The euro zone has made much progress in battling its three-year old debt crisis with the tough reforms taken by hardest-hit countries particularly encouraging and it needs to keep up the momentum, Japan's top financial diplomat said on Wednesday.

He also made conciliatory comments towards China over the dispute between the two countries over sovereignty of a small group of islands that has raised tensions between the two countries.

Takehiko Nakao, vice finance minister for international affairs, told Reuters in an interview that Japan will urge Europe to sustain the pace at a Group of Seven finance chiefs' meeting and annual IMF and World Bank gatherings in Tokyo next week.

Japan has repeatedly voiced concern over the pace and scope of Europe's efforts, worried that the prolonged turmoil was boosting the safe-haven appeal of the yen and driving it to heights that the country's exporters struggled to cope with.

Nakao said the euro crisis remained one of the top challenges for the international community, but also struck a positive note.

"I think the euro zone has made a real effort and has made a lot of progress regarding the policy of the ECB, the rescue funds and stronger governance of the euro system regarding fiscal consolidation," he said.

"Above all, Greece and Spain and other countries are making very serious efforts of reform and fiscal consolidation."

"What I can say is that they should continue to take decisive action to implement things which would sustain and strengthen the economic and monetary union of Europe."

Spain, the euro zone's fourth-largest economy, is expected to seek international help to meet its financing needs after it passed a crisis budget last weekend.

But unlike in the past, Spain's rescue would be supported by the European Central Bank, which last month pledged to buy potentially unlimited amounts of bonds from governments that ask for help and agree to tough economic reforms.

Japan's newly appointed Finance Minister Koriki Jojima told reporters earlier on Wednesday he was likely to bring up Japan's views on the currency during the G7 meeting.

Jojima reiterated Tokyo's long-held position that the yen, largely driven by overseas developments such as the euro crisis, was too strong for Japan's economic conditions and that Tokyo was ready to intervene to correct that - a message echoed by Nakao.

Nakao said next week's discussions will also involve other risks to the world economy, such as a threat of a 'fiscal cliff' of expiring tax breaks and spending cuts in the United States and an economic slowdown in China and other emerging markets.

Yet while China is seen heading for the seventh consecutive quarter of slowing growth in the third quarter, Nakao was optimistic about its longer-run growth prospects.

"They now feel difficulty because of the slowdown in exports to Europe and because of the impact of tightening in response to the inflation hit," he said. "But in the medium-term, China is still a developing country and many people want more things like cars and TV sets so I think that China can achieve high growth more based on domestic demand instead of external demand."

The ministry's top financial diplomat also said that despite a recent flare-up in tensions between the two countries over disputed East China Sea islands, he hoped the two top Asian economies would not abandon efforts to strengthen economic and financial ties.

Sino-Japanese relations deteriorated sharply after Japan in September bought the East China Sea islets that both Tokyo and Beijing claim, sparking anti-Japan protests across the country.

The disputed group of islands, called Senkaku in Japan and Diaoyu in China, are located near rich fishing grounds and potentially huge oil and gas reserves. Taiwan also asserts its own sovereignty over the islets.

Japan and China started trading their currencies directly in June as part of an agreement struck by the leaders of the two countries in December, which also involves Japan buying Chinese government debt.

"There's no signal that we would reverse. I have been in close communication with China and I hope we can continue to deepen cooperation in this area too," Nakao said.

Speaking about a meeting devoted to Myanmar that will be held on the sidelines of next week's gatherings at Tokyo's initiative, Nakao said it would give the nation's leaders a chance to convince creditors of their commitment to reforms and pave the way towards debt relief and large-scale economic assistance.

"I'm not expecting that this meeting is becoming a pledging session. This is still an early stage of a deepening of the dialogue and discussion between Myanmar and donor countries," he said.

"What we want to have is a clear message from Myanmar representatives that they will make further progress in political reform and economic reform and efforts to end internal conflicts."

After decades of military rule the impoverished country embarked on sweeping political and economic reforms, but badly needs debt forgiveness, investment and international assistance to move on.

(Editing by Neil Fullick)