## 1jpnea2023001 ## Source details **Canonical URL:** [1jpnea2023001](https://www.imf.org/-/media/files/publications/cr/2023/english/1jpnea2023001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2023/english/1jpnea2023001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2023/english/1jpnea2023001.pdf.json) --- ### Recent developments - Current account surplus fell to 2.1 percent of GDP in 2022 due to a sharp rise in the value of commodity imports. - External position in 2022 assessed as broadly in line with medium-term fundamentals and desirable policies (preliminary). - Banking sector remains resilient with capital adequacy and liquidity ratios above regulatory requirements, but interest and credit risks have increased. - Headline inflation recorded levels not seen in four decades; Headline inflation has been above 2 percent y/y since April 2022. - COVID-19 related restrictions gradually reduced since 2022, with border reopening in October 2022. ### Near-term outlook and projections - Real GDP growth: - 2022: 1.1 percent - 2023 (projected): 1.3 percent - 2024 (projected): 1.0 percent - Output gap: - 2022: -0.9 - 2023: -0.1 - 2024: 0.2 - Inflation (Headline CPI): - 2022: 2.5 percent - 2023 (proj): 2.7 percent - 2024 (proj): 2.2 percent - Current account: - Current account balance (billions of USD): 2021: 197.3; 2022: 90.0; 2023 (proj): 131.8; 2024 (proj): 180.3 - Current account as percent of GDP: 2021: 3.9; 2022: 2.1; 2023 (proj): 3.0; 2024 (proj): 4.0 - Staff projection: current account surplus projected to bounce to an average of 2.9 percent of GDP in 2023 driven by lower commodity prices and inbound tourism. ### Fiscal outlook, composition, and risks - Primary fiscal deficit will stay elevated in 2023 following the October 2022 fiscal package. - Government operations (selected percent of GDP): - Revenue: 2021: 35.5; 2022: 36.6; 2023 (proj): 36.2; 2024 (proj): 35.7; 2024: 35.4 - Expenditure: 2021: 37.3; 2022: 44.6; 2023 (proj): 42.8; 2024 (proj): 44.0; 2024: 42.1; 2024: 39.4 - Overall Balance: 2020: -3.0; 2021: -9.1; 2022: -6.2; 2023 (proj): -7.8; 2024 (proj): -6.4; 2024: -4.0 - Primary balance: 2020: -2.4; 2021: -8.4; 2022: -5.6; 2023 (proj): -7.5; 2024 (proj): -6.2; 2024: -3.8 - Public debt, gross (percent of GDP): - 2019: 236.4; 2020: 258.7; 2021: 255.4; 2022: 261.3; 2023 (proj): 258.2; 2024 (proj): 256.3 - October 2022 fiscal package (above-the-line expenditures): - April Package: ¥2.7 trillion (0.5 percent of GDP) - September Package: ¥3.5 trillion (0.6 percent of GDP) - October Package: ¥23.9 trillion (4.3 percent of GDP) - Staff assessment: October 2022 package "could have been smaller and better designed"; concern over untargeted energy subsidies and untargeted cash transfers to child-rearing households. ### Monetary policy, BoJ actions, and balance sheet - Monetary stance: ultra-accommodative; Yield Curve Control (YCC) tweak in December widened band around zero percent 10-year JGB yield target from 0.25 to 0.50 percent; short-term policy rate at -0.1 percent. - BoJ balance sheet: - Expanded from 110 percent of GDP at end-2019 to 135 percent of GDP in 2022Q1. - As of January 2023, about 80 percent JGBs; 5 percent ETFs; 2 percent combined equities, REITs, corporate bonds and commercial paper. - BoJ holdings of outstanding 10-year JGBs: close to 82 percent as of mid-February; increase of 15 percentage points since March 2022. - Private sector credit growth: 4.5 percent y/y (end-December, domestic bank loans). - Exchange rate and interventions: - Yen depreciation: by mid-September, yen weakened nearly 27 percent against the US dollar since the Fed started to raise policy rates in March 2022. - Interventions: September 22: nearly USD20 billion; October: around USD43 billion (combined equal 5 percent of forex reserves at end-August). - Forex reserves: US$1.08 trillion at end-October. ### Financial sector soundness and vulnerabilities - Capital and asset quality: - CET1 capital ratios of internationally active banks declined by close to 1 percentage point on average from end-March to end-September 2022. - Major banks NPLs: 0.8 percent as of end-September 2022. - Regional banks NPLs: 1.8 percent as of end-September 2022. - Risks: - Elevated interest-rate and credit risks on banking books, especially for smaller banks with higher and longer-tenor JGB holdings. - Credit imbalances: credit-to-GDP ratio nearly 25 percent above one-sided long-term trend (as of March-2022) and still 16 percent net of corporate savings. - Housing loan risks: large fraction of floating-rate mortgages, increasing loan-to-income ratios, rising share of borrowers with high debt servicing ratios. - NBFIs, life insurers, and pension funds increased overseas holdings and faced valuation losses in 2022. - Supervisory recommendations: - Enhance US dollar liquidity stress resilience. - Closely monitor interest-rate and credit risks; consider macroprudential policies to curb vulnerabilities from housing loans. - Transition insurers to economic-value-based solvency regime by 2025. ### Risks (external, domestic, and scenario) - Downside risks to growth: - deepening geo economic fragmentation and geopolitical tensions; - abrupt slowdown of the global economy; - commodity price volatility; - natural disasters; - cyberthreats. - Monetary policy risk: any abrupt change of the current monetary policy framework could pose risks. - Upside risks to growth: - more robust recovery of consumption, especially services; - stronger-than-expected recovery of inbound tourism. - Growth at Risk (GaR) indicators: - 4 quarters ahead (5th percentile): -2.1 - 8 quarters ahead (5th percentile): -4.5 - 12 quarters ahead (5th percentile): -5.2 ### Policy recommendations (near-term and medium-term) - Near-term: - Focus on achieving the 2 percent inflation target durably and preserving financial stability. - Maintain an accommodative monetary stance to achieve the 2 percent inflation target durably; avoid premature exit from monetary easing and communicate changes clearly. - Consider options for introducing more flexibility under the YCC framework (widen 10-year band and/or raise the 10-year target; shorten the yield curve target; shift to quantity target of JGB purchases with state-contingent amounts). - Use macroprudential and supervisory measures to curb emerging financial vulnerabilities. - Withdraw pandemic-related fiscal support in a timely manner; target new measures to vulnerable households. - Medium-term: - Growth-friendly fiscal consolidation to rebuild fiscal buffers and ensure debt sustainability; adopt a credible medium-term fiscal framework. - Consolidation should include both revenue and expenditure measures; consider unifying and increasing the consumption tax standard rate; strengthen property taxation; rationalize allowances and deductions; increase capital income tax rate; increase social insurance premiums. - Contain health and long-term care spending via efficiency gains and targeted measures. - Strengthen labor market policies to encourage more women and older persons to join the workforce, reduce labor market duality, and improve mobility. - Boost income growth, support startups, deepen digitalization, and achieve climate targets; higher carbon pricing combined with protection for vulnerable populations recommended. ### Alternative scenario: Sustained inflation pressures - Scenario: headline and core inflation reach 5 percent by early 2024, driven by higher-than-expected wage increases. - Policy implications: - Much stronger monetary tightening warranted; both short-term and long-term rates would have to rise, pushing interest rates above the neutral rate by mid-2024. - Tightening would bring inflation down to the target by late-2025 in model but cause larger contractionary impact due to inertia in expectations. - Targeted and temporary liquidity-support measures may be needed while tightening. - Faster withdrawal of pandemic-related spending recommended; targeted transfers to protect vulnerable. - Debt dynamics could worsen as BOJ profit transfers to government decrease with rising rates. ### Selected exact macro and fiscal figures (preserved from report) - Nominal GDP: US$ 4,234 Billion (2022) - GDP per capita: US$ 33,822 (2022) - Population: 125 Million (2022) - Public debt, gross (2019–2024 row): 236.4, 258.7, 255.4, 261.3, 258.2, 256.3 - Headline CPI (2019–2024 row): 0.5, 0.0, -0.2, 2.5, 2.7, 2.2 - Real GDP growth (2019–2024 row): -0.4, -4.3, 2.1, 1.1, 1.3, 1.0 - Current account balance (US$) (2019–2024): 176.3, 147.9, 197.3, 90.0, 131.8, 180.3 - Current account balance (percent of GDP) (2019–2024): 3.4, 2.9, 3.9, 2.1, 3.0, 4.0 - Exchange rates (Yen/dollar rate): 109.0, 106.8, 109.8, 131.5 (for 2019–2022) - BoJ asset composition (as of January 2023): about 80 percent JGBs; 5 percent ETFs; 2 percent combined equities, REITs, corporate bonds and commercial paper. - BoJ holdings of outstanding 10-year JGBs: close to 82 percent as of mid-February. ### Annex highlights - Financial Soundness Indicators (2017–22): CET1 declines for internationally active banks (~1 percentage point between end-March and end-September 2022); major bank NPLs 0.8 percent; regional bank NPLs 1.8 percent (end-September 2022). - Annex I (Household inflation expectations): modified Carlson-Parkin approach yields expectations that rise since 2021 but remain well below 2 percent in 2022Q4; estimated series calibrated so average equals average of actual inflation. - Annex VI (Household savings): household savings peaked at 23 percent of household disposable income in 1974; excess savings close to 11 percent of GDP during the pandemic; households hold close to 55 percent of financial assets as cash and deposits. - Debt Sustainability Analysis (DSA) baseline projections (public debt percent of GDP): - Actual 2021: 255.4; 2022: 261.3; 2023: 258.2; 2024: 256.3; 2025: 257.6; 2026: 259.2; 2027: 261.5; 2028: 264.0; 2029: 264.7; 2030: 266.1; 2031: 268.0 - Annex XI (Spillovers from a rise in JGB yields): an unexpected increase in the slope of the JGB yield curve of 100 basis points associated with an increase in the slope of the U.S. Treasury yield curve by close to 10 basis points. - Annex XII (Startups and innovation): number of unicorns in Japan: six in 2022; valuation of unicorns in Japan: about 8.8 billion dollars in 2022; venture capital share: 0.06 percent of GDP. *Source: IMF staff report (1jpnea2023001).* ### 2.1 percent of GDP in 2022 due to a sharp rise in the value of commodity imports, and the ### JAPAN—STAFF REPORT FOR THE 2023 ARTICLE IV CONSULTATION ### Recent developments - Current account surplus fell to 2.1 percent of GDP in 2022 due to a sharp rise in the value of commodity imports. - The external position in 2022 is assessed as broadly in line with medium-term fundamentals and desirable policies. - The banking sector remains resilient, with capital adequacy and liquidity ratios above regulatory requirements, but interest and credit risks have increased. - Headline inflation recorded levels not seen in four decades. - COVID-19 related restrictions have been gradually reduced since 2022, with border reopening in October 2022. ### Near-term outlook and projections - Economic recovery is projected to continue in the near term amid pent-up demand, supply chain improvements, border reopening and policy support. - Real GDP growth: - 2022: 1.1 percent - 2023 (projected): 1.3 percent, driven by private consumption and business fixed investment - 2024 (projected): 1.0 percent - Output gap is projected to close in early 2023 (Output Gap: 2022: -0.9; 2023: -0.1; 2024: 0.2). - Exports will rise as supply-side constraints ease and inbound tourists return. - Inflation: - Headline CPI: 2022: 2.5 percent; 2023 (proj): 2.7 percent; 2024 (proj): 2.2 percent - Inflation is expected to rise further in early 2023 due to the delayed effect of yen depreciation and border reopening before declining again. - Current account: - Current account balance (billions of USD): 2021: 197.3; 2022: 90.0; 2023 (proj): 131.8; 2024 (proj): 180.3 - Current account as percent of GDP: 2021: 3.9; 2022: 2.1; 2023 (proj): 3.0; 2024 (proj): 4.0 - The current account surplus is projected to bounce to an average of 2.9 percent of GDP in 2023 driven by lower commodity prices and inbound tourism. ### Fiscal outlook and risks - The primary fiscal deficit will stay elevated in 2023 following the adoption of the October 2022 fiscal package. - Government operations (selected): - Revenue (percent of GDP): 2021: 35.5; 2022: 36.6; 2023 (proj): 36.2; 2024 (proj): 35.7; 2024: 35.4 - Expenditure (percent of GDP): 2021: 37.3; 2022: 44.6; 2023 (proj): 42.8; 2024 (proj): 44.0; 2024: 42.1; 2024: 39.4 - Overall Balance (percent of GDP): 2020: -3.0; 2021: -9.1; 2022: -6.2; 2023 (proj): -7.8; 2024 (proj): -6.4; 2024: -4.0 - Primary balance (percent of GDP): 2020: -2.4; 2021: -8.4; 2022: -5.6; 2023 (proj): -7.5; 2024 (proj): -6.2; 2024: -3.8 - Public debt, gross (percent of GDP): 2019: 236.4; 2020: 258.7; 2021: 255.4; 2022: 261.3; 2023 (proj): 258.2; 2024 (proj): 256.3 - Demographic challenge: an aging and declining population will continue to be a major macroeconomic challenge in the medium and long term (Population Growth: 2022: -0.3; 2023 (proj): -0.4; 2024 (proj): -0.5; Old-age dependency: 2022: 48.9; 2023 (proj): 49.3; 2024 (proj): 49.8). ### Risks - Significant external downside risks and domestic two-sided inflation risks (short-term upside more prominent). - Downside risks to growth include: - deepening geo economic fragmentation and geopolitical tensions; - an abrupt slowdown of the global economy; - commodity price volatility; - natural disasters; and - cyberthreats. - Additional risk: any abrupt change of the current monetary policy framework could pose risks to the economy. - Upside risks to growth include: - a more robust recovery of consumption, especially services; and - a stronger-than-expected recovery of inbound tourism. - Financial sector risks: increased interest-rate and credit risks, including credit exposures to leveraged overseas borrowers and large domestic borrowers; resilience to US dollar liquidity stress should be further improved. ### Policy recommendations - Near term: focus on achieving the 2 percent inflation target durably and preserving financial stability. - Fiscal policy: - Growth-friendly fiscal consolidation is warranted to rebuild fiscal buffers and ensure debt sustainability. - Consolidation should be underpinned by a credible medium-term fiscal framework to reduce the primary deficit and put the debt-to-GDP ratio on a clear downward path. - Pandemic-related fiscal support should be withdrawn in a timely manner. - Consolidation efforts should include both revenue and expenditure measures, including better targeted fiscal support to vulnerable households. - Monetary policy: - Maintaining an accommodative monetary policy stance remains appropriate to achieve the 2 percent inflation target durably. - Given two-sided risks to inflation, consider options for introducing more flexibility under the yield curve control framework to better manage those risks and help address the side effects of prolonged easing. - Avoid a premature exit from monetary easing; any changes to monetary policy settings need to be well communicated to facilitate smoother transitions and protect financial stability. - The exchange rate should continue to act as the main shock absorber, limiting foreign exchange interventions to special circumstances, including disorderly market conditions. - Financial stability: - Closely monitor interest-rate and credit risks. - Consider appropriate implementation of macroprudential policies to curb financial vulnerabilities as they emerge, including vulnerabilities from growth in housing loans. - Structural policies: - Boost income growth, support startups, deepen digitalization, and achieve climate targets. - Labor market policies to encourage more women and older persons to join the work force, reduce labor market duality, and improve mobility. - Encourage the Digital Agency to continue coordinating and implementing policies to digitalize the public sector. - Higher carbon pricing could help Japan achieve its climate-related targets in a growth-friendly way; it should be accompanied by measures to protect the most vulnerable people and to enable an orderly transition from high-emission to low-carbon sectors. *Source: JAPAN—STAFF REPORT FOR THE 2023 ARTICLE IV CONSULTATION (IMF staff report, March 7, 2023).* ### 6. Financial Soundness Indicators, 2017-22 ______________________________________________________ 44 ### 6. Financial Soundness Indicators, 2017-22 ### Context - Japan faces recovery from the pandemic alongside implications of the war in Ukraine; borders were reopened in October 2022. - Long-term background: slow growth, muted inflation, large fiscal deficits, and a build-up in government debt. - Real GDP per capita growth in Japan averaged 0.6 percent during 1992-2021 compared to 1.1 percent in other G7 economies. - Gross public debt increased from 62 percent of GDP in 1991 to 262 percent of GDP in 2021. - CPI inflation averaged 0.3 percent since 1992, with periods of deflation. - Policy agenda under the Kishida administration (started October 2021): “a new form of capitalism” with priorities: (i) human capital and distribution, (ii) science, technology and innovation, (iii) start-ups and open innovation, (iv) Green Transformation and Digital Transformation. ### Recent developments — Real economy and inflation - Real GDP increased by 1.1 percent in 2022 and remains below the level in 2019 (annual basis). - Private consumption led the recovery; private investment rebounded. Industrial production recovered strongly as supply chain constraints eased. - Headline inflation developments: - Headline inflation has been above 2 percent y/y since April 2022. - January (presumably January 2023) headline inflation: 4.3 percent y/y. - Staff’s estimate of underlying core inflation: 3.3 percent y/y. - Underlying core inflation defined as headline inflation excluding energy, fresh food, and one-offs. - Survey- and market-based inflation expectations: - Survey-based medium-term inflation expectations for firms rose above 2 percent. - Households’ expectations remained around 1 percent in 2022Q4. - Market-based inflation expectations remained well below 2 percent. ### Recent developments — Wages and labor market - Limited passthrough from inflation to wages despite tight labor market conditions: - Unemployment rate: 2.5 percent. - Labor force participation rate: 63 percent (historical peak). - Job opening-to-applicants ratio: steadily growing. - Wage outcomes: - Agreed average base pay increase in spring 2022: 0.6 percent. - Total wage growth accelerated to 4.8 percent y/y in December (year not specified in excerpt). - Base wage (excluding bonuses) growth: 1.9 percent y/y. - Note: Base wage growth is less volatile than total wage growth and is a more reliable indicator of underlying wage dynamics. - Structural observation: history of stagnant nominal wages in the last 25 years; see companion paper “Structural Barriers to Wage Income Growth in Japan.” ### Fiscal policy and packages in 2022 - Authorities announced a large fiscal package in late October 2022 to cushion higher inflation and accelerate the new capitalism agenda; included subsidies to electricity, gas, oil, and cash transfers to child-rearing households. - Fiscal packages in 2022 (above-the-line expenditure by central and local governments): - April Package: ¥2.7 trillion (0.5 percent of GDP). - September Package: ¥3.5 trillion (0.6 percent of GDP). (Authorities count September measures as part of October package, but treated separately here.) - October Package: ¥23.9 trillion (4.3 percent of GDP). - The impact of the October package on the fiscal deficit is mainly mitigated by better-than-expected revenue performance. - Authorities spent ¥0.3 trillion from their contingency reserve fund in July (2022). ### Monetary policy, BoJ actions, and balance sheet - Monetary policy stance: ultra-accommodative; BoJ emphasizes easing will continue unless inflation picks up durably. - Yield Curve Control (YCC) tweak in December (year not specified): widened band around zero percent 10-year JGB yield target from 0.25 to 0.50 percent; significantly expanded JGB purchases; short-term policy rate left at minus 0.1 percent. - BoJ expanded fund-supplying operations against pooled collateral to incentivize banks to invest in JGBs. - BoJ balance sheet: - Expanded from 110 percent of GDP at end-2019 to 135 percent of GDP in 2022Q1. - Unwinding of COVID-related special lending reduced the balance sheet and monetary base, but increased QE across JGB maturities and expanded fund-supplying operations offset declines. - Private sector credit growth: 4.5 percent y/y (end-December) based on loans from domestically licensed banks. ### Exchange rate dynamics and FX intervention - Monetary policy divergence with peers contributed to yen depreciation and prompted FX intervention—the first since 1998. - Yen depreciation: by mid-September, the yen had weakened nearly 27 percent against the US dollar since the Fed started to raise policy rates in March 2022. - Interventions: - September 22: first intervention of nearly USD20 billion. - October: further interventions amounting to around USD43 billion. - These interventions equal 5 percent of forex reserves at end-August; forex reserves declined to US$1.08 trillion at end-October. - Noted past intervention episodes listed in chart (values included in figure captions, e.g., Oct-Dec 1997: JPY1.1trn; Apr-June 1998: JPY3.0trn; Sept 2022: JPY2.84trn; Oct 2022: JPY6.35trn). ### Financial sector soundness - Banks largely weathered headwinds from global monetary tightening and slowdown: - Common equity Tier 1 (CET1) capital ratios of internationally active banks declined by close to 1 percentage point on average from end-March to end-September 2022. - Core capital ratio (excluding unrealized valuation losses) has been flat for domestically-oriented banks. - Non-performing loans (NPLs) ticked up marginally: - Major banks NPLs: 0.8 percent as of end-September 2022. - Regional banks NPLs: 1.8 percent as of end-September 2022. - Elevated interest rate risks on banking books, especially for smaller banks due to higher and longer-tenor JGB holdings since the pandemic. - Direct exposure of the financial sector to the war in Ukraine has been limited. - Capital adequacy ratios remain well above regulatory minimums (consolidated, in percent of risk-weighted assets; charts indicate series for major and regional banks, domestically and internationally active). ### External sector and current account - Current account surplus narrowed to 2.1 percent of GDP in 2022 from 3.9 percent in 2021 and a 3.8 percent of GDP average in 2016-19. - Deterioration driven by the trade balance due to higher commodity import prices amid Japan’s high reliance on imported energy sources; this outpaced export rises as supply bottlenecks eased. - External position in 2022 assessed as broadly in line with medium-term fundamentals and desirable policies (preliminary; final assessment to be presented in 2023 External Sector Report). - Historical note: revisions changed the 2021 current account surplus from 2.9 percent (in 2022 Article IV report) to 4 percent due to upward revision in primary income balance from reinvested earnings. ### Outlook and risks - Growth projection: - Growth expected to increase to 1.3 percent in 2023, driven by private consumption and business fixed investment. - Output gap projected to close in early 2023. - Current account surplus projected to bounce to an average of 3 percent of GDP in 2023 driven by lower commodity prices and inbound tourism. - Primary fiscal deficit to stay elevated in 2023 following the October 2022 fiscal package. - Inflation projection: - Inflation expected to rise further in early 2023 due to delayed effects of yen depreciation and border reopening, then decline. - Inflation projected to peak in 2023Q1 and gradually fall below 2 percent by end-2024 as import price effects wane and energy subsidies take effect. - Base wage growth expected to accelerate in 2023 but likely remain below the level the BoJ considers consistent with 2 percent inflation sustained. - Under baseline assumptions, headline inflation projected to remain around 1.5 percent in the medium term, below the BoJ’s 2 percent target. - Wage growth of 3 percent would be consistent with inflation of 2 percent and labor productivity growth of 1 percent. - Demographic and structural risks: - Official projections anticipate population will rapidly age and shrink by about 30 percent in the next 40 years, posing a drag on potential growth and a risk to fiscal sustainability with financial stability implications. - Labor market rigidities limit productivity growth and reflation of the economy. - External and policy risks: - Significant external downside risks include: (1) deepening geo economic fragmentation and geopolitical tensions; (2) an abrupt slowdown of the global economy; (3) commodity price volatility; (4) natural disasters; (5) cyberthreats. - Additional risk from any abrupt change of the current monetary policy framework. - Upside growth risks: more robust consumption recovery, especially services, and stronger-than-expected inbound tourism recovery. - Inflation risks are two-sided with short-term upside more prominent. *Source: IMF staff report excerpt for Japan (chapter: 6. Financial Soundness Indicators, 2017-22).* ### 2022. The authorities concurred with the preliminary assessment that Japan’s 2022 external position ### 1jpnea2023001 - 2022. The authorities concurred with the preliminary assessment that Japan’s 2022 external position ### Economic policies: overarching objectives and near- vs. medium-term focus - Goal: achieve the 2 percent inflation target durably without significant overshooting while preserving financial stability and reducing fiscal vulnerabilities over the medium term. - Near-term priorities: - Consider more flexibility in longer-term yields given high uncertainty on the inflation outlook and a narrowing output gap to enable a smoother transition to a neutral monetary stance once the inflation target is durably achieved. - Changes in monetary policy settings should be properly planned and communicated, including to reduce financial sector risks. - Use macroprudential and other policies to curb financial sector vulnerabilities. - Withdraw pandemic-related fiscal support quickly; new measures should be limited and targeted only to vulnerable households to avoid overheating the economy. - Boost labor income to achieve a virtuous cycle of income and growth. - Medium-term priorities: - Implement growth-friendly and credible fiscal consolidation to put public debt on a downward path and rebuild fiscal buffers. - Limit financial support to viable firms to avoid the survival of low-productivity firms. - Undertake labor market and fiscal reforms to raise potential growth, reduce gender inequalities, and offset the drag from fiscal consolidation. - Promote green and digital investment to help achieve climate targets and capture digital-economy benefits. ### A. Fiscal policy — assessment, risks, and recommended direction - Assessment of October 2022 fiscal package: - The large fiscal package adopted in October 2022 "could have been smaller and better designed." - Package mitigates fiscal drag for 2023 and 2024 as past stimulus dissipates, but raises concerns: - Size is too large given the output gap is projected to close in 2023 while debt-to-GDP is already at a high level. - Composition: new electricity and gas subsidy and existing petroleum subsidy are not targeted to vulnerable households; targeted subsidies would have had a stronger GDP impact and less distorted energy consumption. - Cash transfer to child-rearing households could have been targeted; untargeted support will lead to higher household savings because of the low propensity to consume in Japan. - Measures related to structural reforms (digitalization, climate change) are limited. - Recommended near-term stance: - Withdraw fiscal policy support more quickly amid recovery, rising inflation, tighter labor markets, and a closing output gap. - Combination of fiscal packages and the budget for FY2023 will result in a primary deficit of 6.2 percent of GDP in 2023. - Although some near-term fiscal space exists, stimulus measures further narrow that space and will have very limited impact on raising output while aggravating fiscal vulnerabilities and potentially adding to inflation—requiring stronger monetary tightening and increasing fiscal financing costs. - Staff recommends a significantly faster consolidation in 2023 compared to the baseline mainly by unwinding the non-targeted transfer measures with a fiscal multiplier of 0.1, and a more significant consolidation over the medium term. - Any additional spending pressures (national security, green transformation, child-related policies) should be targeted to low-incomes and accompanied by revenue-raising measures. - Medium- and long-term trajectory and risks: - Under current policies, the public debt-to-GDP ratio will increase steadily in the medium and long term. - The primary deficit (% of GDP) is projected to decline in the near term as stimulus phases out but rise in the medium and long term to accommodate age-related spending pressures, especially for health and long-term care. - The interest-growth differential is projected to become less favorable as a declining working-age population weighs on potential growth. - With public debt-to-GDP on an upward path, interest rates could increase suddenly and sovereign stress could emerge. - Measures to bolster fiscal credibility and contain debt: - Adopt realistic projections: - Cabinet Office GDP growth rates and fiscal balances have historically been too optimistic; move to more realistic scenarios and sensitivity analysis based on lower potential growth. - Consider a fiscal council to evaluate realism of macro-projections, provided it has operational independence and adequate resources. - Strengthen the fiscal framework: - Make budget expenditure ceilings binding; limit practice of adopting supplementary budgets except for unexpected large shocks. - Ensure budget documents explain consistency with medium-term fiscal targets and underpin targets with specific measures. - Balance debt sustainability and growth: - Continue to assess progress toward the FY2025 primary balance target while weighing consolidation against the need to provide fiscal support if adverse shocks materialize. - Specific consolidation levers and social-safety measures: - Contain health and long-term care spending: - Nozaki and others (2017) show spending could increase to 14 percent of GDP by 2030. - Possible measures: improve spending efficiency (more use of generic drugs, shorter inpatient care durations, enhanced market-based drug pricing) and target measures (higher copayments for high-income seniors, limiting scope of covered services and drugs). - Increase government revenues: - Options: unifying and increasing the consumption tax standard rate; strengthen property taxation by removing preferential treatment of residential land; rationalize allowances and deductions in personal income taxation; increase the capital income tax rate; increase social insurance premiums. - Strengthen the safety net: - There appears to be a clear gap for the working poor; an earned income tax credit (EITC) scheme could be considered to reduce poverty and enhance labor participation and to rationalize untargeted transfers. ### Authorities’ views on fiscal policy - Ministry of Finance: - Agreed on the need to withdraw special supporting measures related to COVID-19; progress made including termination in January of the temporary expansion of the Employment Adjustment Subsidy. - Energy subsidies will be terminated this fall to support decarbonization initiatives; withdrawal should be carefully undertaken in a growth-friendly manner. - Concurred on the need for fiscal consolidation in the medium to long term amid rising spending pressures; planned increases in expenditure for national security, green transformation, and child-related policies are noted, but concrete offsetting revenue measures are not yet finalized. - Agreed that additional spending measures should be targeted and accompanied by revenue measures. - Acknowledged that the practice of adopting supplemental budgets undermines fiscal discipline and that discipline should be strengthened to put public debt on a downward path. - Emphasized working toward the medium-term fiscal target but noted policies should not be constrained by the current timeline to reach neutral primary balance by FY2025; necessary policies can be consistent with the fiscal consolidation target. - Stressed fiscal structural reforms are in progress, including the expansion of employees’ health/pension insurance coverage to part-time workers last October and the need to improve information sharing among central and local governments for timelier and better-targeted fiscal transfers. ### B. Monetary policy — stance and interaction with other policies - Current assessment: - An accommodative monetary policy stance remains appropriate but needs support from other policies to achieve the 2 percent inflation target sustainably. - With higher inflation, monetary policy is more accommodative as measured by the gap between the actual and natural short-term interest rate. - An overall accommodative stance helps stimulate domestic demand, but without more substantial wage growth, inflation will fall below the 2 percent target by end-2024 as cost increases from import prices and a more depreciated yen wane. - It is necessary to implement policies to raise households’ purchasing power through improvement in wages, in line with the inflation target. - Risks and uncertainties: - Exceptionally high uncertainty surrounds baseline inflation projections with both upside and downside risks. - Near-term upside risks are more prominent given a narrowing output gap and lower real interest rates; sources include delayed effects of yen depreciation, border reopening, second-round effects of imported inflation, fiscal support, and higher-than-expected wage growth. - Staff estimates that a 10 percent depreciation would lead to a *Italic: International Monetary Fund — 1jpnea2023001 (2022).* ### 0.7 percent increase in the CPI level after three to four quarters. Moreover, border reopening is ### 1jpnea2023001 - 0.7 percent increase in the CPI level after three to four quarters. Moreover, border reopening is ### Inflation outlook and risks - Recent and near-term inflation dynamics: - "0.7 percent increase in the CPI level after three to four quarters." - Border reopening is expected to boost services consumption and tighten the labor market. - Japan’s largely backward-looking inflation expectations could prolong high inflation once it emerges. - Downside and upside risks: - Downside risks: slowdown in the global economy; rigidity in inflation expectations; prolonged weak wage growth due to structural labor-market factors. - Upside risks: narrowing output gap and lower real interest rates could raise upside inflation risks. - Survey and market indicators: - Survey-based inflation outlooks have risen above the target while market-based inflation expectations remain low. ### Monetary policy, YCC, and policy options - Rationale for more flexibility in long-term yields: - More flexibility in longer-term yields could better manage two-sided inflation risks and smooth transition to a neutral monetary stance once the 2 percent target is durably achieved. - Flexibility would make policy nimble if easing is warranted in the event of a global recession. - Clear guidance on pre-conditions for a gradual policy rate lift-off would help anchor expectations and strengthen BoJ credibility. - Costly side-effects of prolonged easing highlighted: - As of mid-February, the BoJ holds close to 82 percent of outstanding 10-year JGBs, an increase of 15 percentage points since the Fed tightening cycle began in March 2022. - As of January 2023, about 80 percent of the BoJ’s total assets are composed of JGBs, followed by 5 percent of Exchange Traded Fund (ETFs) and 2 percent combined of equities, Real Estate Investment Trusts (REITs), corporate bonds and commercial paper. - BoJ purchases have reduced liquidity in the JGB market, with market surveys indicating a sharp deterioration in bond market functioning since May. - Options to allow higher long-term yields: - Widen the 10-year target band and/or raise the 10-year target. - Shorten the yield curve target. - Shift from a JGB yield target to a quantity target of JGB purchases (with state-contingent purchase amounts). - Trade-offs for each option: - Widening the 10-year band: minor adjustment but the range must be wide enough for market forces to lead. - Quantity-based approach: avoids defending a yield level but requires state-contingent purchase volumes to avoid financial stability impairment. - Shorter-term yield target: keeps short-term yields low (which matter more for real activity) but may face similar side-effects of targeting a yield level. - Neutral rate context: - Nominal neutral rate estimates for Japan range from 1 to 2 percent based on different methodologies. ### FX intervention (FXI) and exchange rate policy - FXI rationale and limitations: - FXI was triggered by yen volatility; yen depreciation since March 2022 largely reflects interest rate differentials but has depreciated more than implied by underlying drivers since June. - FXI can help lower "excessive" volatility and keep the pace of depreciation aligned with fundamentals, but effects are likely temporary. - Use of FXI should be limited to special circumstances: disorderly market conditions, risks to financial stability from sharp yen movements, and/or concerns that currency movements could de-anchor inflation expectations. - Authorities’ view: - Authorities stated FXI in 2022 addressed excess volatility and was in line with international norms; MoF and BoJ pursue different objectives (exchange rate stability vs domestic price stability). ### Financial stability and macro-financial vulnerabilities - Key developments and vulnerabilities: - Major internationally-active banks have lengthened tenor of cross-currency swaps and strengthened dollar deposit base since mid-2010s; further resilience to US dollar liquidity stress warranted. - Non-bank financial institutions (NBFIs), life insurers, and pension funds increased overseas holdings and faced valuation losses in 2022; GPIF had negative investment returns in 2022 but cumulative returns remain well above long-term targets. - Credit imbalances: BIS credit-to-GDP gap is high by historical standards; credit-to-GDP ratio is nearly 25 percent above its one-sided long-term trend (as of March-2022) and is still 16 percent net of corporate savings. - Recent credit expansion driven by increasing loans to corporates (nearly half publicly guaranteed), housing, and commercial real estate loans. - Housing loan risks: large fraction of floating-rate mortgages, increasing loan-to-income ratios, rising share of borrowers with high debt servicing ratios. - Crypto risks: FTX collapse highlighted vulnerabilities; FSA assessed ML/TF risks from crypto assets as high and passed legislation, expected to be in effect in 2023, on crypto asset transfers in line with the “travel rule”. - Direct exposure to Russia-Ukraine conflict is limited: Japanese banks’ claims on Russia and Ukraine prior to the War were about 9 billion US dollars (less than 0.2 percent of total claims of banks in Russia); Japan-domiciled investment funds have less than 0.1 percent exposure to Russian assets. - Macroprudential and supervisory recommendations: - Consider macroprudential policies to curb vulnerabilities from growth in housing loans. - Reduce the public credit guarantee ratio for new loans to encourage better risk assessment by lenders. - FSA to broaden systemic risk assessment scope, strengthen foreign currency liquidity stress testing, revamp Early Warning System, and transition to economic-value-based solvency regime for insurers by 2025. - Banks should enhance risk management as pandemic support is unwound and as they expand into new business areas. - Financial sector resilience and risks of higher yields: - An increase in JGB yields could cause valuation losses on banks’ JGB holdings, with stronger losses for smaller banks relative to capital, but a steeper yield curve tends to improve banks’ profitability over time. - Leveraged financial institutions with fragile hedges could trigger adverse loops of rising yields and deleveraging; orderly yield changes and high-quality data are essential. - A rise in short-term domestic rates could pose household risks given high shares of variable-rate mortgages and higher loan-to-income and debt service-to-income ratios. - Rise in JGB yields could have global spillovers through portfolio rebalancing by international investors. ### Alternative scenario: Sustained inflation pressures - Scenario specification and dynamics: - Alternative scenario: headline and core inflation reach 5 percent by early 2024, driven by higher-than-expected wage increases. - Underlying model: higher inflation driven by a demand shock following an AR(1) process with persistence parameter close to 0.7. - Japan’s inflation expectations are highly backward-looking; observed inflation estimated to contribute close to 65 percent towards formation of inflation expectations. - Policy responses and implications: - Much stronger monetary tightening would be warranted; both short-term and long-term rates would have to rise, pushing interest rates above the neutral rate by mid-2024. - Such tightening would bring inflation down to the target by late-2025 in the model but would produce a larger contractionary impact due to inertia in expectations. - BoJ may be constrained in normalizing policy quickly given current stance far from neutral; targeted and temporary liquidity-support measures may be needed while tightening. - Fiscal policy: faster withdrawal of pandemic-related spending would dampen domestic demand; targeted transfers could mitigate adverse effects and protect the vulnerable while avoiding inflationary pressure. - Debt dynamics: as interest rates rise, BOJ profit transfers to government may decrease, worsening debt dynamics and strengthening the case for fiscal consolidation. - Financial stability monitoring: - Any changes to YCC would have short- and medium-term financial stability implications; authorities should be ready to intervene to preserve stability. - Banks with increased JGB holdings during the pandemic are exposed to movements in yields; some banks reduced duration risk (average maturity of JGB holdings of 1-2 years). - Risks to households from higher short-term rates and to leveraged institutions require monitoring and availability of high-quality data. ### Structural reforms, climate, digitalization, and fiscal policy - Structural policy priorities to boost potential growth and the virtuous cycle of income and growth: - Boost labor supply (encourage female and senior labor force participation; advance work-style reforms including telework; eliminate social security and tax distortions related to dependent spouses). - Encourage higher wage growth via structural reforms (reduce labor market duality; improve mobility; shift to job-based employment and merit-based pay). - Strengthen workforce in STEM fields (training and reskilling; encourage students and women into STEM; raise returns to STEM education through merit-based promotions and flexible work arrangements). - Startups, corporate investment, and innovation: - Promote startups via improved financing (venture capital), entrepreneurial education, reduced personal guarantees, and university start-up hubs. - Use fiscal incentives to increase returns to investment, especially in ICT technology and R&D, as firms hold more cash due to intangible capital and financial frictions. - Climate transition: - Japan committed to net zero by 2050 and an upgraded interim target of 46 percent reduction in GHG emissions by 2030 (relative to 2013). - Government plans to expand carbon pricing beginning in FY2028; revenues to service green transformation bonds for public green investment. - BoJ disbursed about 0.6 percent of GDP to banks in funds-supplying operations to support climate finance. - Policy package needed: green investments in electricity and transport, gradually rising carbon pricing, elimination of untargeted subsidies for gas, electricity, and fuel, and targeted support for vulnerable households and high-emission firms. - Digitalization and governance: - Digital Agency actions: expand "My Number" digital ID coverage; standardize local government IT systems to improve data sharing and targeted transfers. - Continue corporate governance reforms (revised Corporate Governance Code, June 2021) to enhance board independence, diversity, and ESG focus. - Continue to promote open, stable, and transparent trade policies and strengthen WTO dispute settlement. ### Fiscal stance and key macro projections (selected exact figures from report) - Fiscal and macro projections and indicators (selected figures preserved exactly as reported): - Nominal GDP: US$ 4,234 Billion (2022) - GDP per capita: US$ 33,822 (2022) - Population: 125 Million (2022) - Public debt, gross: 236.4, 258.7, 255.4, 261.3, 258.2, 256.3 (for 2019–2024 row in Table 1) - Headline CPI: 0.5, 0.0, -0.2, 2.5, 2.7, 2.2 (for 2019–2024 row in Table 1) - Real GDP growth: -0.4, -4.3, 2.1, 1.1, 1.3, 1.0 (for 2019–2024 row in Table 1) - Current account balance (US$): 176.3, 147.9, 197.3, 90.0, 131.8, 180.3 (for 2019–2024) - Current account balance (percent of GDP): 3.4, 2.9, 3.9, 2.1, 3.0, 4.0 (for 2019–2024) - Exchange rates (Yen/dollar rate): 109.0, 106.8, 109.8, 131.5 (for 2019–2022) - BoJ asset composition (as of January 2023): about 80 percent JGBs; 5 percent ETFs; 2 percent combined equities, REITs, corporate bonds and commercial paper. - BoJ holdings of outstanding 10-year JGBs: close to 82 percent as of mid-February; increase of 15 percentage points since March 2022. - Fiscal policy recommendation: - Withdraw pandemic-related fiscal support more quickly; pursue growth-friendly fiscal consolidation to reduce the primary deficit and put public debt-to-GDP ratio on a clear downward path. - Any additional spending measures should be targeted to the vulnerable and paired with revenue measures. - Government spending should focus on priority areas such as green and digital transformation. *Source: IMF staff report (1jpnea2023001).* ### Annex I. Estimating Household Inflation Expectations ### Annex I. Estimating Household Inflation Expectations ### Measurement challenges and biases in quantitative survey responses - Quantitative survey responses from the Bank of Japan Opinion Survey on the General Public’s Views and Behavior are biased upward. - Identified sources of bias: - Households tend to react more to positive inflation shocks than to negative inflation shocks. - Bunching bias: most responses are integers and multiples of 5. - Influence of outliers. - The Opinion Survey elicits both a numeric expectation and a qualitative response on whether prices will “go up,” “go down,” or “remain the same.”1 ### Methodological adjustment: modified Carlson-Parkin approach - To avoid upward bias, qualitative survey responses are converted into quantitative inflation expectations using a modified Carlson-Parkin method.2 - Modification accommodates the five qualitative choices in the Opinion Survey: - “go up significantly” - “go up slightly” - “remain almost the same” - “go down slightly” - “go down significantly” - References retained in source: Carlson and Parkin (1975) and the modified implementation (Ito and Kaihatsu, 2016).3 ### Estimated expectations and comparison with quantitative responses - The estimated household inflation expectations are calibrated so that their average equals the average of actual inflation, thereby eliminating the upward bias present in raw numeric responses. - Compared with quantitative survey responses, the modified-estimate series: - Is less volatile. - Rises since 2021 but remains well below the Bank of Japan’s two-percent inflation target. - Specific period referenced: expectations remain well below the 2 percent inflation target in 2022Q4. ### Interpretations and implications - Using qualitative-to-quantitative conversion reduces upward and volatility biases inherent in household numeric responses and yields expectations that align with observed inflation averages. - The adjusted series indicates household expectations increased from 2021 to 2022 but did not reach the BoJ’s 2 percent target as of 2022Q4. - The chart in the source contrasts Perception (average), Expectations (5-year), and Actual inflation over multiple quarters (series labels preserved as in source). *Source: Annex I. Estimating Household Inflation Expectations, IMF.* ### Annex VI. What Drives Japanese Household Savings? ### Annex VI. What Drives Japanese Household Savings? ### A. Developments in Household Savings - Long-term trend: household savings rate trended down after peaking at 23 percent of household disposable income in 1974, but reversed since 2016. - Three pre-pandemic phases: - Phase 1: increasing and high savings rate until the 1980s driven by post-war growth, rising household incomes, tax incentives for saving, and an under-developed social security system. - Phase 2: falling savings rate starting in the 1980s driven by ageing population, abolition of tax breaks for savings, decreasing/stagnant labor income growth, and improvement in public pension benefits. Net household savings rate (as percent of GDP and net disposable income) turned negative in 2013 as spending surged ahead of the April 2014 consumption tax hike. - Phase 3: starting in 2016 household savings rate rebounded but remained at low levels until the COVID-19 pandemic; conjectured drivers include concerns about fiscal sustainability and social security given high public debt and falling consumer confidence. - Pandemic impact: - Household savings rate rose sharply during the pandemic, reaching a peak of more than 20 percent of household disposable income. - Excess savings were close to 11 percent of GDP due to mostly-saved cash handouts. - Households have started to spend some excess savings, but saving rate remains above pre-pandemic levels/norm. - Age-group patterns: - Changing patterns observed across all age groups, indicating drivers beyond demographics. - Younger Japanese (age groups below 45) tend to save the highest proportion of their disposable incomes. - Asset composition and returns: - Households hold close to 55 percent of their financial assets as cash and deposit. - Comparative cash/deposit shares: United States 20 percent, United Kingdom 25 percent, Euro Area 34 percent. - Over last 20 years, household financial assets in Japan increased only 1.4 times versus tripling in the US and increasing 2.3 times in the UK. ### B. Key Drivers of Household Savings - Demographics: - Old age dependency ratio increased from 10 percent in 1973 to 47 percent in 2019. - When adjusted for increasing old-age employment the increase was from 8 percent to 36 percent. - Rising old age dependency ratio is associated with lower household savings; young age dependency and life expectancy do not appear significant. - Monetary policy: - Monetary easing associated with lower household savings rate via the interest rate (substitution) channel; substitution effect dominates income effect. - Low interest rates reduce returns on cash/deposit-heavy portfolios, depressing households’ ability to increase savings. - Fiscal policy: - Higher social security spending by government is significantly associated with lower household savings because households need to save less for retirement and health. - Social security spending rose from around 3 percent of GDP in 1960 to close to 13 percent in 2019. - Fiscal expansions are linked with increases in household savings (precautionary saving) as rising public deficits could trigger expectations of higher future taxes and lower government expenditure. - Concern about fiscal sustainability (including social security sustainability) is consistent with the rise in household savings starting 2016 when reforms halted growth in social transfers. - Corporate savings and substitutability: - Strong evidence of substitutability between corporate and household savings. - Some wealthy private owners have increased firms’ cash holdings, representing a shift from household to corporate savings. - Empirical estimation highlights (see Box 1 and regression table): - Data: yearly data spanning 1980–2019. Dependent variable: aggregate net household savings as a share of disposable income and as a share of GDP. Estimation: OLS on first differences; robustness checks with lagged regressors and system GMM. - Key regression coefficients (standard errors in parentheses): - Real Short-Term Rate: 0.188 (0.092) for Net Household Savings as a % of GDP; 0.311 (0.146) for Net Household Savings as a % of Disposable Income. - Public Savings: -0.455 (0.153) ; -0.713 (0.243). - Private sector credit: 0.027 (0.030) ; 0.076 (0.043). - Social Security Expenditure: -1.877 (0.483) ; -2.974 (0.766). - Real wages: 8.477 (3.751) ; 13.442 (5.944). - Corporate Savings: -0.276 (0.127) ; -0.394 (0.201). - Labor productivity: 0.300 (0.103) ; 0.436 (0.163). - Real growth rate of per capita GDP: -0.089 (0.128) ; -0.144 (0.203). - Old Age Dependency: -1.071 (0.548) ; -1.778 (0.868). - Young Age Dependency: -0.103 (0.673) ; -0.034 (1.067). - Life Expectancy: -0.457 (0.468) ; -0.653 (0.742). - Observations: 45; R-squared: 0.645 and 0.634 for the two specifications. - Statistical significance denoted by *, **, *** as in the source. ### C. Policy Implications - Macro and fiscal considerations: - Future private savings trajectory affects internal and external balance; household savings as a share of GDP could resume decline due to ageing. - Japan’s old age dependency ratio is expected to rise to more than 80 percent of the working age population in 2050. - Ageing will put upward pressure on fiscal expenditure (healthcare and pensions), which could encourage precautionary household saving and depress consumption. - A credible medium-term fiscal framework to reduce the deficit and put the debt-to-GDP path on a clear downward path could diminish policy uncertainty, bolster household consumption, and support corporate investment. - Policies should ensure sustainability of social security spending by containing health and long-term care expenditure while closing gaps in safety nets for the working poor. - Financial literacy and asset allocation: - Improving financial literacy will help households diversify from cash/deposits into higher-yielding investments. - Japanese respondents scored an average of 7 percentage points lower on comparable questions in the 2019 financial literacy survey than respondents in the United States, Germany, and the United Kingdom. - Diversification away from cash could increase households’ interest income and exposure to sustained increases in corporate value, improving financial sustainability in old age. _This summary is based on "Annex VI. What Drives Japanese Household Savings?" in the provided IMF content._ ### 1. Debt Coverage in the DSA: 1/ ### 1. Debt Coverage in the DSA: 1/ ### Debt Coverage and Scope - Coverage: general government. - Gross debt is the main indicator; net debt is also important in Japan given the large financial assets held by the government. - Not all financial assets are available to meet debt obligations (for example, social security assets for future obligations). - Subsector inclusion (Baseline): - Budgetary central government: Yes - Extra budgetary funds (EBFs): No - Social security funds (SSFs): Yes - State governments: Yes - Local governments: Yes - Public nonfinancial corporations: No - Central bank: No - Other public financial corporations: No - Reporting on intra-government debt holdings: GG: expected. ### Instrument and Accounting Notes - Basis of recording: Non-cash basis / Cash basis distinctions noted but summary indicates debt stock valuation conventions include nominal value, face value, and market value distinctions. - Valuation notes: - Nominal value: amount the debtor owes at a moment in time. - Face value: undiscounted principal to be paid at maturity. - Market value: value as if acquired in market transactions on the reference date; only traded debt securities have observed market values. - Stock of arrears could be used as a proxy in the absence of accrual data on other accounts payable. ### Consolidation and Holders - Debt consolidation across sectors: total flags indicate consolidation at general government level. - Commentary: Domestic creditors held more than 85 percent of public debt in 2021. - Within domestic creditors, Bank of Japan share increased from 12 percent in 2012 to 44 percent in 2021. - All public debt is governed by domestic law. - Debt is mostly long term, with an average residual maturity above 6 years. ### Debt Structure Indicators (selected) - Residual maturity: 6. years (as stated). - Domestic creditors share: >85 percent (2021). - Bank of Japan share: 12 percent (2012) → 44 percent (2021). ### Baseline Scenario (Percent of GDP unless indicated otherwise) - Public debt: - Actual 2021: 255.4 - 2022: 261.3 - 2023: 258.2 - 2024: 256.3 - 2025: 257.6 - 2026: 259.2 - 2027: 261.5 - 2028: 264.0 - 2029: 264.7 - 2030: 266.1 - 2031: 268.0 - Change in public debt: - 2021: -3.3 - 2022: 5.9 - 2023: -3.1 - 2024: -1.9 - 2025: 1.3 - 2026: 1.7 - 2027: 2.2 - 2028: 2.5 - 2029: 0.7 - 2030: 1.5 - 2031: 1.8 - Contribution of identified flows: - 2021: 7.0 - 2022: -2.0 - 2023: -0.8 - 2024: 2.3 - 2025: 2.6 - 2026: 3.2 - 2027: 3.5 - 2028: 1.7 - 2029: 2.4 - 2030: 2.8 - Primary deficit: - 2021: 5.6 - 2022: 7.5 - 2023: 6.2 - 2024: 3.8 - 2025: 2.7 - 2026: 2.9 - 2027: 3.1 - 2028: 3.2 - 2029: 3.4 - 2030: 3.5 - 2031: 3.6 - Noninterest revenues: 35.6 (2021), 35.1 (2022), 34.6 (2023 onward 34.4 repeated through 2031 with 34.4 noted in table). - Noninterest expenditures: 41.2 (2021), 42.6 (2022), 40.9 (2023), 38.3 (2024), 37.1 (2025), 37.3 (2026), 37.5 (2027), 37.7 (2028), 37.8 (2029), 37.9 (2030), 38.0 (2031). - Automatic debt dynamics: - 2021: -3.3 - 2022: -1.9 - 2023: -11.7 - 2024: -8.0 - 2025: -3.7 - 2026: -3.4 - 2027: -3.0 - 2028: -2.8 - 2029: -2.7 - 2030: -2.1 - 2031: -1.8 - Real interest rate and relative inflation: - 2021: 2.1 - 2022: 0.8 - 2023: -8.3 - 2024: -5.4 - 2025: -2.2 - 2026: -2.2 - 2027: -2.0 - 2028: -1.7 - 2029: -1.7 - 2030: -1.3 - 2031: -1.0 - Real GDP growth (memo): - 2021: 2.1 - 2022: 1.1 - 2023: 1.3 - 2024: 1.0 - 2025: 0.6 - 2026: 0.5 - 2027: 0.4 - 2028: 0.4 - 2029: 0.4 - 2030: 0.3 - 2031: 0.3 - Inflation (GDP deflator; percent): - 2021: -0.2 - 2022: 0.3 - 2023: 3.8 - 2024: 2.6 - 2025–2031: 1.3 (repeated) - Nominal GDP growth (percent): - 2021: 1.9 - 2022: 1.3 - 2023: 5.2 - 2024: 3.7 - 2025: 1.9 - 2026: 1.8 - 2027: 1.7 - 2028: 1.7 - 2029: 1.7 - 2030: 1.6 - 2031: 1.6 - Effective interest rate (percent): - 2021: 0.6 - 2022: 0.6 - 2023: 0.5 - 2024: 0.5 - 2025: 0.5 - 2026: 0.5 - 2027: 0.5 - 2028: 0.6 - 2029: 0.7 - 2030: 0.8 - 2031: 1.0 - Gross financing needs: - 2021: 68.0 - 2022: 62.1 - 2023: 57.2 - 2024: 54.9 - 2025: 52.9 - 2026: 52.9 - 2027: 54.4 - 2028: 55.3 - 2029: 56.0 - 2030: 54.9 - 2031: 54.3 - Of which: debt service (local currency): - 2021: 63.4 - 2022: 55.7 - 2023: 52.0 - 2024: 52.1 - 2025: 51.2 - 2026: 51.0 - 2027: 52.3 - 2028: 53.0 - 2029: 53.6 - 2030: 52.3 - 2031: 51.7 - Foreign currency financing: 0.00 across the projection table. ### Staff Commentary on Baseline - Public debt will rise over the forecast horizon, reflecting a primary deficit that remains about 3 ppts of GDP above its debt stabilizing level in 2031. - Contribution to change in public debt chart highlights cumulative impacts from primary deficit, real interest rate and relative inflation, real GDP growth, exchange rate depreciation, other flows, and residual. ### Realism of Baseline Assumptions - Realism analysis indicates a large median forecast error for medium-term primary deficit and public debt projections over 2011-19, suggesting a pessimistic bias. - The projected three-year adjustment in the cyclically-adjusted primary balance is high compared to historical experience; partly explained by unwinding support measures during the pandemic. - Forecast track record and distributions use comparator groups and historical observations; color codes indicate percentile bands for realism assessments. ### Medium-Term Risk Analysis - Debt Fanchart and GFN Financeability indices point to high risk. - Key indicators and values: - Fanchart width: 68.8 - Probability of debt not stabilizing (pct): 53.00.4 (as printed) - Terminal debt level x institutions index: 65.41.4 (as printed) - Debt fanchart index: ...2.9 (as printed) - Average GFN in baseline: 55.719.0 (as printed) - Bank claims on government (pct bank assets): 11.73.8 (as printed) - Change in claims on govt. in stress (pct bank assets): 1.20.4 (as printed) - GFN financeability index: ...23.2 (as printed) - Probability of missed crisis, 2022-2027 (if stress not predicted): 81.8 pct. - Probability of false alarm, 2022-2027 (if stress predicted): 3.4 pct. - Commentary: High risk arises from high debt levels even when adjusted by institutional quality and high average gross financing needs; significant bank financing in the baseline activates the banking stress test reflecting a large positive credit gap (BIS measure). ### Annex VIII — Exchange Rate Movement and FXI in 2022 - VAR analysis (weekly data January 2009–November 2022) indicates yen depreciated more than implied by underlying drivers since June 2022. - Evidence suggests speculation may explain part of “excessive” depreciation (e.g., increases in net short positions). - Option implied USD/JPY volatility elevated since March 2022. - Net yen short positions and interoffice assets of foreign bank branches (used as proxy for carry trades) have increased but remain lower than historical peaks. - Cross-currency basis swap premia widened during September to November 2022, potentially indicating financial frictions. - Authorities intervened to support the yen; interventions reduced exchange rate volatility somewhat for a limited duration and reversed some net yen short positions. - Historical example: 1998 interventions led to yen appreciating between 3-5 percent each time, but gains were reversed in subsequent ~2 weeks. - Literature note: Fratzscher et al (2019) using daily intervention data for 33 central banks (1995-2011) find FXI can be effective at smoothing exchange rates in the short run, particularly during high volatility. ### Annex IX — Growth at Risk (GaR) - GaR framework finds elevated downside risks over a longer horizon for Japan. - Short term (4 quarters): GaR at the 5th percentile is -2.1 percent. - Medium term: GaR at the 5th percentile lower than -4 percent; specific reported percentiles: - 4 quarters ahead (5th percentile): -2.1 - 8 quarters ahead (5th percentile): -4.5 - 12 quarters ahead (5th percentile): -5.2 - Domestic financial conditions index (FCI) constructed from real short-term interest rate, interbank spread, corporate local debt spread, equity price return and volatility; a U.S. FCI (Chicago NCI) is also used. - FCI behavior: tightened sharply during Global Financial Crisis and at pandemic outset; mildly tighter since mid-last year after easing during pandemic. *Source: 1jpnea2023001 - 1. Debt Coverage in the DSA: 1/* ### Annex X . Progress on 2017 FSAP Key Recommendations ### 1jpnea2023001 - Annex X . Progress on 2017 FSAP Key Recommendations ### Cross-Cutting Issues - Recommendation: Further raise corporate governance standards to bolster independence of board and oversight functions from senior management across banking and insurance sectors (FSA). Time Frame: NT - Update: The Corporate Governance Code was revised further in June 2021, focusing on enhancing board independence, corporate diversity, and sustainability and ESG considerations. - Update: The revised Code increases the required number of independent directors from at least two to at least one-third of the board for prime market listed companies (where necessary, a majority of the board members should be elected as independent directors), and requires establishing nomination and remuneration committees. - Update: Major financial institutions, including the three megabank groups, have completed transition to “Company with Nominating committee, etc.” as outlined in Japan's Companies Act. - Update: Per “the Comprehensive Guidelines for Supervision for Insurance Companies”, it is required for insurance companies to appoint at least two outside directors since 2016. Supervisory guidelines were revised in light of the ComFrame in 2020 to bolster effective group-wide supervision of internationally-active insurance groups (IAIGs). - Recommendation: Further develop internal processes to support full risk-based supervision for banks, insurers, and securities firms (FSA, SESC). Time Frame: I - Update: The FSA published “Principles of Prudential Policy” in March 2019, laying out its forward-looking approach to macroprudential and microprudential supervision. - Update: A draft “Supervisory Guideline” paper clarifying internal supervisory procedures was solicited for comments in October 2019. - Update: The FSA has enhanced risk-based AML/CFT/CPF measures; FATF 4th Mutual Evaluation Report of Japan published in August 2021 recognized improvements. - Update: FSA conducts personnel training by field experts (including on-demand video training, online lectures/workshops/conferences), and assigns personnel flexibly each year. - Recommendation: Consider enhancing independence of the FSA and BoJ in key supervisory issues (PM, MoF, FSA, BoJ). Time Frame: MT - Update: Under consideration by the authorities. ### Systemic Risks - Recommendation: Develop own supervisory stress testing model for solvency and liquidity risk analysis for banks, and for solvency risk analysis for insurers, as well as stress test large exposures periodically (FSA). Time Frame: NT - Update: Since 2019, the FSA and the BoJ have conducted common stress testing using authority scenarios for major financial institutions. - Update: FSA periodically requests from megabanks a list of credit amounts and internal ratings of domestic and foreign client exposures to simulate downgrading effects on credit costs. - Update: FSA conducts simplified stress tests on all insurance companies using stress scenarios at the severity of the Lehman Shock. - Update: FSA periodically collects data on exposures and ratings of major insurance companies to identify large concentration in specific borrowers and sectors. - Recommendation: Continue conducting liquidity stress testing regularly for significant foreign currencies and require banks to hold sufficient counterbalancing capacity, particularly high-quality liquid assets (FSA). Time Frame: I - Update: In cooperation with the BoJ, FSA continued foreign currency liquidity stress tests for three megabanks (using freely set scenarios) and engaged with banks on depth and frequency of internal tests. - Update: FSA confirmed the three megabanks conduct frequent foreign currency liquidity stress testing. - Update: FSA strengthened cooperation with host authorities, including an intensive review of foreign currency liquidity risk management by the three megabanks jointly with host authorities. - Update: FSA launched an annual joint survey with the BoJ on foreign currency liquidity of the three megabanks in FY2021. ### Financial Sector Oversight - Recommendation: Give the FSA the power to set capital requirements for banks based on specific risk profiles (Gov). Time Frame: I - Update: The FSA’s revamped “Early Warning Mechanism” achieves a result similar to Pillar 2 capital buffers by identifying banks with medium-term profitability or soundness concerns and engaging management to take early remedial actions. - Update: The FSA periodically simulates each bank’s core net profit or capital ratio under stressed conditions for a horizon of about 5 years, conducts in-depth dialogues, and can conduct governance reviews via on-site inspections or issue business improvement orders. - Recommendation: Take further steps to implement an economic-value-based solvency regime for insurers (FSA). Time Frame: NT - Update: Following recommendations of The Advisory Council on the Economic Value-based Solvency Framework (June 2020), the FSA aims to conduct annual field testing for all insurance companies, finalize the standards in 2024, and apply the new solvency regulations from 2025. - Update: The “Insurance Capital Standard” will be introduced as a capital standard for Internationally Active Insurance Groups (IAIGs) in 2025 after a five-year monitoring period from 2020. - Update: FSA released a comprehensive summary document in June 2021 and published in June 2022 the basic contents of the new framework to promote a seamless shift. - Recommendation: Introduce more specific periodic reporting requirements and more proactive investigations into related party transactions (FSA). Time Frame: I - Update: FSA requires banks conducting transactions with a related party where arm’s length rule may apply to seek approval; requirements clarified by the Regulation for Enforcement of the Banking Act and supervisory guidelines. - Update: In 2022, no case was approved among the three megabanks. - Update: FSA imposes business scope restrictions on banking groups and assesses the existing framework as sufficient to prevent violations of the arm’s-length rule. - Recommendation: Ensure robust supervision of systemically important securities firms by ensuring access to sufficient experienced staff and onsite monitoring of overseas operations (FSA, SESC). Time Frame: I - Update: A dedicated team (Monitoring Office for Major Securities Firms) established to monitor major securities firms; conducts year-round monitoring with the Securities Division and the Securities and Exchange Surveillance Commission. - Update: On-site investigations of overseas operations were conducted once in FY2017, four times in FY2018, and remotely or via interviews since the pandemic outbreak. - Recommendation: Enhance recovery plan further by including extreme stress scenarios and mitigate contagion risks through clearing members (JSCC). Time Frame: I - Update: In Listed Derivatives clearing, the JSCC set a cap on the cash call to non-defaulting clearing members, after consuming all resources set in the revised scheme. - Recommendation: Address recovery planning issues on regulation for central counterparties (FSA). Time Frame: I - Update: FSA revised the “Comprehensive Guidelines for Supervision of Financial Market Infrastructures” in June 2022; requires JSCC to develop and submit a recovery plan once a year (or when important changes occur). ### Macroprudential Policy - Recommendation: Clarify the mandate of the Council for Cooperation on Financial Stability (FSA, BoJ). Time Frame: NT - Update: The Council has convened bi-annually since 2014 to exchange views on the state of the financial system and markets to strengthen cooperation on macroprudential policy. - Update: Lower-level liaison meetings discuss CCyB necessity and report to the Council. - Update: Since 2020, FSA and BoJ coordinate to reduce reporting duplications and achieve higher-quality monitoring. - Recommendation: Consider proactively enhancing the macroprudential toolbox, including sectoral tools (FSA). Time Frame: NT - Update: FSA monitors emerging systemic risks via microprudential supervision covering lending to real estate, monitoring of CLO holdings, and foreign currency liquidity, jointly with BoJ. - Update: FSA conducts systemic risk assessment jointly with BoJ under the CCyB framework on a quarterly basis and specifies indicators and processes for determining CCyB rates in supervisory guidelines. - Recommendation: Continue to broaden and deepen the scope of systemic risk assessments (FSA, BoJ). Time Frame: NT - Update: Since FY2021, FSA conducts cross-sectional monitoring of market risks, including domestic and foreign interest rate risks, for some regional banks and major life insurers (in addition to major banks). - Update: FSA is considering a new data collection framework for non-banks (funds) to strengthen risk monitoring and analyze interconnectedness. - Update: Per the “IAIS Holistic Framework for Systemic Risk,” FSA has monitored risk management of IAIGs and other required companies since FY2020 for liquidity risk management, macro exposures, and interconnectedness. - Update: FSA has dedicated monitoring teams for nine major banking groups, five major securities companies, and a dedicated monitoring team for FinTech companies. ### Crisis Management, Resolution, and Financial Safety Nets - Recommendation: Strengthen resolution framework by removing ambiguities in choice of tools, introduce statutory bail-in power, clarify triggers for early entry into resolution, and ensure courts do not hinder effective resolution (FSA). Time Frame: NT - Update: FSA has made efforts to limit temporary public support needs through measures to improve resolvability; FSA’s July 2017 report contains recommendations for further strengthening resolution framework. - Recommendation: Consider broadening the perimeter of institutions to establish loss-absorbing capacity (FSA). Time Frame: NT - Update: FSA published “The Revisions to The FSA's Approach to Introduce the TLAC Framework” (April 2018). - Update: TLAC requirements adopted to G-SIBs in Japan since March 2019, pursuant to the FSB’s TLAC Term Sheet. - Update: TLAC requirements were applied to a D-SIB since March 2021. - Update: JFSA will continue to monitor for newly designated G-SIBs or D-SIBs meeting criteria. - Recommendation: Encourage earlier prompt corrective action and provide clearer path to resolution (FSA). Time Frame: NT - Update: The FSA’s revamped “Early Warning Mechanism” guides supervisory interventions; periodic 5-year stressed simulations; in-depth dialogues; governance reviews; business improvement orders. - Update: A pre-determined corrective action order is issued if capital adequacy or leverage ratios fall below minimum requirements; restrictions on capital distributions introduced if capital buffers fall below a certain level. - Recommendation: Enhance crisis preparedness and coordination via an interagency crisis management forum (MoF, Minister for FS, BoJ, FSA, DICJ). Time Frame: NT - Update: FSA regularly exchanges views with the Deposit Insurance Corporation of Japan (DICJ). FSA, MoF, BoJ, and DICJ cooperate daily on resolvability and crisis preparedness. - Update: Authorities (FSA, BoJ, DICJ) and Japanese G-SIBs met at a joint workshop in October 2022 for testing and assurance and to exchange views including cases of foreign G-SIBs. - Recommendation: Establish an orderly resolution regime, following international guidance, for central counterparties and other FMI operators (FSA). Time Frame: MT - Update: Under consideration by the authorities. - Recommendation: Strengthen framework for emergency liquidity assistance and tighten preconditions for use of temporary public funding in resolution (MoF, BoJ). Time Frame: NT - Update: Under consideration by the authorities. ### Financial Intermediation - Recommendation: Continue engaging with banks on implications of macroeconomic and demographic trends and take timely actions when viability concerns are identified (FSA). Time Frame: I - Update: “Strategic Priorities July 2021-June 2022” summarizes measures including amendments to the “Anti-Monopoly Act”, establishment of a grant scheme for regional banks to improve business efficiency through mergers, and promoting digitalization and regional revitalization. - Update: FSA is engaging institutions on IT strategy and digital transformation (“Strategic Priorities July 2022-June 2023”). - Recommendation: Encourage banks to evolve risk management practices in line with new business activities (FSA). Time Frame: NT - Update: FSA encourages regional banks to build capacity to provision in a more forward-looking manner. - Update: Recent amendment to the Banking Act allows banks to expand business scope and increase stakes in firms up to 100 percent to support regional vitalization and debt restructuring when conditions warrant. - Recommendation: Encourage regional and Shinkin banks to review cost reduction, consolidation, income diversification, and fee structures to address medium-term profitability concerns (FSA, Gov). Time Frame: NT - Update: “Special Deposit Facility to Enhance the Resilience of the Regional Financial System” implemented by the BoJ in November 2020 aims to strengthen regional financial institutions' business foundations (scheduled to end in March 2023). The scheme provides extra interest on current account balances held by regional financial institutions that meet certain requirements. - Update: 2021 amendments to the Banking Act provide further flexibility in business operations for banks. - Update: FSA’s revamped “Early Warning System” encourages targeted measures to address medium-term profitability concerns. - Update: Parliament approved legislation in May 2020 that would exempt M&A between domestic regional banks from the anti-monopoly law if the FSA approves the M&A plan as credibly promoting profitability and enhancing financial services. - Recommendation: Lower coverage of credit guarantees (SME Agency). Time Frame: MT - Update: Government introduced full public credit guarantees for eligible SMEs at the outbreak of the pandemic (SMEs facing a significant drop in y/y sales were deemed eligible). - Update: FSA allowed banks to assign zero risk-weights to such loans and exercised regulatory flexibility for adjustments during the pandemic. - Update: Government expanded program of effective zero interest loans without collateral to private sector banks with interest subsidies paid directly by the Organization for Small & Medium Enterprises and Regional Innovation. ### Annex XI — Spillovers from a Rise in JGB Yields - Key facts and context: - Japan has the largest net foreign asset position in the world ($3.2 trillion US dollars, as of 2022Q3), mainly reflecting large official reserves (held mostly as U.S. Treasury securities), foreign direct investment, and outward portfolio investment by banks, life insurers, and pension funds. - Japanese banks’ cross-border claims amount to nearly 4.6 trillion US dollars as of end-June 2022. - Channels and risks: - Changes in long-term interest rates in Japan could have significant spillover effects on global yields via portfolio reallocation by Japanese investors. - A sharp rise in JGB yields, especially if due to an increase in risk premium rather than strengthening of the economy, could induce further capital losses on bond holders and trigger deleveraging including overseas positions; impact could be larger if accompanied by a sharp drop in domestic equity prices. - Historically, global sovereign yields and JGB yields are highly correlated (especially before YCC); higher domestic yields could lead to increases in overseas yields, including in emerging markets if global risk premia rises. - Empirical finding: - Staff analysis suggests that an unexpected increase in the slope of the JGB yield curve of 100 basis points is associated with an increase in the slope of the U.S. Treasury yield curve by close to 10 basis points. - Additional considerations: - Yield spillovers could be larger in debt markets where Japanese investors have a higher share and they repatriate in case of higher long-term JGB yields. - Foreigners active in Japanese equity and JGB markets could also transmit shocks from Japan to the rest of the world. *Annex X. Progress on 2017 FSAP Key Recommendations — IMF content provided in the source PDF.* ### Annex XII. Startups and Innovation ### Annex XII. Startups and Innovation ### Size of the startup ecosystem - The number of unicorns, defined as startups valued at and above one billion US dollars, stood at six in Japan in 2022 (out of about 1200 globally). - The valuation of unicorns in Japan was about 8.8 billion dollars in 2022, compared with 2 trillion dollars in the U.S. - Unicorns in Japan are mostly based in Tokyo, with a focus on FinTech, artificial intelligence, and mobile and communications. ### Venture capital funding and financing gaps - Venture capital investment provides startup companies with private equity financing when they do not have access to capital markets, bank loans, or other debt instruments at the early stage of their businesses. - The share of venture capital investment in Japan remains relatively low at 0.06 percent of GDP. - International comparisons in the text: - Israel: above 2 percent - U.S.: 0.63 percent - Possible reasons for low venture capital share in Japan: relatively low profitability and early exits of startups. - Policy implication: Expanding the scale and the availability of venture capital equity investment can help support startups in Japan. - Note: A network of “business angels”, who invest in startups and provide advice and access to their networks, is also crucial for the development of startups (OECD, 2021). ### Firm entry and exit, personal guarantees, and "zombie" firms - The exit rate of Japanese firms remains relatively low by international standards. - Personal guarantees imply that bankruptcy could be associated with the loss of the entrepreneur’s home and other assets not directly linked to the bankrupt firm (OECD, 2017). - Social stigma contributes to the low use of personal insolvency (Garrido, et. al., 2020). - As a result, owners of non-viable small firms have incentives to rollover loans to prevent bankruptcy and to support “zombie” firms, resulting in low investment, employment growth and productivity growth in Japan (Hong et. al., 2021). - Policy recommendation: Reduced personal guarantees could help encourage entrepreneurship and allow unproductive firms to exit, which could in turn support investment and innovation, generate employment, and improve productivity. - Trade-off noted: Reduced personal guarantees may imply a rise in the cost of bank loans, underscoring the importance of venture capital equity financing for startups. ### Human capital, entrepreneurship education, and labor market flexibility - Less than one third of the working-age population in Japan views entrepreneurship as a good career choice (OECD, 2017). - Entrepreneurship education can help improve the perception and the image of entrepreneurship. - Closer collaboration between universities and startups can help spur innovation and translate research to entrepreneurship. - A gradual shift from the lifelong employment system could encourage young talents to consider setting up their own companies and to have a second chance in case startups fail. - Example reference: A number of leading universities in the U.S. have designated resources to encourage startups, see for example, Stanford, Harvard, and MIT. ### Government plan: "Grand Design" and policy directions - The grand design of the new form of capitalism appropriately targeted key areas to improve innovation and to encourage startups. - Financing measures in the plan include: - Expand public capital investment in venture capital. - Redirect personal financial assets and long-term investment funds to venture investment. - Risk culture measures in the plan include: - Recognizes constraints of personal guarantees on entrepreneurship. - Plans to revise the system of personal guarantees for startup fundings. - Human capital and linkage measures: - Highlights the importance of entrepreneurship education. - Strengthening the relationship between startups and universities. - Conditional note: A successful implementation of the startup development plan and further flexibility in the labor market would be crucial to encourage startups and innovation in Japan. *Prepared by TengTeng Xu (APD) with support from Kaustubh Chahande (APD).* ### 4. However, the failure of SVB, concerns over Credit Suisse, and the ensuing turmoil ### 1jpnea2023001 - 4. However, the failure of SVB, concerns over Credit Suisse, and the ensuing turmoil ### Financial market turmoil and immediate impact on Japanese banks - Japanese banks’ stock prices dropped by about 16 percent on average between March 9-16 (with stronger impact for some smaller banks). - Factors contributing to the drop: - Increased market scrutiny over Japanese financial institutions’ unrealized losses on their bond holdings. - Heightened investor risk aversion globally. - Flattening in the JGB yield curve impacting prospective bank profitability. - BoJ intervention in equity markets: - The BoJ bought 70.1 billion yen each in Exchange Traded Funds (ETF) on two consecutive days—March 13 and 14—respectively. - ETF purchases are part of BoJ’s monetary easing measures. - Limiting factors to a stronger adverse impact: - Limited direct exposure of Japanese banks to SVB and Credit Suisse. - Prompt actions by respective authorities to prevent further spillovers. - Staff assessment: risks to financial stability remain broadly unchanged. ### Recent economic developments - Economic pickup and risks: - The Japanese economy is moderately picking up, supported mainly by private demand; most GDP components recovered to their pre-COVID level in 2022. - The services sector is recovering more slowly than in other advanced economies. - Both corporate goods and consumer prices increased to their highest levels in 40 years. - Near-term outlook: - The economy is expected to continue expanding in the near term, supported by government economic policies. - Downside risks include global energy and food price developments, global tightening, and an economic downturn. ### Fiscal policy - Measures and objectives: - Government adopted multiple economic measures in FY 2022 and in the budget plan for FY 2023. - Direction of temporary fiscal support aligned with staff advice, including gradual withdrawal of COVID-related measures and reduction of energy subsidies this year. - Need to make fiscal transfers more timely and targeted (agreed with staff). - Fiscal position and consolidation: - Outstanding debt of Central and Local Governments to GDP ratio projected to reach about 217 percent at end-March 2023. - Government will advance expenditure and revenue reforms to achieve the fiscal target of a consolidated (central and local Government) primary balance surplus in FY2025. - Defense capabilities will be dramatically reinforced; financial resources will be secured to maintain stable defense capabilities. - Ongoing reforms include social security system adjustments (annual review of drug prices; revisions to out-of-pocket medical expenses for late-stage elderly) to keep necessary increases within levels equivalent to expected increases due to population aging. - Government will work on improving budget quality via digitalization and introducing incentives for each policy objective. ### Monetary policy - BoJ framework and stance: - The Bank of Japan (BOJ) will continue with Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control, aiming to achieve the price stability target of 2 percent, as long as necessary. - Year-on-year rate of increase in the CPI (all items less fresh food) is likely to decelerate toward the middle of fiscal 2023 due to government measures pushing down energy prices and waning pass-through effects of import price-driven cost increases. - Thereafter, the rate of increase is projected to accelerate again moderately due to improvement in the output gap, rises in medium- to long-term inflation expectations and in wage growth, and waning effects of economic measures pushing down energy prices. - For the time being, BOJ will support financing mainly of firms, maintain stability in financial markets, and will not hesitate to take additional easing measures if necessary. - BOJ view on staff recommendations: - Necessary to be mindful of both upside and downside risks to price developments. - Maintaining the current monetary policy framework is appropriate. - BOJ will continue to implement the most appropriate policy measures, taking into account economic, price, and financial developments. ### Financial sector oversight and policy focus - Stability and resilience: - Japan's financial system has been maintaining stability on the whole. - Capital adequacy ratios of banks are sufficiently above regulatory requirements. - Lenders have kept the ratios of performing loans and investment grade loans high for both domestic and foreign lending. - BOJ macro stress testing indicates Japanese financial institutions on the whole are resilient. - Housing loan market delinquency rate has been at a historically low level; no significant vulnerabilities at this point. - Monitoring and risks: - Authorities will closely monitor the impact of rising foreign interest rates on profitability of financial institutions and the influence of rising energy and raw material prices on credit risks. - Authorities will monitor future developments in domestic and international economies and financial markets, including impacts of recent U.S. bank failures on financial system stability. - Policy measures and priorities: - Facilitate financial institutions’ efforts to support businesses. - Bolster financial institutions' business foundations. - Develop a financial system addressing structural challenges. - Encourage financial institutions to provide support for firms’ cash flow and business improvement and transformation. - Encourage strengthening governance and risk management of credit, security holdings and foreign currency funding. - Promote sustainable finance and facilitate transition to a digital society from a financial perspective. - Continue efforts to address AML/CTF issues and cyber risks, and ensure confidence in the financial system. ### External sector and exchange rate policy - Exchange rate volatility in 2022: - Many currencies moved significantly with increased volatility; the Japanese yen moved in a rapid and one-sided manner, with speculative trading behind such moves. - Authorities note “excess volatility or disorderly movements in exchange rates can have adverse implications for economic and financial stability,” as agreed at the IMFC and the G20/G7. - Authorities intervened in the exchange market to address excess volatility in September and October 2022 for the first time since 2011. - Authorities view their intervention as effective in mitigating excess volatility driven by speculation. - Current account assessment and EBA methodology: - Agree with staff’s preliminary assessment that projected 2022 current account balance is broadly in line with fundamentals and desired policies. - Authorities urge the Fund to review the EBA methodology to: - Appropriately consider the nature of the income account (income balance accounts for a dominant portion of the current account, particularly in advanced economies). - Consider the effect of capital transactions, which greatly affect exchange rates and have little to do with current account transactions. - Reconsider linking exchange rates to the assessment of current account balances. ### Growth strategy and structural reforms - New Form of Capitalism and policy focus: - Grand Design and Action Plan for a New Form of Capitalism developed in June 2022 to address structural issues. - Emphasis on cooperation between public and private sectors; viewing challenges as growth drivers. - Labor market reforms: - Bolster reforms to enhance sustainable wage increases. - Measures include enhancing labor productivity, optimizing small and medium-sized business subcontracting, ensuring appropriate pass-through of input costs, facilitating labor mobility to growth industries, and reskilling. - Digital transformation and innovation: - Digital Agency (founded in 2021) to encourage online government procedures and digitization of health insurance cards utilizing individual number cards. - Promote medical and architectural DX, standardized electronic medical record information, 3D city models for buildings, and unique identification numbers for land and buildings. - Review of 40,000 relevant laws and regulations; “Plan for a Comprehensive Review of Regulations in light of the Digital Principles” published June 2022; corresponding bill to be submitted to the Diet. - Continue supporting innovation and start-ups; Annex XII contains insightful analysis (not reproduced here). - Demographics and family policy: - Immediate action to reverse the declining birthrate is imperative. - Specific measures under discussion include financial assistance and support for early education, and subsidies to care services. - The Children and Families Agency will be founded in April of this year; a broad framework for future actions will be published by June. - Gender and regional policies: - Promote female active engagement and close the gender wage gap; broadened scope of companies required to develop action plans; mandatory for large companies to provide information on gender wage gaps. - Pursue social security reforms to remove disincentives for female labor participation and make systems neutral regarding work styles and time. - Support vibrant local communities via revival of inbound tourism, expansion of exports of agricultural, forestry and fishery products and food. - Promote digital infrastructure (optical fiber connections and 5G) and new services including automated driving. ### Climate change and green transformation (GX) - GX objectives and targets: - Committed to reducing greenhouse gas emissions by 46% by FY 2030 and achieving net-zero greenhouse gas emissions by 2050. - Under the Basic Policy for the Realization of GX (approved February 2023), Government and private sector will invest over 150 trillion yen over the next ten years towards GX. - Government will issue new government bonds, estimated to be 20 trillion yen, backed by expected revenue increase through carbon pricing. - Investment priorities: - Prioritize renewable energy as a primary energy source. - Promote public-private investment in energy efficiency, expanding new and decarbonized power sources such as hydrogen and ammonia, and development of innovative technologies. - Aim to increase predictability for corporate investment and accelerate decarbonization efforts among the private sector. - Financial sector climate-risk initiatives: - Major financial institutions have enhanced capacity to conduct scenario analyses. - FSA and BOJ, with three major banks and three major non-life insurance groups, conducted a pilot scenario analysis exercise on climate-related risks. - Growing number of regional financial institutions have endorsed the Task Force on Climate-related Financial Disclosures (TCFD) recommendations and enhanced disclosure based on the TCFD framework. - FSA released in July 2022 the "Supervisory Guidance on Climate-related Risk Management and Client Engagement." - “The Code of Conduct for ESG Evaluation and Data Providers” was published at the end of last year. - "Comprehensive Supervisory Guidelines for Financial Instruments Business Operators, etc. regarding ESG Investment Trusts" is scheduled to be formulated by the end of March 2023. ### Conclusion and authorities’ engagement with the Fund - Authorities value close collaboration with the Fund and look forward to deepening discussions to tackle domestic and international macroeconomic challenges. - Authorities thank the Mission Chief, Mr. Salgado, and his team for their analysis and policy discussions presented in the Staff Report and Selected Issues Paper. *Statement by Jun Mizuguchi, Executive Director for Japan, Mikari Kashima, Alternate Executive Director, and Inaho Ogihara, Advisor to the Executive Director — March 22, 2023* --- _Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1jpnea2023001.pdf_