IMF Executive Board Concludes 2013 Article IV Consultation with JapanPress Release No. 13/296
August 5, 2013
The new government announced in December 2012 a new policy framework to end decades-long deflation and raise growth. The new policy regime calls for a coordinated policy effort by the Bank of Japan (BoJ) and the government to jumpstart the economy and create sustained growth synergies through bold structural reforms. The announcement was followed by a quick set of actions.
On the back of this new policy framework, growth accelerated sharply in early 2013. First quarter GDP growth rose to 4.1 percent (seasonally adjusted annual rate) after two quarters of stagnation. Rising equity values stimulated consumption and exports rebounded supported by strong regional demand and a weaker yen. Inflation expectations have started to increase and actual inflation recorded positive growth in June.
Financial and exchange markets were buoyant in early 2013 and the immediate aftermath of Quantitative and Qualitative Monetary Easing (QQME). From September 2012 to mid-May 2013 the Nikkei stock index rose by about 80 percent, but temporarily dropped sharply by around 15 percent. As of end June, the yen has depreciated by about 20 percent in real effective terms since mid-2012. Ten-year bond yields have remained unchanged around 80-90 basis points since the beginning of the year, although they briefly declined to historic lows of about 45 basis points after the announcement of QQME.
The near-term outlook has improved considerably, buoyed by stimulus. The Japanese economy is expected to grow by about 2 percent, mainly as a result of the new fiscal stimulus and monetary easing feeding through to private consumption and with some lag to investment. A strengthening of external demand, helped by depreciation, and frontloading of consumption ahead of the April 2014 consumption tax increase further supports the recovery. In 2014, growth is expected to moderate to 1.2 percent as a continued pick-up in private domestic demand is offset by fiscal withdrawal from the consumption tax increase—from 5 to 8 percent—and an unwinding of reconstruction spending. Over the medium term, growth is expected to converge to 1 percent as a recovery in investment is offset by a slowdown in labor supply due to population aging.
Capital positions of major financial institutions have improved due to strong equity performance, rising income from securities trading, and capital gains on Japanese Government Bonds and foreign asset holdings, while credit costs in banks remain limited. Profits for internationally active banks have also risen due to relatively high net interest margins on overseas loans, which rose by 20 percent (year-on-year). Implementation of Basel III requirement has commenced in March 2013.
Executive Board Assessment
Executive Directors noted that Japan’s near-term economic prospects have improved with the adoption of vigorous macroeconomic policies combining fiscal stimulus with unprecedented monetary easing. Directors agreed, however, that the growth outlook is subject to significant risks, primarily stemming from incomplete domestic reforms and a weaker external environment, and that sustained implementation of the authorities’ reform program is the best way to minimize these risks.
Directors welcomed the new monetary policy framework, which should make an important contribution to end deflation. They noted that careful communication and flexibility in execution are essential to contain market volatility and ensure effective policy transmission. At the same time, some Directors encouraged the authorities to prepare plans for an eventual exit from quantitative and qualitative monetary easing, even if that exit likely remains far off into the future.
Directors concurred that a credible medium-term fiscal plan should be adopted promptly to contain fiscal risks and reduce policy uncertainty. They noted that bringing down public debt as a share of GDP will require a significant adjustment over the next decade. In this regard, Directors generally supported the authorities’ plans to double the consumption tax rate by 2015, although a few Directors expressed concern over the possible adverse impact on growth. Directors also underscored that additional revenue and expenditure measures will be needed beyond 2015.
Directors took note of the staff’s assessment that the exchange rate is moderately undervalued at present, but stressed the large margin of uncertainty surrounding this assessment in the wake of the recent changes in the macroeconomic policy framework.
Directors noted that the financial system is generally sound, but low profitability and exposure to interest rate risk remain a concern. They agreed that the successful implementation of a comprehensive structural reform package would contribute to enhancing financial sector stability. Directors welcomed recent progress on regulatory reform, but called for a strengthening of capital standards for regional banks, and for careful monitoring of foreign-funding by major banks.
Directors stressed that the new monetary framework should be supported by wide-ranging structural reforms, which can play a key role in the authorities’ efforts to eradicate deflationary expectations and achieve self-sustaining growth. They called for steadfast implementation of a comprehensive agenda focused on reducing excessive labor market duality, deregulating agriculture and services, revitalizing small and medium enterprises, eliminating constraints on the provision of risk capital to firms, creating fiscal incentives to work and invest, and further relaxing immigration requirements. Directors welcomed the government’s steps to boost the employment of women, and also, generally, its intention to join the Trans-Pacific Partnership.