Transcript of a Teleconference Call on the International Monetary Fund’s 2011 Article IV Consultation with Japan

July 19, 2011

Washington, D.C.
Tuesday, July 19, 2011

MR. PRADHAN: Thank you, and good morning to everyone who’s on line. Let me start by saying my name is Mahmood Pradhan. I’m the IMF’s Mission Chief for Japan, and I have with me two colleagues, Martin Mühleisen, who led the Japan spillover report this year, and I’ll say a little bit more about that in a minute. And I also have Kenneth Kang who is the Division Chief managing our work on Japan and manages the team.

I will start by giving a brief outline of the focus of this year’s Article IV Consultation and then open up for your questions. Let me say that -- and let me remind you before we start that this call is embargoed until noon U.S. East Coast time, probably quite near the end of our call.

Let me start by giving you the highlights of this year’s Consultation. The focus has been on three issues, all as you will see very closely related. First, how much damage the earthquake has caused to the economy and how it has affected the outlook near term and over the medium term. The second issue we have focused on is the fiscal strategy, and this is in two parts: What are the immediate plans for fiscal policy given the damage to the economy from the earthquake and the tsunami and a number of related issues? The second part of this fiscal strategy is how to deal with fiscal policy over the medium term? And the essence here is not to lose sight of the need in Japan to reduce public debt over the medium term. And in that fiscal strategy, a centerpiece of our policy advice has been that the authorities should consider raising the consumption tax -- I’ll talk a little bit more about that -- and this change in the consumption tax they should consider introducing next year when we expect the cyclical recovery to be underway.

And in the context of supporting the recovery, we also see a strong role for the BOJ to continue along the lines of something it started last October, the Comprehensive Monetary Easing Program, which involves purchasing assets, including private sector assets, and we have encouraged the BOJ to expand this particular part of the asset purchase program further.

And lastly, we have not forgotten that Japan needs a longer term growth strategy, reforms that would change potential growth of the economy and raise it. And here we have focused on three areas: One is to increase labor force participation of some, what I might call underrepresented groups in the labor force -- that is women, the elderly, and the young. The second part of this growth strategy is to be more constructive overtime in trade partnerships, particularly the TPP (Trans-pacific Partnership), and to join the negotiations on TPP and to open up the economy and benefit from external integration with other economies.

And finally before I get into a little bit more detail, I want to say that this year the IMF has also introduced what we call the Spillover Reports for five systemic areas, Japan is one of them. And I introduced my colleague earlier, Martin Mühleisen, who led the work on this year’s Japan Spillover Report, which is also being issued in conjunction with the Article IV Staff Report. And we will take questions on this later, but very briefly, the focus of Spillover Report is asking questions about how Japan’s domestic environment, how policies in Japan, affect the rest of the world. Spillover Reports for the other countries ask similar questions in the other systemic areas, and the other areas are the U.S., the U.K., the Euro area, and China.

We will not talk about those reports. That’s the subject of other press events and also those reports will be available, but I just wanted to give you some background. Let me highlight the summary of this year’s focus. As you will see from the report, there are two or three key issues. One is that the earthquake has had a very major impact on the economy. We see both the first quarter and the second quarter of 2011 were very adversely impacted, and that is what is behind our significant downward revision of growth. We now expect growth to be minus three-quarters of a percent this year, but we expect a strong rebound. We believe some of this -- part of this rebound has already begun. The situation is normalizing. We see strong growth in the second half of this year on an annualized basis. We think this will run at around 5 percent a year. And next year, for the year as a whole we see the economy growing at 2.9 percent. And the key drivers of this recovery are: one, the supplementary budgets that you are all familiar with. We’ve seen two amounting to about 1.2 percent of GDP. We expect a third to be sizeable, somewhere in the region of 2 percent of GDP. That is built into our growth forecast for next year.

Second, we see a rebound in consumer sentiment. We note that employment levels have held up quite well with adjustments mostly in hours worked; therefore, we do not see a major hit to household income. Rather we think consumer sentiment has suffered unduly and that the recovery in consumer sentiment should support the recovery next year.

And finally, as a normalization of production facilities and the supply chain disruptions and power disruptions -- as those things normalize, we expect exports and production to rebound.

In terms of the characterization of our forecast, we appreciate the uncertainties, which are perhaps unusually large going forward. One source of this uncertainty is the availability of power over the medium term as Japan addresses questions about how much to rely on nuclear power, whether to switch to other sources of power, and what that would do to energy costs in both the near and the medium term.

Let me stop there because I want to give you time to ask your questions. And as I said, I have two colleagues with me, and I may well defer some of your questions to them.

QUESTIONER: Hi. Thank you for doing this, and I have two questions. Mr. Pradhan, regarding the consumption tax, when we take a look at this Public Information Notice, in this assessment by the Executive Directors, the recommendation for raising consumption tax isn’t that specific compared to the Staff Report. And I just wanted to know the reasoning behind this?

And also secondly, I’d like to ask about the power shortage situation which you just touched on. The power situation has been constantly changed in Japan by Prime Minister Kan. He wants to eliminate nuclear plants in japan. So what’s your sense on those situations, particularly the situation right now, and also what would be the effect of these policy changes in Japan going forward?

MR. PRADHAN: Okay, thank you. Let me start with your question on the consumption tax and the assessment of this proposal by the IMF’s Board. The PIN statement is a summary of that discussion; therefore, it is not surprising that it doesn’t have details and is not specific. But in the PIN statement Executive Directors were supportive of our medium-term fiscal strategy, and that medium-term fiscal strategy is not just a consumption tax. It includes other measures. And by other measures, I mean it includes expenditure reductions in certain areas. Some of the reforms that would allow raising, for example, the pension age, that would allow reducing social security expenditures to some extent. There’s very limited room to reduce non-social security spending. It includes improving the efficiency of the tax system, particularly the personal tax system exemptions and allowances. So in answer to your question, I would not read too much into the PIN statement on your specific point that the PIN statement was not as specific as the proposals you see. The Staff Report was approved by the Board and that’s why you have it and is going to be released soon.

Let me turn to your second question. There are two separate issues to my mind on the power shortage. One is a near-term and the other is a longer-term power issue. The near-term issue is about the 54 nuclear reactors, all of them as you know will be inspected by early spring. Now for some of them, there is a feeling among some communities in Japan that they may not allow these reactors to be restarted even if they pass their technical inspection. That’s a source of uncertainty, and this is what I touched on in terms of next year’s forecast. For example, if a lot of nuclear reactors were not restarted, then Japan would have to switch to alternative energy, the costs would be higher, and that would affect our assessment of the recovery. We do not have firm information given the nature of the issue on how many reactors will not be restarted or if the restart would be delayed for a significant amount of time. We see this as a source of uncertainty.

The second issue which you refer to on your point about concerns the Prime Minister expressed about Japan’s reliance on nuclear power -- we see this as a much longer-term issue. We would expect in the political debate about nuclear power, that any decision to reduce reliance on nuclear power would, of course, take into account the time it will take to find alternative energy sources. But we do not know where this debate will progress to at this stage. But I want to emphasize that replacing nuclear power with other sources of power is a longer-term issue. Of course, if it’s done too rapidly, it will affect energy costs because if Japan cannot switch to other sources of power in that fast a time, then it will be a concern. But again, I want to emphasize that this is a wider debate on which we do not see any decisions yet.

QUESTIONER: Thank you. Let me quickly follow up on the first point. So on staff proposals for Japan to raise the consumption tax to 15 percent in several years. Dids the Executive Board support those recommendations?


QUESTIONER: Okay, thank you so much.

QUESTIONER: Thank you for the call. You’ve made some recommendations for the Bank of Japan to continue its policy stimulus, particularly its asset purchase program or at least considering it and being prepared to use it. And in the Staff Report you also highlight their response. I took it as a slight reluctance to implement the sort of program that you’re suggesting. One, is that an accurate perception of their response? And two, if it is, what concerns do you have if they do not move ahead as you recommend?

MR. PRADHAN: Mostly the Bank of Japan and the IMF are on the same page in terms of the monetary easing or, if you will, increasing the accommodative stance of monetary policy would require unconventional measures given that we are already at very low interest rates. And, in fact, the Bank of Japan started this program before the earthquake. Where are we are right now? In your reference you sense some slight reluctance. The backdrop is that they -- the Bank of Japan -- see inflation at a slightly higher level than we do. And you will see the differences in the staff report. They see inflation at around 0.7 percent. And the reason for that is they see higher increases in commodity prices than we do. So the differences in our views on the inflation outlook are relatively straightforward and easy to explain. We have a concern, based on our view of commodity prices and the recent history of Japan’s inflation that deflation risks will persist. And that view is based on what we see as a very large output gap in the economy, and that’s why we think they could expand the asset purchase program further. Their view is that they stand very willing to expand that asset purchase program. They do not see an immediate need to do this. And as I said, the backdrop is a different view on inflation.

Let me say that there is no fundamental disagreement on the program, on the size of the program, and as you know, they expanded it immediately after the earthquake. And in our recommendations, effectively what we are saying is they could use up the space they have in what they’ve already expanded. They expanded it from five to ten trillion yen, and they haven’t used up that ten trillion yet. I hope that answers your question.

QUESTIONER: Yes, it did, the first part. The second part, what are the consequences of –

MR. PRADHAN: Oh, I’m sorry.

QUESTIONER: -- if they’re wrong about inflation and the IMF is right?

MR. PRADHAN: Well, as I said, if inflation turns out to be much weaker than their own forecast, they stand willing to expand the program. If they did it as developments turn out to be different from what they expect and they were fairly rapid in reacting to this I don’t see any major consequences, and I have full faith that they will. I would say they are just as vigilant if not more vigilant on these issues than we are.

QUESTIONER: Thank you very much.

MR. PRADHAN: Thank you.

QUESTIONER: Okay. I just asked about the spillover report and you mentioned that the disruption of the supply chain. Could you tell us a little more about the current situation in Japan on the supply chain disruption and the potential impact of those going forward, like the near-term and medium-term?

MR. PRADHAN: Let me take your question in two parts. I will come back to our current assessment of where things are in terms of the supply chain and the power disruptions, but I want to turn to Martin to explain how we’ve dealt with this in the broader spillover report. So I’m going to ask Martin to first talk about the spillover report and what the focus of that report was about, and then I’ll come back to our current assessment of the supply chain or power disruption issue. Martin?

MR. MÜHLEISEN: Yes, thank you for your question. The major focus of the Spillover Report, of course, was the economic and financial policies, but clearly with the earthquake happening we had to look into the impact of that one, too. We did this in two ways: One, we looked at the direct impact on, for example, production values abroad. And I think we mentioned in the report with a little box and charts, for example, the impact on U.S. car production. And we also looked into the reaction of sectors in other countries that were producing goods in similar areas as those that were affected by the earthquake. What we found in general was the impact was temporary, in part because the authorities have already kind of taken very strong steps to alleviate any shortcomings there. And from our reading of changes in macro forecasts and the assessment of other countries that are trading with Japan, we found that there was no major or no significant downgrade to their forecast. So in our view as long as the shortages are addressed very quickly, which they are, the overall impact should be fairly temporary.

MR. PRADHAN: Okay. Thanks, Martin. Actually, let me turn to Ken to answer -- Ken, can you take the supply chain question, our current assessment of the power issue?

MR. KANG: Okay, on the supply chain issue, I think our assessment is that supply chain constraints have eased faster than we had originally expected. I would point to the fact that industrial production after declining sharply by 15 percent in March has recovered for the past two months. And the forward-looking indicators do point to a fairly solid rebound in production activity looking ahead.

Also as Martin pointed out, given that exports are also showing signs of recovery, we expect exports to pick up also in the second half of the year as the supply constraints ease, as the electricity situation stabilizes. And we’re already hearing stories that major producers like Toyota and Renesas, one of the key suppliers of electronic microprocessors for automobiles, have moved forward their timetable for restoring full capacity to the summer. I think these are all encouraging signs that this supply side disruption will be short lived.

MR. PRADHAN: Okay. Thank you, Ken.

QUESTIONER: Hi, I just wanted to follow up a little bit.

MR. PRADHAN: Yes, go ahead.

QUESTIONER: So regarding the impact by the supply chain disruption in Japan, initially when we had a conference call early May, the initial assessment by the IMF was that the impact of those will be limited. Then the United States came out and started to say that the impact is more significant than it had predicted. I just wanted to ask about both your assessment at the beginning was wrong. And I’d also like to ask about what was your thinking process up until now or if the IMF analysis at the beginning which was limited is still the case? Is it that the United States is just using the disruption of the Japanese situation as a kind of excuse to explain a little of their economy?

MR. PRADHAN: Okay, thank you. Our initial assessment was based on very, very limited information, and to take you back to that time just immediately after the earthquake, we did not know how large the decline in industrial production in March was. And as we now know and as you know that was the largest monthly decline ever, about a 15 percent fall in industrial production in Japan. We did not know at that time how large an interruption to the supply chain this would turn out to be, how key components would paralyze or would stop production of cars both in Japan and in other parts of the world. That data became available later. So, yes, we were wrong then, but our assessment was based on very limited information.

Secondly, what has surprised us and many other people -- and I touched on this in my earlier remarks -- is the very, very large decline in consumer sentiment and consumption expenditures when there was no corresponding fall or certainly not of that magnitude to household incomes. That has surprised us, and as I mentioned, that is now also a factor behind our forecast of a strong rebound and a strong recovery. I think if you look at all other forecasters who were also assessing Japan’s outlook, you will find a very, very similar pattern, that early assessments were less pessimistic than when more data became available. And as people realized that this was not just a supply shock, but at the same time there had been a big demand shock, the assessments changed and they all revised down. Now, I’m ignoring, of course, some differences between the assessments. But broadly speaking, the pattern for all forecasters has been very similar.

QUESTIONER: Yes, hi. We had some overnight comments from the Bank of Japan’s Yamaguchi regarding the yen. I was wondering whether you have the same concerns as he does over the strength of the yen and how that’s going to impact this recovery that you’re forecasting?

MR. PRADHAN: Okay, let me start by saying we’re reluctant, for very good reasons to comment on very short-term movements of exchange rates, first because we don’t have the expertise to comment on very short-term movements, secondly because these things often get reversed and don’t have a large bearing on the outlook. With that just as a caveat, let me say that the yen -- two issues on the yen. One is that in real effective terms the yen is broadly where it has been for the last 20 years. In nominal effective terms, we see the yen has been fairly stable against the major currencies for this year to date. Perhaps your question is focused too much on movements of the yen versus one currency, the dollar.

The second issue that I would point out is that there are differences between some of the movements of the yen now, and say immediately after the earthquake. Immediately after the earthquake, we saw the yen appreciate perhaps a little rapidly, but at the same time we saw a large decline in equity markets. This time around, over the last week or two when the yen has been strengthening against the dollar, there have been movements in other currencies as well. And we see equity markets as broadly stable and nothing unusual happening to Japan’s equities relative to other major equity markets.

QUESTIONER: Do you see any major exposures to the European banking crisis from the financial sector in Japan?

MR. PRADHAN: The direct exposure of Japan’s banks to some of the peripheral European countries is very, very small, about 1 percent of total bank assets. I think that’s very manageable, probably about $100 billion we’re talking about. The indirect effects of any global financial kind of distress or stress are always a bit harder to predict. But the exposure of the Japanese banks to foreign assets generally is relatively low and to the assets of some of the countries under the spotlight are actually very low.

QUESTIONER: I’m just wondering the Japanese stock market is declining because of the debt ceiling issue, the uncertainty around the debt ceiling issue in the United States.


QUESTIONER: And you are doing research on the spillover effect so are you right now looking into that spillover effect from the debt ceiling issue around the world or if so, could you give us some sense of those?

MR. PRADHAN: I’m not involved directly on work on the U.S. debt ceiling. That would be a question you would have to ask our U.S. team and their perspectives on that. Generally, I’d say that there are some movements in global stock markets that are perhaps partly related to the U.S. debt ceiling issue, but also other events going on around the world including some of the difficulties in Europe. But beyond that I could not tell you what the direct impact of the U.S. debt ceiling negotiations is. And I suspect that’s pretty difficult to detect in financial markets.

QUESTIONER: Thank you very much.



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