IMF team completes the 2007 Article IV consultation discussions with Japan

Press Release No. 07/106
May 24, 2007

An IMF team, led by Mr. Daniel Citrin, Deputy Director of the Asia and Pacific Department, visited Tokyo to conduct the annual Article IV review of the Japanese economy. The team held wide-ranging discussions with senior government and Bank of Japan officials on recent economic developments and the policy challenges ahead. The IMF's First Deputy Managing Director, Mr. John Lipsky, joined the mission for the final policy discussions.

The near-term outlook for the Japanese economy is favorable. The IMF team projects GDP growth to remain at about 2 percent in 2007-2008. While external demand is expected to moderate, domestic spending should maintain its momentum. Prices have recently been depressed by temporary factors. However, with the economy operating at around full capacity, inflation is expected to rise gradually.

The favorable economic performance has been supported by appropriate macroeconomic and structural policies. Nevertheless, important tasks remain on the policy agenda. The priorities are to secure fiscal sustainability, to further strengthen the financial system, and to boost productivity through deeper structural reforms.

Regarding fiscal policy, the time is right for a faster pace of fiscal consolidation. The authorities should be commended for the remarkable progress over the last three years in reducing the fiscal deficit. But more needs to be done to reduce the public debt burden and cope with the prospective fiscal costs of population ageing. Every effort should be made to maintain tight control over public spending. However, given the size of the task, it is likely that revenue measures will also be needed in the years ahead.

Monetary policy should continue to be centered on securing price stability and durable growth. Monetary conditions have been appropriately accommodative in a very low inflation environment. We agree with the Bank of Japan that it should continue to adjust policy gradually in response to incoming data, mindful that there are no signs of worrisome financial imbalances or price pressures.

With the health of the banking system improving further, financial sector policies are focused on the challenges ahead. A growing appetite for investing in risky assets—both domestic and foreign—calls for continued regulatory vigilance and sound risk management. For banks, the priorities are to raise core profitability by diversifying income sources and strengthening lending practices. Further development of the capital markets will strengthen the financial system, help allocate more efficiently Japan's large savings, and ultimately promote growth and efficiency in the economy at large. The reform of the government financial institutions continues and should be managed carefully to ensure a level playing field for all institutions.

More broadly, deeper structural reforms are needed to improve Japan's growth potential and safeguard living standards. As identified by the government in the context of the IMF's recently concluded Multilateral Consultation, the reform priorities are to increase labor market flexibility, promote competition through greater market opening, and deepen trade integration. Much has been accomplished in these areas but the agenda is far from finished. Stepped up efforts will only strengthen the foundations of a lasting expansion.



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