Press Release No. 15/352

Press Release: IMF Executive Board Concludes 2015 Article IV Consultation with Japan

July 23, 2015

On July 17, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with Japan.

A modest economic recovery is underway. GDP is expected to grow at an above-potential pace this year (0.8 percent) buoyed by gradually strengthening private consumption on higher real wages and a gradual recovery of external demand. Inflation remains well below the Bank of Japan’s 2 percent target partly due to commodity price developments, but will start to pick up toward the end of this year with the dissipation of the negative effects of falling oil prices and higher wage growth.

Ongoing structural reforms have improved long-term prospects modestly. Growth is projected to stabilize at around 0.7 percent over the medium term with improvements in productivity and capital formation and higher labor force participation offsetting headwinds from the diminishing labor force. On the back of the closing of the output gap, a tight labor market and renewed favorable wage-price dynamics, inflation is expected to increase gradually to about 1.5percent over the medium term under current policies. However, risks to this outlook are tilted to the downside with the most important risks stemming from weak domestic demand and incomplete policies, particularly with regard to the fiscal consolidation and structural reforms.

Abenomics needs to be reloaded so that policy shortcomings do not become a drag on growth and inflation. In addition to swift implementation of already announced reforms, further high-impact structural reforms are urgently needed to lift growth, facilitate fiscal consolidation, and unburden monetary policy. The next round of reforms should lift labor supply, reduce labor market duality, continue agricultural and services sector deregulation and turn the financial sector into a driver of reforms.

A credible medium-term fiscal consolidation plan is needed to remove uncertainty about the direction of policies that may be holding back domestic demand. The medium-term fiscal reform plan should aim to put debt on a downward path, based on realistic economic assumptions, and specify structural revenue and expenditure measures upfront. The Bank of Japan needs to stand ready to ease further, provide stronger guidance to markets through enhanced communication, and put greater emphasis on achieving the 2 percent inflation target in a stable manner. However, further monetary easing without bolder structural reforms and a credible medium-term fiscal consolidation plan could lead to sluggish domestic demand and overreliance on yen depreciation to pursue domestic policy objectives, with possible adverse spillovers abroad.

Executive Board Assessment²

Executive Directors welcomed the improved medium-term outlook for growth and inflation. Directors commended the authorities for persistently pursuing the three-pronged economic strategy to lift growth, overcome entrenched deflation, and reduce public indebtedness. With risks tilted to the downside, Directors underscored that it would be essential to reinvigorate all elements of the government’s economic strategy, the success of which will also be beneficial for the global economy.

Directors emphasized the urgency of completing far-reaching structural reforms to address the challenge of population aging and achieve the ambitious growth objectives of the revitalization strategy. They welcomed the recent progress in improving corporate governance and raising female labor force participation. Directors encouraged further growth-enhancing reforms to increase labor supply, reduce labor market duality, and deregulate the agricultural and service sectors. Continued efforts are also needed to enhance the efficiency of resource allocation through the financial system.

Directors agreed that the fiscal consolidation strategy needs to strike a balance between making progress on deficit reduction and supporting growth and inflation momentum. They welcomed the recent announcement of a medium-term fiscal consolidation plan with specific primary deficit targets while acknowledging the need for flexibility to take account of economic and price developments. Directors noted that prudent economic assumptions, identification of concrete measures to put the debt-to-GDP ratio on a downward trajectory, and strong fiscal institutions would help impart credibility to the consolidation plan. Specifically, ongoing efforts to raise the consumption tax and reform expenditures are crucial to this strategy.

Directors stressed that raising inflation in a stable manner remains an important— albeit challenging—priority. They were reassured by the authorities’ readiness to take further monetary policy action as necessary, complemented with enhanced communication to guide markets. Directors encouraged the authorities to continue to improve monetary policy transmission, and to strengthen momentum for wage increases in the tripartite dialogue.

Directors agreed that the financial system remains sound and well capitalized. They supported initiatives to further enhance its resilience to risks, including from volatility in interest rates and liquidity in the government bond market. Directors saw scope for financial institutions to seek higher returns while improving their risk management tools. They emphasized the role of macroprudential policies in addressing financial stability risks in a low interest rate environment.

Directors took note of the staff’s assessment that Japan’s external position was broadly consistent with fundamentals in 2014 but that the yen has depreciated since then. Going forward, ambitious structural reforms to boost domestic demand and credible fiscal consolidation are critical to avoid overreliance on the depreciation of the yen. These efforts will ease the burden of monetary policy, as well as help avert negative spillovers from portfolio rebalancing by Japanese financial institutions.