: Could Japan fall back into recession next year?)

Critics of the tax say the measure could hamper Japan's nascent economic recovery, and recent media reports have suggested Prime Minister Shinzo Abe is considering delaying the hike.

"It (tax hikes measure) will slow (Japan's) growth by 0.3 percent to 0.4 percent," said Schiff. "But you need to weigh against that the large benefits that it will generate by cementing some confidence in the ability and willingness of the government to take on the fiscal problem," he said.

"We don't think the tax will put the recovery off its rails," he added.

(Read more: Japan faces most crucial earnings season in a decade)

Since Prime Minister Shinzo Abe was elected into power late last year, he has embarked on a radical plan to overhaul the economy through aggressive monetary stimulus, fiscal stimulus and structural reform, known as 'Abenomics,' which so far has been successful in generating positive sentiment not seen in the country for decades.

Tomohiro Ohsumi | Bloomberg | Getty Images

According to Schiff, confidence is key in ensuring increases in wages and investment, which he describes as "the next stage of recovery" that markets need to see.

"We've seen rapid growth largely driven by stimulus and some consumption but we want to see firms raise wages and invest more. And to do that they need to be fully convinced that this recovery is on and it's going to be sustainable," he said.

Inflation target delayed

Schiff sounded a note of caution on the likelihood of the Bank of Japan (BOJ) achieving its inflation target of reaching 2 percent in two years and said a three to four year timeframe was more realistic.

"We've seen that they [markets] have started to respond [to inflation expectations] but [inflation levels] are not anywhere near 2 percent which implies the BOJ's target is not fully credible... but is certainly moving in the right direction," said Schiff.

(Read more: No need to doubt our reform vow: Japan minister)

"In our baseline we have 2 percent inflation.. being achieved in 2016 and 2017," he added.

Inflation has shown some signs of picking up, with core inflation jumping to 0.4 percent in June, its highest level since the end of 2008.

(Read more: At last, inflation in Japan is speeding up)

Japan's government has forecast growth of 2.8 percent in the fiscal year 2013/2014, but warned that growth would slow to 1 percent in 2014/2015 as the sales tax hike weighs on consumption.

—By CNBC's Katie Holliday: Follow her on Twitter @hollidaykatie