The International Monetary Fund, in its annual report, predicted that unless Japan acted decisively to shore up its banking sector and stimulate its economy, a new round of Asian currency turbulence could be set in motion.

In addition, a sharp correction in the stock markets of the United States and Europe would further dampen recovery efforts in emerging economies. The study carried out by the IMF staff focussed on key developments through last July, according to Charles Adams, assistant director of the fund's research department.

"Several of the risks we've identified in this report have subsequently materalised," Adams told a press conference here, noting that the study was completed before the Russian economy neared collapse, Latin America came under threat and world stock prices plunged. "We'renow looking at a broader crisis in emerging capital markets than we were only a couple of months ago," he said.

The report warns that "the current situation in the global capital markets contains a number of significant risks and uncertainties, as well as the possibility of heightened volatility and large asset price corrections in period ahead."

It said private capital flows to emerging markets registered a sharp 67 billion dollar contraction last year, the first such decline this decade, as investors steered clear of troubled Asian economies. The fund also highlighted the profoundly destabilising effects of large and sudden swings in capital flows to emerging markets.

In some instances, it said, countries might have to impose temporary controls -- in the form of takes -- to reduce their vulnerability to the effects of short-term capital investment.

Such a step should complement improved data dissemination on emerging market conditions, as a means of improving investor behaviour, as well asinitiatives to establish strong regulatory and supervisory systems.

The IMF was blunt in its insistence that Japan move quickly to reform its banking sector, currently riddled with bad loans, and boost growth. The report said private capital flows to all emerging markets in 1997 fell 67 billion dollars to 173.7 billion.

Most of the decline in total capital flows to Asia was concentrated in countries hit hardest by financial weakness like Thailand, Malaysia, Indonesia and South Korea. "The failure of Japan to deal promptly and forcefully with its banking and financial sector problems is contributing to significant domestic economic weakness and downward pulls on the yen, risking significant spillovers and another round of Asian currency turmoil," the report warned.

The study in addition cited the potentially damaging impact of a dramatic correction in us stock values. "US stock prices are even more overvalued now than they were one or two years ago, and especially in light of the slow down in earningsgrowth that has already taken place, the current phase of the business cycle and the likelihood of further fallout from Asia."

A severe correction could aggravate weaknesses in the Japanese economic and financial system... And make the risk of spillovers more worrisome than usual, the report said.

Adams observed that markets in the US and Europe were now experiencing "some correction, some fall back" from stock valuations which have been "difficult to rationalise". Asia, from 1994 to 1996 the largest recipient of private capital flows to emerging markets, registered a drop-off of nearly 100 billion dollars last year to 13.9 billion.