Transcript of a Conference Call on Japan Article IV Consultation

Washington, D.C.
Thursday, July 31, 2014

PARTICIPANTS:
JERRY SCHIFF, Deputy Director for Asia and Pacific Department and Mission Chief for Japan, IMF
STEPHAN DANNINGER, Division Chief for Asia and Pacific Department, IMF
KEIKO UTSUNOMIYA, Senior Media Relations Officer, IMF

MS. UTSUNOMIYA: Good morning, Washington, and good evening, Tokyo. I am Keiko Utsunomiya, senior media relations officer for the IMF, welcoming you to conference call on conclusion of the 2014 Article IV Consultation with Japan. Staff report and related documents have been published and made available online.

With me today is Mr. Jerry Schiff, the deputy director of the IMF’s Asia and Pacific Department and Mission Chief for Japan; and also Mr. Stephan Danninger, chief of the division in Asia and Pacific Department that includes the team working on Japan. This conference call is on the record, and we’ll start off with brief opening remarks by Jerry.

MR. SCHIFF: Thank you very much and good morning or good evening to you. The Japanese economy has been gradually gaining traction under Abenomics. The underlying strength of the economy at this moment is difficult to ascertain given that the timing of economic activity has been strongly affected by the increase in the consumption tax rate on April 1. Partly reflecting this, recent data have been mixed with some disappointing results in the last several weeks. Taken as a whole, however, we still see these data as broadly consistent with the idea that the impact of the tax hike will be relatively short lived and that the economy will return to modest, but above potential, growth in the second half of the year. In particular let me give you a few details.

Following an expected short contraction in April after the tax rate hike, consumption has been slowly recovering and consumer confidence is also showing signs of recovering. We think that wages are a key here and that tight labor markets suggest the potential for gains ahead, which would support modest consumption.

Private investment also appears to be on a gradual upward trend, although here signs are more mixed. After an unexpectedly sharp pickup in the first quarter, there seems to have been significant payback in recent months. But economic fundamentals, including tightening capacity constraints, very healthy balance sheets with large cash balances, and negative real interest rates, all suggest that investment should return to a moderate upward path in the third quarter. The recent Tankan Survey data on business investment plans also supports this view.

Exports have yet to show a clear pickup despite the large yen depreciation since the start of Abenomics. To some extent this should not be a surprise as sizeable depreciations in the past have also taken six to eight quarters to have a positive impact on the trade balance. But we do see important structural reasons for a slower and more modest export recovery this time around, including the fact that Japanese corporates have increasingly been moving their production abroad. Looking forward we anticipate a modest rebound in exports as the impact of the weaker yen feeds through to firms’ behavior and as global growth strengthens.

With this as background, the IMF projects growth at 1.6 percent this year and 1.1 percent in 2015, both figures above potential. But as I think is clear from what I’ve said so far, there are considerable downward risks to this outlook, especially if confidence in the broad reform process declines. Japan is also vulnerable to external shocks, including from geopolitical tensions, through trade flows, energy prices, and safe haven effects. This uncertain outlook places a premium on continued strong efforts to implement a comprehensive growth strategy and to address the still large public debt burden.

On the former, the Japanese authorities have announced a series of structural measures, which are in various stages of implementation, and which represent good progress.The third arrow of Abenomics was always going to be more of a marathon than a sprint given the need for legislation and the time for careful implementation. Nevertheless, it’s critical to move as quickly as possible both to strengthen confidence now and to raise potential growth over the longer term.

Also, we think the scope of the reforms needs to be broadened. As one example, the economy is currently bumping up against labor shortages and government’s plans to raise female labor force participation will be helpful in addressing this. But success in this area would also require the tackling of the duality of the labor market and attracting additional foreign labor. Similarly, special economic zones could provide an important laboratory for reform, but only if ambitious deregulation within these zones is pursued.

With regard to fiscal policy, the rise in the consumption tax rate from 5 to 8 percent was a major accomplishment, and the implementation next year of the planned hike to 10 percent with uniform rates will represent further important progress. But significantly more adjustment will be needed to bring debt down as a share of GDP.

There’s no single right way to do this, but we’ve emphasized several points. Most importantly, there’s a need to lay out a concrete medium-term plan to reduce debt as a share of GDP. Such a plan would allow a gradual adjustment and provide space for flexibility to respond to cyclical downturns.

Second, the adjustment should be done in as pro-growth a manner as possible. There are a number of measures, including steps to broaden the personal income tax base,that can help reduce the deficit while also providing better incentives to work and invest.

Third, given the large size of the adjustment needed, both revenue and expenditure measures will be needed.

And, finally, the effort to reduce the deficit needs to be broadly shared with due regard for issues of fairness.

Finally regarding monetary policy, we see the Bank of Japan as having been successful to date in raising inflation as well as inflation expectations. It’s easy to forget the doubts expressed by many at the start of QQE that inflation could ever be brought into positive territory in Japan. While it’s premature to declare victory, our view is that the current policy is working and should be continued until the 2 percent target is achieved in a stable manner. However, should underlying growth begin to slow or inflation begin to turn downward, the BOJ should respond quickly as it indicated that it would.

With these remarks I’d like to thank you again, and I’m happy to answer any questions you might have.

MS. UTSUNOMIYA: Thank you, Jerry. Let me remind you that this conference call is on the record. And now we’d like to take questions from you.

QUESTIONER: I was wondering if you could just elaborate a bit more about the labor shortage issues. Some of the measures you mentioned are things the IMF has been recommending for a while, so I’m wondering if you see any progress. I mean the women, obviously there’s been a big step on that as far as getting more women into the labor market, but do you think there are any other measures that could have a quick impact or that can be done fairly quickly to try to address the immediate labor shortages of some industries?

MR. SCHIFF: Thanks very much for that. It’s a good question. I think there has been progress on bringing women’s labor force participation rates toward the averages of advanced economies, but there’s still a lot more that needs to be done there.

For example, the main measure has been to begin to increase the number of slots in daycare centers in Japan and that’s proceeding, although it will take some time to reach their goals. We think that could be complemented, for example, by deregulation in the daycare industry so that the private sector can participate alongside of the public sector in delivering these services.

Another area that could have a relatively quick impact would be some changes with regard to foreign labor. That’s also under consideration by the government, but we would need to see some forward movement in actually implementing that. And we’d like to see it be made easier for foreign workers to come in and more attractive for them to do so.

Some of the other measures will take more time, for example, to address duality in the labor market. That refers to the fact that -- for those who don’t know that -- Japan has had a growing share of its workforce in the so-called nonregular sector where workers are less well protected and also less productive and receiving less training and on-the-job education. So it’s been a kind of negative development overall and has also limited wage gains. That would take some time to filter through, but we think it’s something that the Japanese government needs to turn its attention to quite urgently as well.

QUESTIONER: Good morning. Thank you very much. My question concerns the Bank of Japan. You mentioned that you believe the Bank of Japan has been successful with its policy to date and the report notes that they shouldn’t ease monetary policy further at this point, although the report also forecasts inflation to reach 2 percent by 2017, which is somewhere behind when the Bank of Japan intended to return inflation to 2 percent. So with that in mind, are you saying the Bank of Japan is unable to get inflation to 2 percent by 2015 or that it would be too costly to get inflation to 2 percent by that point? Thank you.

MR. SCHIFF: That’s a good question. I don’t think I’m saying either of those actually. Our projection is that inflation of 2 percent will be reached in 2017. There’s certainly a large margin for debate there, more than typical because Japan is attempting to exit 15 or so years of deflation. It’s extremely difficult to know, for example, how expectations might develop, and there’s no reason to think that expectations would necessarily rise in a linear fashion. So it’s certainly plausible that inflation of 2 percent can be reached by the BOJ within their target period, but that is not our baseline projection. For us, however, that’s not a major problem as long as progress is continually being made toward the achievement of 2 percent in a stable manner and as long as that’s happening, we don’t feel there’s a need to step up the current level of monetary accommodation. You have to remember that the current level of asset purchases is already extremely large. So by calling for the continuation we’re already backing a quite aggressive policy and we think that it would make sense to continue that as long as progress is being made.

However, as we also said, if there signs that progress has stopped or reversed then the Bank of Japan needs to be ready to act very quickly to either increase the size of their asset purchases or to somehow change the composition toward longer term assets.

QUESTIONER: Thank you, just a follow up on that then. One of the policy board members, Takahide Kiuchi, this morning spoke about how he thinks the Bank of Japan should attempt to achieve 2 percent inflation in “the medium to long term” instead of a set period of two years. It seems that he, too, isn’t too concerned with the timeframe. So would you support his view that perhaps that language would better serve the Bank of Japan’s goals?

MR. SCHIFF: Well, I think their current forward guidance is pretty clear. It has two key sections, one of which notes that they -- I’m not using the precise language here -- but that they believe that they can achieve 2 percent within about two years. But the second part, which is at least as important, underlines that they will continue to engage in monetary accommodation until 2 percent is achieved in a stable manner. So I think those two elements combined are a very sensible and clear approach.

MS. UTSUNOMIYA: If there are no questions at this point, I would like to read out a question I received via email.

“What do you think is the possibility of inflation in Japan accelerating faster than even the Bank of Japan expects given the tight labor market and structural rigidity that make it difficult for the supply side to much rising demand for labor and goods? Also, how do you rate the changes of long-term bond yields rising rapidly in Japan?”

MR. SCHIFF: Thank you very much. As we were just discussing, under our baseline inflation will rise toward the 2 percent level over the next several years as the output gap closes and inflation expectations increase.

In terms of risks, we’ve been focused much more on the possibility that inflation will not rise to 2 percent either because the economic reform process disappoints or perhaps just because inflation expectations turn out to be much more sticky than we expected. But the risk posed in this question can’t be discounted either. In particular, it is possible that labor market or other constraints would mean that prices rise to 2 percent before strong growth is achieved. But whether at that stage inflation would rise further would depend on a number of factors, including how the Bank of Japan would react and how rapidly the needed structural reforms would be implemented. In particular as we were discussing earlier, measures to raise labor supply and enhance the functioning of labor markets would be critical in making sure that these constraints are not overly binding.

With regard to the question about bond yields, we do expect bond yields to rise over time, reflecting both higher inflation and faster growth in the economy. But such an increase would not be problematic, especially because we expect the Bank of Japan to be in the market over the medium term, which would help to smooth the adjustment of rates. If there’s a spike in interest rates of the sort that’s contemplated in the question, that would probably arise from a loss in confidence by investors in the government’s ability to address their fiscal problems. If that were to occur, it would have serious repercussions for Japan for its financial sector, for its growth prospects, and also for the global economy. And that’s why we have been emphasizing for a number of years now the need to have a credible and concrete medium-term plan and to implement it.

QUESTIONER: Hi. Since there’s no one else, I figured I could ask a follow up. I was wondering about the exports. You mentioned that some Japanese corporates are moving production overseas. So do you think that exports are kind of in for a lower period in general? But there’s these structural changes, so they may not turnaround completely the way they have in the past with depreciations. So if you could just elaborate a bit more. It’s interesting.

MR. SCHIFF: Yes, thanks. I think the short answer is yes. We do see exports beginning to turnaround later this year and next year based on the fact that depreciations typically take some time to have their full effect and because global growth will hopefully be better. But we also do see long-term export prospects as moderating compared to the past. One of the big reasons is that Japan, like other advanced economies, has increasingly moved its exports abroad. And actually sales by Japanese corporates abroad now exceed exports by Japan. So that means both that exports are lower, but also that the impact of exchange rate changes is probably also lower. Actually we project over the medium terms that Japan will continue to have a trade deficit, but will maintain a current account surplus because of the still sizeable flows that come into the country from their foreign investments.

MS. UTSUNOMIYA: If there are no further questions, we’d like to conclude this morning’s press conference call on Japan. Thank you very much for your participation. See you again next time.

MR. SCHIFF: Thank you.



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