Transcript of a Conference Call On the 2008 Article IV Consultation with Japan

July 29, 2008

Washington, D.C., Tuesday, July 29, 2008

MS. GAVIRIA: Hello, everyone. I'm Angela Gaviria, with the IMF's press Office. I'm happy to welcome you on this conference call on the 2008 Article IV Consultation with Japan. Let me introduce the speakers, Daniel Citrin, who is Deputy Director in the Asia and Pacific Department of the IMF and the Mission Chief for Japan. Also here with me is James Gordon, who is Division Chief in the same department. Daniel Citrin will have some brief remarks, and then he and James will be happy to take your questions.

MR. CITRIN: Thank you. Just some very brief remarks summarizing our assessments of the economic situation and main policy requirements at this juncture.

We see the economy in Japan clearly slowing now, but nevertheless headed for a soft landing. Through the first quarter of this year growth remained quite strong, assisted by strong exports to emerging markets, in Asia as well as non-traditional markets, such as in the Middle East.

Timely liquidity provisions by the Central Bank, and the banking sector's relatively limited exposure to subprime assets, also helped to cushion the effects of global financial pressures that are affecting us now.

More recently however, since the first quarter, clearly activity has been slowing rather substantially, and this is in line with decelerating growth in the rest of the world, as well as reflecting the effects of the increasing global commodity prices and associated loss in Japan's terms of trade.

So the economy is clearly slowing, but nevertheless we're projecting a soft landing as I said at the outset, and growth to amount to about 1.5 percent or slightly less, both this year and next. This of course is somewhat below what we consider to be potential growth in Japan, and well below the slightly over 2 percent average growth registered during the long expansionary phase from 2003 to 2007. But nevertheless we have a relatively modest downturn. At the same time, headline inflation, mainly reflecting the surge in global fuel and other commodity prices, has risen to around 2 percent, in the latest month. But underlying inflation stripped of these, of the food and fuel price increases, remains at around zero.

Now, while we foresee a soft landing, the growth outlook of course is subject to considerable uncertainty, particularly related to the depth of the U.S. slowdown and the effects of the ongoing financial turmoil. And the highly volatile global commodity price situation also makes inflation very difficult to project.

Nevertheless, with the downturn expected to be modest, and inflation I think still contained, our view is that the current policy settings in Japan are broadly appropriate, and that no major shift in economic policies is needed.

More specifically, interest rate policy should remain accommodative at this time, and fiscal policy, which this year we regard to be broadly neutral, should remain focused on medium-term challenges associated with reducing the large public debt. We don't believe there's any case for a large fiscal expansion. And at the same time, the Financial Services Agency should continue their efforts to strengthen the financial sector.

Let me just stop there. We'll be happy to take questions.

QUESTIONER: I was wondering if you could explain a little on which factors you think will prevent Japan from slipping into a recession. I know a couple of private sector banks have made more pessimistic forecasts than you're making now.

MR. CITRIN: Let me clarify. We do see certainly the economy moving relatively sideways for the last three quarters of this year. And the number of 1.5 or slightly below—we may end up with a slightly lower forecast of 1.3, 1.4, when all is said and done—reflects to an important extent the carryover effects of the very strong first quarter. Indeed, we do see the economy slowing to probably a virtual standstill in the second quarter of the year, and rather weak growth in the second half of the year, before beginning to recover next year.

That said, again several factors are cushioning the slowdown. One is that exports are being held up by strong growth in the rest of Asia, and in the non-traditional markets—and we do so far see some slowdown in Asia, but growth should remain relatively robust there—and also the fact that the banking sector... notwithstanding announcements of fairly substantial losses by financial firms in Japan being announced recently, has relatively limited exposure to subprime assets, implies that the losses have been mainly an earnings event that is not affecting the ability of the Japanese banks to lend, and not leading to any kind of credit crunch. And, finally, non-financial corporate profits, while declining and certainly being squeezed by the surge in import input prices, are coming off historical highs in previous years. And you see in the Bank of Japan's short-term corporate survey that positive investment is still projected by companies, their plans are for modest but positive increases in investments.

So, we see the underlying fundamentals remaining relatively strong, and surely they're headed for a period of weak growth, but we nevertheless see the landing will be rather soft.

QUESTIONER: I was just wondering if you could elaborate a little more on the monetary policy outlook. You said that the Bank of Japan is appropriate to remain accommodative for now, but at what point should they move if inflation becomes more of a problem? When will high commodity prices cause the Bank of Japan to move?

MR. CITRIN: It's a very difficult question. Clearly, if you look at the monthly reports and the statements they've made after the last couple of monthly policy meetings, the Bank of Japan is very aware of the downside risks to the economy. The Governor has said he doesn't have any preset view on whether inflation risks or growth risks are dominant at this juncture, but that clearly given the uncertainties and the growth outlook, they're taking a wait and see attitude, which we agree with at this time.

And on the inflation front, they do need to worry that the increase in headline inflation, which as you note reflects mainly food and fuel, volatile elements, and stripped of these factors, inflation is very low or even still close to zero, and with the slowing global economy, perhaps some of this froth on fuel and food will come off, so that the headline inflation may even start to come down on a 12-month basis in the months ahead.

So it's a balancing act. They'll be looking at incoming data over the next few months. At this point, I guess our view would be that given very low underlying core inflation in Japan and the risks to the growth outlook, there's very little cost to waiting until there's clear evidence that the downside risks are receding or being eliminated, at which point interest rates, which are very low now and highly accommodative, should be normalized. But I think we're not there yet, and clearly the Bank of Japan is going to be looking very carefully at incoming data in the months ahead.

QUESTIONER: I have a slightly different question. You know the U.S. is facing this mountain of bad debt now, and I see a lot of references to the U.S. and Japan experiences in people's notes and comments on the economy. Do you think there are parallels between the U.S. experience now and what Japan has gone through?

MR. CITRIN: Clearly there are some parallels. I think that the big difference was that in Japan, the whole financial sector and lending was collateralized by property and when the land price collapse hit Japan in the early 1990's this affected the economy in an unforeseen way that perhaps was not fully appreciated at the time.

The ability of Japanese banks to lend was severely curtailed, and... corporations had a massive debt overhang at that time and massive excess capacity reflecting over investment, and many corporations also had a large overhang of labor force as well. All this was not fully appreciated and it took a long time for the authorities to recognize, and for losses to be written off, and so the restructuring process in both banks and non-banks took a long, long time to even be initiated before being completed.

In the U.S. there are certainly some parallels. A lot of private spending has been leveraged off of unsustainably high property prices, but I guess the difference is that there's been a much quicker recognition of the problem and much faster response by the affected financial firms to raise capital. And so, while the recovery is foreseen to take longer in this recession in the U.S. than in other non-housing related recessions, our forecasts for the U.S. don't see the typical V-shaped recovery, and the recovery will be slower to come, nevertheless, I think the response has been quite different from that which took place in Japan during the 1990's, and, in that sense, it's very different.

MR. GORDON: If I can add, certainly one of the differences is in terms of the fiscal policy response—Japan for many years attempted to pump prime and use government spending to keep the economy going, whereas in the U.S. today the word "temporary" is used with fiscal stimulus, so that tells you the difference from the `90's.

QUESTIONER: You see the economy coming to a virtual standstill, but you're not calling it a recession. I just want to make sure that that's correct. The other thing would be: We've seen on our wire a discussion that the interest rate hikes could take place, may happen more likely in early 2009, and I wanted to find out what your outlook was for the economy, you know, starting in 2009. I know you're predicting 1.5 percent, but I was wondering if you think things might turn a little in 2009.

MR. CITRIN: I hate to use these words, recession, or any other label. Clearly, the growth registered in the first quarter, which was an annual rate of 4.0 percent increase, could not be sustained, and this was partly due to data problems related to leap year. Clearly that wasn't sustainable, and forecasters expected a very weak second quarter.

And actually our view is consistent with that. We see the economy basically flat in the second quarter, not growing at all. And one interesting thing is that, certainly while the sort of high frequency monthly numbers of consumer spending do show some slow down in the second quarter, they're not anywhere near as weak as the sharp declines shown by consumer confidence and investment and business confidence indices. So actual spending has actually held up quite well, notwithstanding the sharp fall in confidence in Japan, and actually I think that's probably a phenomenon that we see in many other countries, as well.

So we see a flat second quarter, we see in the second half of the year some small, positive growth, with perhaps the economy growing at an annual rate of around 0.5 percent. Our main point is rather than focusing on the precise numbers, we do see the economy moving sort of sideways, whether it's slightly positive, flat, or even slightly negative in one quarter.And then we do see some gradual pick-up beginning in the first quarter, but perhaps the economy not really beginning to recover until the second quarter of 2009. And for 2009, we see, over the course of the year, growth returning to around potential and perhaps slightly below, around 1.5 percent, something like that.

QUESTIONER: So would that then warrant a rate increase or do you think they need to still be extremely careful?

MR. CITRIN: I don't want to speculate on the precise timing. I think that the view of the authorities, which we agree with, is that monetary policy is unusually loose and unusually accommodative, and, you see, this measured or assessed in various ways such as to Taylor rules and other indicators of financial conditions—all come to the same conclusion.

And so over time, as the economy begins to recover and the downside risks are substantially eliminated, I would say that interest rates should be normalized, meaning they should begin to rise. When exactly this takes place, it's difficult to speculate. Clearly the global financial turmoil has continued to surprise everyone on the down side, things normalize and seem to stabilize, and then so far most of the surprises have been on the down side.

So it's really hard to tell when the risks will be eliminated. There's been a lot of speculation going on for the last several years already that the Bank of Japan is itching to raise interest rates and itching to tighten at the earliest opportunity, but I think when you look back at the last couple of years, the end of Governor Fukui's term, and the first few months of Governor Shirakawa's term, they've been very prudent and very mindful of the need to move gradually and to be flexible in the conduct of their interest rate policy, and I expect that attitude to continue.

QUESTIONER: I'm not an expert on the Japanese economy by any means, but is it correct that Japan imports most of its oil?


QUESTIONER: So bearing in mind the sharp increases in oil prices over the last year, how much of an impact is that having on the Japanese economy?

MR. CITRIN: That's had a big impact already. The last few years, Japan was experiencing annual terms of trade losses of around 5 percent a year, and this year we estimate that the terms of trade will decline by about 12 percent. Over the space of about four years, the terms of trade have deteriorated by around 30 percent.

Now, they've been cushioned, the corporate sector has been cushioned, and sorry, before I get there, you already see in the latest numbers, wholesale prices rising by around 6.0 percent, I think a 15-year high. So clearly, not just oil, but other commodity price increases have hurt Japan. How have they managed? First of all, Japan, since the last oil crisis in the early `80's has become very energy efficient. It's in a completely different situation in terms of energy efficiency, with the ratio of fuel imports to GDP now very low. This, combined with the fact that corporate profits were overall very high, allowed them to absorb the increases in prices in their profit margins without putting too much of a squeeze.

This year the situation has changed somewhat qualitatively and there's less room for corporations and companies to absorb these increases in their costs. That's why you see already all of a sudden this year fairly rapid increases in headline CPI, going very quickly from around zero to 2.0 percent over the space of the last six months, something like that.

MR. GORDON: If I could just add, although Japan is an oil importer, it's also an exporter to oil exporting countries. It's been a partial offset, the fact that exports to non-U.S. destinations, particularly say Russia or the Middle East, have been very buoyant. That's what held up exports in the first quarter.

MR. CITRIN: I remember meeting with an executive of Toyota one year ago, and they were saying, even at that time, the U.S. was a very large market, but their fastest growing markets were not only China, but Russia. So clearly, growth in these regions has helped the economy quite significantly.

QUESTIONER: Do you look at the Japanese car exports to the U.S., is that something you look at? Bearing in mind that the Japanese manufacturers produce highly efficient vehicles, have you seen any impact on those exports to the United States?

MR. GORDON: Certainly that area is a very fast growing segment, but it's still from a very low base, so I don't think that's driving the top line sales growth in autos. The big growth in auto exports has been to China and to other emerging markets, and not necessarily on fuel-efficient cars, just regular cars.

QUESTIONER: There's been discussion regarding the setting up of a Sovereign Wealth Fund, but it looks like the authorities oppose it, I notice that you mention it here. Do you have any thoughts on whether the foreign reserves should be put into the Sovereign Wealth Fund? Also, any comments on the management of foreign reserves in Japan?

MR. CITRIN: The Ministry of Finance is not necessarily in favor of the proposals. Unlike in other cases, where the Sovereign Wealth Funds represent net earnings from say commodity exports and the net revenues of the public sector, in Japan's case, the reserves emanate from intervention in the foreign exchange market that is matched by domestic liabilities related to the yen bonds that needed to be issued so that the Ministry of Finance could come up with the yen liquidity to purchase the foreign exchange. So, in that sense, it doesn't necessarily represent net wealth of the government, or of the public, for that matter. Obviously, to the extent that interest rates remained close to zero in Japan for a long time, and the yen remained relatively weak, and interest rates abroad were higher, in a net sense, the yen value of this fund, if you want to call it, increased.

But it's very different in character, and the assets are matched by liabilities, and so one needs to be very careful if you're going to start investing it. Rather than setting up a separate fund, it's more a question of appropriate public debt management of the Ministry of Finance, and one needs to take into account the exchange risk associated with these foreign assets, as well, because you could suffer a lot of capital loss if the yen appreciates—for now they've been making gains in net terms, but this could turn. Also, you have domestic debt that's associated with the foreign assets, so it's not so simple a matter.

Even in the proposals of my good friend Taka Ito to set up a Sovereign Wealth Fund, he's only talking about possibly investing the interest earnings. I think everyone recognizes that there are large domestic debts associated with the assets.

MS. GAVIRIA: We conclude this conference call here. Thank you very much, everyone, for participating.


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