Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
2009 Article IV Consultation with Japan:Concluding Statement of the IMF MissionMay 20, 2009
The global crisis is highlighting Japan’s close integration with the rest of the world. While Japan was not at the center of the initial crisis, the collapse in external demand and financial spillovers have plunged the economy into the most severe recession in decades. Against this backdrop, the authorities’ near-term emphasis is appropriately on supporting growth and preserving financial stability. As the crisis abates, the priority should shift to implementing strategies to secure fiscal sustainability and rebalance growth. This statement summarizes our preliminary policy recommendations, which will be more fully discussed in our forthcoming Article IV report.
I. The Outlook
1. Despite recent tentative signs of stabilization at home and abroad, the outlook remains uncertain.
|Japan: Near-Term Projections|
|(Calendar Year, Growth Rate)|
Total domestic demand
Net exports (contribution)
Current account balance (in billions of U.S. dollars)
In percent of GDP
General government balance 1/
Structural balance 1/
Primary balance excluding social security 1/
Source: World Economic Outlook, April 2009.
• Baseline. Based on April WEO projections, we expect GDP to contract by 6¼ percent in 2009, and expand by ½ percent in 2010.1 The worst in production declines is likely behind, and fiscal stimulus should provide significant support to growth this year and next. Nonetheless, underlying growth momentum is expected to remain weak as the export collapse spills over to domestic demand and financial conditions remain tight. Along with a pickup in global growth, a sustained recovery should take hold during the course of 2010. Given a large output gap, inflation is projected to remain mildly negative until 2011.
• Risks. The outlook remains subject to high uncertainty, with risks tilted to the downside. A delayed global recovery is a key source of downside risk, while tight credit conditions and a deteriorating labor market weigh on prospects domestically. On the upside, faster-than-expected growth in China could bolster Japan’s manufacturing exports, although the benefits would likely be limited given the low import content of China’s public spending. While the probability is low, tail-risk scenarios involving another severe credit event, like the one that took place after the Lehman Brothers collapse, or a loss of market confidence in the sustainability of public finances around the world cannot be ruled out.
II. Policies to Support Growth and Preserve Stability in the Near-Term
A. Supporting Growth with Monetary Policy
2. The BoJ’s policy response to the crisis has been well-calibrated. Should downside risks materialize, further steps may be needed.
• Background. The BoJ’s current three-pronged strategy—involving policy rate cuts, measures to ensure the stability of financial markets, and steps to facilitate corporate financing—has provided monetary policy support to the economy and helped ease credit conditions in a number of markets. The funding situation for some borrowers, however, remains tight, especially for SMEs and low-rated corporates.
• Near-term stance. Under our baseline scenario, monetary policy should remain accommodative, especially in light of the significant widening of the output gap and downward pressures on prices. With the monetary transmission mechanism still functional and fiscal policy expansionary, the current accommodative stance should provide meaningful support to growth during the downturn.
• Ensuring the stability of financial markets and facilitating corporate financing. Should the outlook deteriorate and financial stresses re-emerge, the BoJ could expand its operations to support growth and stabilize markets. In such circumstances, the BoJ could consider relaxing the eligibility criteria for commercial paper and corporate bond purchases to reduce spreads for low-rated borrowers. Another alternative would be for the BoJ to extend the maturity of its operations for corporate financing and its FX swap facility to help reduce the cost of longer-term funding. The BoJ could also increase its JGB purchases to facilitate money market operations. At the same time, the BoJ should continue to minimize risks to its balance sheet, while mapping out the exit strategy for unwinding these policies.
3. Further enhancements to the BoJ’s communication strategy could help guide market expectations during the downturn. Explaining the three-pronged strategy has been helpful in clarifying the BoJ's policy intentions in a broad range of areas. Communication has also been enhanced by the publication of two-year forecasts for growth and inflation and more comprehensive discussion of risk factors. In the current deflationary environment, with a gap between the BoJ Policy Board’s two-year inflation forecast and its medium-term understanding of price stability,2 clarifying the time horizon over which inflation is expected to return to a range consistent with this understanding might help anchor medium-term inflation expectations in positive territory. Although the case may be less compelling than during the period of quantitative easing, a commitment to maintaining low interest rates until prices recover might also help cap longer-term rates going forward.
4. According to staff analysis, the current value of the yen is consistent with medium-term fundamentals. The yen has appreciated significantly in real effective terms since last August, supported by an unwinding of carry trades and narrowing interest rate differentials against key currencies. We continue to support the official policy that the yen should be market determined, with intervention only justified to counter disruptive exchange rate movements.
B. Fiscal Policy Priorities
5. While fiscal policy should remain flexible to address further downside risks, a medium-term plan for securing sustainability needs to be formulated to take effect once the recovery takes hold. Japan’s cumulative stimulus spending is sizable at almost 5 percent of GDP—well above the G-20 average—and when combined with the automatic stabilizers will give a meaningful lift to growth. With regard to the recent stimulus package, the one-off nature of the tax measures and the expansion of vocational training to boost productivity over the medium-term are particularly welcome. However, along with the slowing economy, the stimulus has widened the deficit significantly and on current trends, net public debt could rise to about 135 percent by 2014.
• Near-term fiscal stance. Under our baseline forecast, the current expansion of fiscal policy will provide important support to activity during the downturn. However, should the recession persist longer than expected, additional stimulus could be provided in FY2010, with a continued emphasis on measures that are targeted and reversible.
• Medium-term fiscal sustainability. Given the increase in public debt and growing pressures from an aging society, it will be important at the same time to outline a medium-term consolidation strategy that would take effect once the crisis abates. In this context, one option would be to shift to a cap on the public debt ratio over the medium term rather than the current practice of targeting the primary balance. One reason for such a change is that a focus on debt levels may be more easily understood by the public and thus create a better awareness of the need to embark on fiscal consolidation. Whatever the target chosen, the consolidation plan will likely require expenditure measures and comprehensive tax reforms, including a commitment to raise the consumption tax after the recovery takes hold. 3
• Pension reforms. Priorities include securing stable revenues for the government’s higher contributions to the national pension plan and addressing generational inequalities. This year’s actuarial update provides an opportunity to revise the assumptions of the system’s financial position in light of changes in the outlook, and make any parametric changes that may be needed.
• Public debt management. To finance the stimulus measures, gross JGB issuances are expected to rise to as high as 30 percent of GDP in FY2009. Short-term risks appear contained given limited foreign ownership of JGBs and the high level of domestic savings, while close communication with market participants has helped prepare investors for the large expected increase in issuances. Nevertheless, the capacity of the market to absorb JGBs will likely diminish over time due to population aging, underscoring the need to achieve medium-term fiscal sustainability.
C. Stabilizing and Strengthening the Financial and Corporate Sectors
6. Bank profits have declined on rising credit costs and large losses on equity holdings, while the corporate sector faces risks from a prolonged downturn. Banks have responded by raising new capital and some regional banks have applied for public funds, but rising bankruptcies, falling land values, and thin lending margins are constraining profitability and putting pressure on banks’ capital positions. Although corporations entered the recession with strong balance sheets, profits have been hit by the collapse in global demand and the stronger yen, highlighting the risk of further corrosive feedback between financial strains and weakening activity.
7. In this environment, the focus of financial policies should be to strengthen the resilience of the system in case downside risks emerge. 4 Government and BoJ measures have been effective in stabilizing the financial system and facilitating corporate financing. To prepare for risks from a more protracted slowdown, policies should focus on:
• Strengthening bank capital and profitability. To enhance the level and quality of capital in the system, public funds could be targeted to help restructure and/or merge weak banks and facilitate the raising of private capital. Further consolidation would also help address the long-standing structural problem of low profitability and excess capacity, particularly for some regional and smaller banks.
• Reducing risks from bank equity holdings. While the current approach of applying higher capital charges on bank equity holdings from 2014 is consistent with Basel-II, recent events highlight the risks from continued large equity holdings. This is a difficult issue to resolve, for example, as direct equity purchases from banks by the public sector may prove challenging for some banks given their unrealized losses. Instead, perhaps some ring-fencing or partial insurance could be considered to protect bank balance sheets from a sharp decline in equity prices. Such insurance could also be offered in exchange for a commitment from banks to reduce their holdings when prices recover.
• Resolving systemically important nonbanks. The current global crisis has highlighted the need for establishing frameworks to address liquidity and solvency concerns of systemically important nonbanks, such as life insurance companies. Such a framework could also be useful in Japan.
• Restarting the market for securitization. Reflecting difficulties in the real estate and consumer finance markets, issuances of securitized assets remain sluggish. Steps to restart the securitization market, such as by providing partial guarantees on asset-backed securities, could help SMEs, REITs and nonbanks regain access to market financing.
• Promoting corporate restructuring. A public asset management company, similar to the Industrial Revitalization Corporation of Japan (IRCJ), could be restarted to assist banks in working out viable but distressed firms and promoting a market for restructuring. The recent expansion of public credit guarantees has helped to stabilize SME finances, but the generous terms raise the risk of large fiscal costs while slowing the pace of restructuring. Reverting to partial coverage or a more risk-based scheme would encourage banks to take actions against distressed borrowers, and could be a part of an exit strategy for allowing markets to drive the restructuring process.
III. Structural Reforms to Rebalance Growth over the Medium-Term
8. The nature of the current turmoil lends greater immediacy to the long-standing need to rebalance growth. On current policies, potential growth could fall from about 1¾ percent in 2007 to close to 1 percent over the medium term, as investment rates decline with global deleveraging, while structural rigidities prevent a reallocation of labor and capital from export-oriented sectors to domestic services.
9. Given the need to absorb excess labor and reallocate capital, the short-term emphasis should be on reforms which create new investment and job opportunities. Concerted efforts to deregulate the agricultural and services sectors—including medical, child, and elderly care—are needed to create new drivers for growth and job creation. Further reforms in the areas of inward FDI and financial market development, as discussed during the Multilateral Consultation and last year’s Article IV consultation, could also support rebalancing. In light of the sharp increase in unemployment, difficult labor market reforms could be put on hold for now, but pressures to reduce market flexibility should be resisted.
10. In summary—like the rest of the world—Japan faces a difficult set of immediate and longer-term challenges. The authorities are taking appropriate steps to support the economy in the face of the export collapse and financial spillovers from the global crisis. In the near-term, policies should continue to be aimed at supporting growth, while preserving financial stability. Over the medium-term, reforms to restore fiscal sustainability, deregulate the service sector, and enhance labor and product market flexibility will help Japan to rebalance growth and lay the foundation for a sustained expansion.
Finally, we thank the authorities for their close cooperation and warm hospitality. We have benefited a great deal from our discussions over the past week and look forward to your views on these preliminary conclusions.
1 The mission will update its growth projections prior to the Article IV Board meeting in July on the basis of the Q1 GDP data release and other indicators.
2 In the BoJ’s April Outlook report, the FY2010 forecast of the majority of the BoJ Policy Board members for core inflation (excl. fresh food) was between -1.1 and -0.8 percent, whereas the Policy Board members’ understanding of price stability corresponds to headline inflation of 0 to 2 percent.
3 For instance, staff analysis suggests that capping net debt at 130 percent of GDP (230 percent of GDP in gross terms) would require an adjustment in the primary balance of around 1 percent of GDP annually during FY2011-2014. After FY2014, further measures would be needed to place the debt ratio on a downward path.
4 The BoJ already conducts fairly comprehensive and rigorous macro stress tests in its semi-annual Financial System Report. In the stress tests outlined in its March 2009 report, Tier 1 capital ratios in FY2009 for the bottom 10 percent of banks would fall below the level in the late 1990s and early 2000s under a scenario with GDP growth of -4 percent in FY2009 and the TOPIX falling to the same level as its bottom after the collapse of the bubble economy at the time when the report was prepared. In addition, capital quality in some banks remains weak, given their reliance on preferred and other hybrid instruments.