By Leika Kihara

(Reuters) -The International Monetary Fund on Thursday warned of “uncertainty” around the direction of Japan’s monetary policy, saying a possible shift from ultra-low interest rates could have a significant impact on global financial markets.

Krishna Srinivasan, director of the IMF’s Asia and Pacific Department, also pointed to risks surrounding Asia’s economic outlook including from weakening exports to advanced economies, slowing productivity in China and a fragmentation of global trade.

“Over the medium term, we expect the Chinese economy to experience a slowdown in productivity and investment, which will lower growth below 4 percent by 2028,” he said.

“In addition, we see a risk that the global economy fragments into trading blocs,” which could deal a particularly heavy blow to export-reliant Asia, Srinivasan said in a briefing at the Asian Development Bank’s annual meeting in Incheon.

While most Asian central banks must keep tightening monetary policy, Japan remains an exception with inflation still moderate – though this could change.

“There is uncertainty around the direction of monetary policy in Japan, amid a rise in inflation,” Srinivasan said.

“Changes in Japan’s monetary policy that lead to further increases in government bond yields could have global spillovers through Japanese investors, who have large investment positions in debt instruments abroad,” Srinivasan said.

“Portfolio rebalancing of these investors could trigger a rise in global yields, causing portfolio outflows for some countries,” he added.

With inflation exceeding its 2% target, markets are rife with speculation the Bank of Japan (BOJ) could modify its bond yield control policy in coming months.

The BOJ kept ultra-low interest rates on Friday but announced a plan to review its past monetary policy moves, laying the groundwork for new governor Kazuo Ueda to phase out his predecessor’s massive stimulus programme.

Srinivasan said China’s rapid recovery after the re-opening from pandemic-related curbs will likely lift exports in some Asian countries including South Korea.

“The initial phase of the recovery in China has been led by consumption and services, but at any time in the second half of the year, we will see a change from consumption and services to more manufacturing demand,” Srinivasan told reporters.

While headline inflation is moderating in South Korea on lower energy prices, core inflation excluding food and energy costs has yet to come down decisively, he said.

That meant the Bank of Korea (BOK) must avoid a premature monetary easing, though it should also minimize the risk of tightening policy too much, he said.

“Taking these considerations together, the BOK has appropriately paused rate hikes in the February and April meetings, while keeping options open for further hikes depending on incoming data.”

(Reporting by Leika Kihara in Tokyo and Jihoon Lee in Incheon, South KoreaEditing by Shri Navaratnam)