Press Release No. 03/77

Press Release: Statement by IMF First Deputy Managing Director, Anne Krueger, in Tokyo

June 4, 2003

The following statement was made on June 4, 2003 by Ms. Anne Krueger, First Deputy Managing Director of the IMF, at the conclusion of her visit to Tokyo on June 3-4 in conjunction with the 2003 Article IV mission to Japan:

"During the past two days I have had the opportunity to discuss Japan's economic situation with senior officials. I am pleased to note that significant progress has been made on several fronts. Non-performing loans have been reduced and corporate sector performance has improved. Actions to ease monetary policy have helped maintain financial stability and may have prevented deflation from worsening. Also, steps have been taken to cut public works spending and improve its efficiency.

"Nevertheless, the overall economic situation remains difficult. The outlook is for continued sluggish economic growth and for deflation to remain entrenched. At the same time, a major concern is the rapidly rising public debt, which in relation to GDP is now the highest by far among the G-7 countries.

"The combination of continued deflation and slow growth will make it difficult for banks to reduce further their nonperforming loans and for corporations to become more profitable and strengthen their balance sheets. The weak economy will also hamper efforts to reduce the fiscal deficit. We therefore believe that a bold and comprehensive policy package is needed to enable the economy to escape from its present deflationary trap. The strategy we recommend involves four interrelated elements:

• First, financial sector reforms should be broadened and accelerated, building on the Program for Financial Revival. Faster progress in dealing with bad loans is essential if banks are to resume lending to viable corporations.

• Second, corporate restructuring must be speeded up. This is necessary if banks' bad loans are to be successfully resolved and for corporate investment to recover. The Industrial Revitalization Corporation of Japan can facilitate the needed restructuring, especially by coordinating creditors.

• Third, strengthened efforts to end deflation are required. Zero short term interest rates and the weak banking system have limited the effectiveness of the traditional channels of monetary policy. However, purchases of a wider range of assets would allow monetary policy to act more directly through asset prices, as well as by expanding liquidity. Also, a medium-term inflation target combined with clear communication of the strengthened strategy would help convince the public that deflation will end, and encourage spending.

• Fourth, a medium-term program for restoring fiscal sustainability needs to be adopted and its implementation begun as soon as possible. Delays would only cause the debt to mount further, making the problem much harder to solve. The program must involve comprehensive reform of the social security system, whose finances will otherwise soon deteriorate sharply as the population ages. Fiscal sustainability will also require spending cuts and tax increases to reduce the budget deficit. The official ten-year goal to balance the budget excluding interest payments and social security is a step in the right direction, but may not be sufficiently ambitious.

"This strategy will not be an easy one to follow, as it requires politically difficult choices and may involve short-run economic costs. But in our view it offers the best chance of restoring economic vitality to Japan, and allowing the country again to become one of the engines of global growth and prosperity."