## 1jpnea2024010 ## Source details **Canonical URL:** [1jpnea2024010](https://www.imf.org/-/media/files/publications/cr/2024/english/1jpnea2024010.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2024/english/1jpnea2024010.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2024/english/1jpnea2024010.pdf.json) --- ### Recent Economic Developments - Context and challenges - Broad-based price increases after three decades of low inflation. - Main longer-term challenge: low productivity growth due to population aging and labor market rigidity. - Policy priorities under the “new form of capitalism” agenda: investment in science and technology, startups and innovation, green transformation (GX), and digital transformation (DX); children-related policies to address low birthrates and support families. - Fiscal burden increased; recent fiscal spending increases and announced tax cuts raise Japan’s fiscal burden and worsen its debt-to-GDP ratio. - Output, demand and labor market - Real GDP surpassed the 2019Q3 peak in 2023Q2; output gap estimated to have closed. - GDP growth for 2023: 1.9 percent (full year). - Growth waned in the second half of 2023 due to weaker consumption following negative real wage growth. - Households and corporates accumulated excess savings from pandemic support measures and higher profits. - Labor force participation: 63 percent (a 24 year high). - Unemployment rate: 2.6 percent. - Nominal wage growth: averaged 2 percent since May 2023 and remained above 2 percent since September on a same-sample basis, but below core inflation. - Annual spring wage negotiations (Shunto): 2.1 percent rise in base pay in 2023 (up from 0.6 percent in 2022). - Rengo announced a 5.3 percent rise in headline wage (about 3.6 percent in base pay) in the first two rounds of results in 2024 — the highest pay hike in three decades. - Inflation and tourism - Headline inflation above two percent (y/y) since April 2022. - Core inflation (excluding fresh food and energy) appears to have peaked at a high level and is increasingly demand driven. - Inbound tourism more than quadrupled since border reopening in October 2022 and rose above the pre-pandemic level in October 2023; travel receipts 5 percent higher in 2023Q3 compared with 2019Q3. - Survey-based medium-term inflation expectations for firms: above the Bank of Japan’s 2-percent target since 2022Q3. - Average household inflation expectations in the BoJ opinion survey: record high levels since 2006. ### Monetary Policy, BoJ Balance Sheet, and Credit Conditions - March 2024 BoJ policy shift - Abolished Yield Curve Control; no longer target a particular level of the 10-year JGB yield. - Hiked the short-term policy rate for the first time since February 2007; ended NIRP; policy rate band increased by about 10 bps to range from 0 to 0.1 percent (from -0.1 to 0 percent). - Exited Quantitative and Qualitative Easing (QQE) while maintaining JGB purchases; gross JGB purchases to be maintained at around the current average (recently about 6 trillion yen per month). - Halted purchases of ETFs and J-REITs immediately; will gradually reduce commercial paper and corporate bond purchases, discontinuing them in about a year. - Stated accommodative financial conditions will be maintained for the time being as long-term inflation expectations have not yet been anchored at 2 percent. - BoJ balance sheet and assets - BoJ balance sheet at 126 percent of GDP. - Government bonds constitute close to 80 percent of the BoJ’s balance sheet as of February 2024. - BoJ owns close to 85 percent of outstanding 10-year JGBs and 54 percent of all JGBs (noted elsewhere). - Annual redemptions of BoJ’s JGB holdings in the range of 70-80 trillion yen. - Plan to continue JGB monthly purchases at broadly the same amount as before (currently about 6 trillion yen) could see BoJ's holdings of JGBs roughly stay constant in nominal terms. - ETFs and J-REITs constitute 5 percent and less than 0.1 percent of BoJ’s balance sheet, respectively. - Commercial paper and corporate bonds constitute close to 1.1 percent of BoJ’s assets and would roll off as they mature. - Credit and real rates - Credit to private non-financial sector: corporate credit grew 3.6 percent y/y; CRE loans grew 6.6 percent y/y; housing loans grew 3.2 percent y/y. - Despite policy changes, monetary policy remains ultra-accommodative in real terms due to higher realized inflation and inflation expectations leading to lower and negative real short- and long-term rates. - Nominal neutral rate estimates for Japan range from 1 to 2 percent. ### Exchange Rate and External Sector - Yen and intervention - Yen depreciation: about 9 percent weaker against the U.S. dollar in 2023; depreciated more than 7 percent in 2024 (as of March 29). - Authorities intervened in September and October 2022; refrained since but issued verbal warnings when US$-yen breached 150 in October and November 2023, and in February and March 2024. - Empirical analysis: yen depreciation in 2023 broadly in line with interest rate differentials until around October 2023; carry trade positions played an increasing role thereafter. - External balances and REER - Current account surplus: 3.4 percent of GDP in 2023 (up from 2 percent in 2022). - Primary income balance declined to 5.9 percent of GDP in 2023 from a historic high of 6.2 percent of GDP in 2022. - Net foreign assets at 80 percent of GDP as of end-September 2023. - REER depreciated close to 5 percent in 2023 following a depreciation of 14 percent in 2022. - 2023 (% GDP) summary: CA: 3.4; Cycl. Adj. CA: 3.6; EBA Norm: 4.0; EBA Gap: -0.4; Staff Adjustors: 0.0; Staff Gap: -0.4. - IMF staff CA gap implies a REER gap of 2.1 percent in 2023 (with an estimated elasticity of 0.18 applied); assessed REER gap range −4.2 to 8.4 percent, midpoint 2.1 percent. ### Fiscal Developments, Outlook, and Debt Dynamics - Fiscal package and measures - Authorities announced a fiscal stimulus package in early November. - Staff estimates: above-the-line public spending of general government about 2.3 percent of GDP; planned tax cut 0.7 percent of GDP; total fiscal impact about 3 percent of GDP. - Headline amount of the fiscal package: about 4.3 percent (public spending about 3.6 percent and tax cut about 0.7 percent). - Tax reduction announced in November 2023: reduction in income and local residential tax applied to all income earners except those earning above 20 million JPY annually (less than one percent of population); tax reduction amounts to 40,000 JPY ($275) per person and set to be implemented from June 2024. - Fiscal aggregates and baseline projections (selected) - Primary deficit: over 5 percent of GDP since the pandemic; primary deficit for 2023: 5.6. - Debt-to-GDP ratio around 252 percent of GDP in 2023. - Baseline public debt (percent of GDP): 2022: 257.2; 2023: 252.4; 2024: 254.6; 2025: 252.6; 2026: 251.3; 2027: 251.0; 2028: 251.0; 2029: 251.9; 2030: 250.8; 2031: 250.0; 2032: 249.6. - Primary deficit projections (percent of GDP): 2022: 3.9; 2023: 5.6; 2024: 6.4; 2025: 3.0; 2026: 2.7; 2027: 2.8; 2028: 2.8; 2029: 2.9; 2030: 3.2; 2031: 3.2; 2032: 3.4. - Gross financing needs (percent of GDP): 2022: 58.3; 2023: 48.4; 2024: 52.7; 2025: 58.7; 2026: 58.9; 2027: 62.3; 2028: 67.0; 2029: 67.3; 2030: 66.6; 2031: 69.8; 2032: 71.7. - Outlook and staff assessment - Growth projections: 2024: projected to decelerate to 0.9 percent. - Medium term: potential growth expected to decline to just below 0.5 percent after near-term gains fade. - Primary fiscal deficit expected to remain elevated at 6.4 percent in 2024 due to the latest fiscal stimulus package. - Under the baseline, gross public debt projected to fall from 257 percent of GDP in 2022 to 250 percent of GDP in 2032. - Final Medium-term index: High; Debt fanchart and GFN modules point to high risk. - Probability of debt non-stabilization and financeability concerns reported via DFI and GFI metrics (e.g., GFN financeability index (GFI): 23.3; risk signal: High). - Staff fiscal recommendations - Fiscal consolidation needed to rebuild buffers and ensure debt sustainability; staff recommends a significantly faster fiscal consolidation than the baseline. - Additional expenditure should be better targeted and offset by higher revenues or savings. - Suggested revenue mobilization options include: unifying and increasing the consumption tax rate; strengthening financial income taxation for high-income earners; reinforcing property taxation by eliminating preferential treatment for residential land; rationalizing allowances and deductions in personal income taxation; unifying the lower corporate income tax rate for SMEs with the standard rate; increasing premiums for social insurance. - Health expenditure containment measures and rationalization of children-related spending suggested. - Note: Impact on debt-to-GDP from FY2024 budget: defense approximately 1.3 percent of GDP, GX 0.1 percent of GDP, children-related 0.2 percent of GDP. Budget allocation to the Digital Agency in FY23 (initial and supplementary budget) is about 0.1 percent of GDP. ### Financial Sector: Performance, Risks, and Policy Actions - Market and institutions - Stock market indices reached multi-decade highs; equity valuations up across sectors since January 2023; most sectors up by more than 20 percent; TOPIX banking sector index up more than 50 percent. - Foreign net stock purchases in prime/upper-segment market: about US$24 billion in 2023; US$14 billion in January 2024. - Banks: well-capitalized with sizeable liquidity buffers; non-performing or special-mention loans at record low levels (e.g., 0.7 percent for major banks as of end-September 2023). - Japanese mega banking groups posted a 70 percent increase y/y in profit in the first half of the fiscal year. - FSAP findings and macroprudential recommendations - Key vulnerabilities: sizeable securities holdings under mark-to-market accounting; some banks’ foreign currency exposures; signs of overheating in parts of the real estate markets. - FSAP household stress testing: house price-to-income ratio 30 percent higher than its long-term trend. - Model estimates: residential and commercial real estate markets overvalued by, on average, 17 and 30 percent, respectively. - Recommended policies: - Borrower-based macroprudential measures to enhance household resilience; complement the industry practice of the 5-year/125 percent rule. - Continued close monitoring of domestic CRE markets and supervisors mindful of CRE segment exposures. - Develop revised supervisory risk methodology, revamp Early Warning System (EWS), establish quantitative minimum liquidity requirements for non-internationally active banks, and grant supervisors power to set individual bank capital ratios above minimums. - Strengthen inter-agency coordination, expand the Common Data Platform, assign a formal mandate to the Council for Cooperation on Financial Stability (CCFS). - Enhance recovery and resolution planning coverage and consider expanding ELA eligibility to systemic NBFIs, prioritizing CCPs. - Authorities broadly concurred with many recommendations but cautioned about possible adverse effects of borrower-based measures and did not see a need to assign a formal mandate to the CCFS. ### Risks to Growth and Inflation - Risks to growth (downside) - Slowdown in the global economy (including in China). - Deepening geoeconomic fragmentation. - More volatile food and energy prices. - Domestic: weak consumption related to negative real wage growth; more acute labor shortages; a return to a zero-inflation environment; potential price correction in overheated real estate segments. - Risks to growth (upside) - Additional recovery of inbound tourism; a stronger global economy. - Risks to inflation - Upside: backward-looking inflation expectations; significantly stronger-than-expected wages following spring negotiations; uncertainty on exchange rate pass through. - Downside: faster decline in global goods and import prices. - Alternative adverse scenario (deteriorating market confidence) - Assumptions: sizable additional fiscal stimulus in FY2024 and FY2025 without revenues causes the primary balance to deteriorate by close to 5 percent of GDP relative to baseline; in 2024 the primary deficit about two standard deviations above baseline. - Projected outcomes: 10-year government bond yields around 3.5 percent (more than 200-basis point increase compared with the baseline) and initial yen depreciation; sharp rise in sovereign risk premium; BoJ forced into faster rate hikes; tighter monetary conditions; valuation losses and credit-cost pressures for financial institutions. - Policy implication: underscores importance of fiscal discipline and tightening fiscal spending in the near term. ### Structural Policies, Startups, and Green Transition - Structural reform priorities - Expand childcare facilities and progress on workstyle and labor market reforms to improve career prospects for women and support fertility. - Reduce labor market dualism and better target social benefit programs. - Improve access to equity funding and increase firm dynamism to support startups and innovation. - Continue digitalization and corporate governance improvements. - Startups and equity funding - Better access to equity funding is crucial for startups’ growth and exits. - A more flexible labor market and shift away from lifelong employment could encourage entrepreneurship. - Suggested reform: introduce a Single Open-Ended Contract for newly hired workers, complemented by a model combining flexibility and security. - Green transition and carbon pricing - Japan: seventh largest emitter of global GHG; interim target: 46 percent reduction in GHG emissions by 2030, relative to 2013 levels; pledged to end new construction of domestic unabated coal power plants. - Japan contributed $1.5 billion to the United Nation’s Green Climate Fund and $6.6 billion to the IMF’s Resilience and Sustainability Trust. - Policy needs: expanding carbon pricing, introducing carbon credits trading, additional infrastructure investment, green subsidies; protect vulnerable households from distributional effects and phase out untargeted energy subsidies. ### Carbon Tax Incidence and Revenue Recycling (Annex) - Simulated carbon tax - Policy simulated: economy-wide carbon tax rising in equal annual increments starting from 2026 to reach US$ 75/ton CO2e in 2030. - In 2030 modeled reduction in GHG emissions: 17.6 percent relative to BAU (amounts to 81 percent of Japan’s NDC requirement). - Fiscal impact: modeled carbon tax would raise revenues of around 1 percent of GDP. - Without recycling, households on average lose over 2 percent of their total consumption in 2030. - Recycling scenario (half recycled to bottom 20 percent) - Assumption: Half of revenues (around 0.5 percent of GDP) recycled into targeted cash transfers to deciles 1-2. - Net consumption impacts: Deciles 1-2 could enjoy net increases in consumption of over 15 percent, on average. - Redistribution: household consumption-based Gini coefficient decreases by approximately 3 percent under post-recycling scenario. - Macroeconomic implication: recycled revenues would more than offset the initially negative impact of the carbon tax on real GDP growth. - Caution: overcompensating low-income households through recycling may have opportunity costs; alternative redistribution via the broader tax-benefit system could be more efficient. ### Data, Statistics, and Administrative Notes - Japan adheres to the IMF’s SDDS Plus since April 18, 2016, and reports various high-frequency indicators; reserves at end-2022: $1.1 trillion (about 26 percent of GDP). - Recommended administrative note: next Article IV consultation on the standard 12-month cycle. *Source: IMF staff report — 1. Recent Economic Developments; related chapters and annexes (1jpnea2024010).* ### 1. Recent Economic Developments ______________________________________________________________ 31 ### 1. Recent Economic Developments ### Context - The Japanese economy continues to grow after the pandemic, with broad-based price increases following three decades of low inflation. - Main longer-term challenge: low productivity growth due to population aging and labor market rigidity. - Policy priorities under the “new form of capitalism” agenda: investment in science and technology, startups and innovation, green transformation (GX), and digital transformation (DX); children-related policies to address low birthrates and support families. - Fiscal burden has increased as many new policy initiatives have no concrete revenue offsets; recent fiscal spending increases and announced tax cuts raise Japan’s fiscal burden and worsen its debt-to-GDP ratio. ### Recent Developments — Growth and Demand - Real GDP surpassed the 2019Q3 peak in 2023Q2; the output gap is estimated to have closed. - Growth was uneven: goods and services exports rose above pre-pandemic peak, while private consumption and investment remain below. - Households and corporates accumulated excess savings from pandemic support measures and higher profits. - GDP growth for 2023: 1.9 percent (full year). - GDP growth waned in the second half of 2023 due to weaker consumption following negative real wage growth. ### Inflation Developments - Headline inflation has been above two percent (y/y) since April 2022. - Core inflation (excluding fresh food and energy) appears to have peaked at a high level and is increasingly demand driven as the output gap closes and labor shortages intensify. - Inbound tourism: number of inbound tourists more than quadrupled since border reopening in October 2022 and rose above the pre-pandemic level in October 2023; travel receipts 5 percent higher in 2023Q3 compared with 2019Q3. - Survey-based medium-term inflation expectations for firms: above the Bank of Japan’s 2-percent target since 2022Q3. - Average household inflation expectations in the BoJ opinion survey: record high levels since 2006. - Measures of underlying inflation indicate above-target inflation is broad-based across products and services for the first time in three decades. ### Labor Market and Wages - Labor force participation: 63 percent (a 24 year high). - Unemployment rate: 2.6 percent. - Nominal wage growth: averaged 2 percent since May 2023 and remained above 2 percent since September on a same-sample basis, but below core inflation. - Annual spring wage negotiations (Shunto): 2.1 percent rise in base pay in 2023 (up from 0.6 percent in 2022). - Rengo announced a 5.3 percent rise in headline wage (about 3.6 percent in base pay) in the first two rounds of results in 2024 — the highest pay hike in three decades; Keidanren has endorsed strong wage increases. ### Monetary and Credit Conditions / BoJ Policy Shift - At the March 2024 monetary policy meeting the BoJ: - Abolished Yield Curve Control and transitioned back to a standard short-term policy rate targeting framework; will no longer target a particular level of the 10-year JGB yield. - Hiked the short-term policy rate for the first time since February 2007, ending NIRP and shifting to the uncollateralized overnight call rate as the main policy target; policy rate band increased by about 10 bps to range from 0 to 0.1 percent (from -0.1 to 0 percent previously). - Exited Quantitative and Qualitative Easing (QQE) while maintaining JGB purchases; gross JGB purchases to be maintained at around the current average (recently about 6 trillion yen per month) across maturities, keeping holdings broadly unchanged as previous holdings mature. - Halted purchases of ETFs and J-REITs immediately; will gradually reduce commercial paper and corporate bond purchases, discontinuing them in about a year. - Stated accommodative financial conditions will be maintained for the time being as long-term inflation expectations have not yet been anchored at 2 percent. - Prior to March, BoJ had already scaled back asset purchases: balance sheet expanded by close to 6.5 percent y/y in December 2023 mainly from JGB purchases, but net JGB purchases trended down since November 2023 and hovered close to zero; ETF purchases at an all-time low in 2023; J-REIT purchases halted since June 2022; COVID-related exposure increases to commercial paper unwound and corporate bond exposures partly unwound. - Despite policy changes, monetary policy remains ultra-accommodative in real terms due to higher realized inflation and inflation expectations leading to lower and negative real short- and long-term rates. ### Exchange Rate and External Sector - Yen depreciation: about 9 percent weaker against the U.S. dollar in 2023; depreciated more than 7 percent in 2024 (as of March 29). - Authorities intervened in September and October 2022, have refrained from intervention since but issued verbal warnings when US$-yen breached 150 in October and November 2023, and in February and March 2024. - Empirical analysis: yen depreciation in 2023 broadly in line with interest rate differentials until around October 2023; more recently carry trade positions played an increasing role. - External position (preliminary): 2023 assessed as broadly in line with medium-term fundamentals and desirable policies. - Current account surplus: 3.4 percent of GDP in 2023 (up from 2 percent in 2022); primary income surplus remains strong supported by yen depreciation and net foreign assets at 80 percent of GDP as of end-September 2023. ### Financial Sector Developments - Stock market: indices reached multi-decade highs; equity valuations up across sectors since January 2023, most sectors up by more than 20 percent; TOPIX banking sector index up more than 50 percent. - Foreign net stock purchases in prime/upper-segment market: about US$24 billion in 2023 (record since 2014); US$14 billion in January 2024. - Banks: generally well-capitalized with sizeable liquidity buffers; non-performing or special-mention loans at record low levels (e.g., 0.7 percent for major banks as of end-September 2023). - Japanese mega banking groups: posted strong profit growth in first half of the fiscal year (a 70 percent increase y/y) due to widening overseas lending margins, portfolio rebalancing into higher-yield overseas debt securities, and a weaker yen. - Non-banks: insurers maintain good profitability and statutory solvency margins; life insurers reduced foreign currency hedging in FY2022; GPIF maintains healthy long-term investment return with mark-to-market bond losses more than offset by equity gains. - Credit to private non-financial sector: corporate credit grew 3.6 percent y/y driven by demand; CRE loans grew 6.6 percent y/y; housing loans grew 3.2 percent y/y. - Credit-to-GDP gap decreased by 6 percentage points y/y from 22 percent in June 2022; netting out accumulated corporate cash and deposits, the credit-to-GDP gap is estimated to be 14 percent. - Corporate bankruptcies have increased, largely confined to services and small firms, attributed to rising prices and labor shortages. ### Fiscal Developments - Authorities announced a sizable new fiscal stimulus package in early November. - Staff estimates: above-the-line public spending of general government about 2.3 percent of GDP; planned tax cut 0.7 percent of GDP; total fiscal impact about 3 percent of GDP. - Headline amount of the fiscal package: about 4.3 percent (public spending about 3.6 percent and tax cut about 0.7 percent). The package includes already announced measures (e.g., defense). - Fiscal package pillars: 1) mitigate inflation impact on households (personal income tax cut, cash transfers to low-income households, extension of energy subsidies); 2) support for companies to offer sustained wage hikes; 3) domestic investment (AI/space research subsidies, semiconductor-related investment); 4) social reform addressing declining population, including children-related policies; 5) national resilience (national security, disaster prevention/mitigation). - Tax reduction announced in November 2023: reduction in income and local residential tax applied to all income earners except those earning above 20 million JPY annually (less than one percent of population); tax reduction amounts to 40,000 JPY ($275) per person and set to be implemented from June 2024. - Primary deficit and public debt: primary deficit has remained elevated at over 5 percent of GDP since the pandemic; debt-to-GDP ratio around 252 percent of GDP in 2023. ### Outlook and Risks - Growth projections: - 2024: projected to decelerate to 0.9 percent, owing to fading one-off factors supporting 2023 growth (including tourism). - Near term: growth expected to remain weak in first half of 2024 due to protracted negative real wage growth; consumption expected to pick up in the latter half of 2024 and 2025 as nominal wages rise and headline inflation falls, supporting higher real wages. - Medium term: growth expected to slow gradually due to population aging; potential growth expected to decline to just below 0.5 percent after near-term gains from higher female labor force participation fade. - Fiscal outlook: - Primary fiscal deficit expected to remain elevated at 6.4 percent in 2024, reflecting the latest fiscal stimulus package. - Primary deficit in percent of GDP projected to decline in near term as stimulus phases out, but to rise in medium and long term to accommodate age-related spending pressures. - Inflation outlook: - Core inflation expected to decline gradually as higher import prices wane but projected to stay above two percent until the second half of 2025. - Headline inflation expected to moderate to around 2 percent in the medium term, in line with the BoJ’s 2 percent target. - External outlook: - Current account surplus expected to increase slightly to 3.5 percent of GDP. - Current account surplus expected to remain close to 3.4 percent of GDP in the medium term. - Risks: - Downside risks to growth from persistently weak consumption and a return of higher real wage pressures; fiscal sustainability risks from rising age-related spending and limited revenue offsets; monetary and exchange rate volatility given global policy divergences and carry trade dynamics. *Source: IMF staff report — 1. Recent Economic Developments (Japan).* ### 16. Risks to growth and inflation are broadly balanced. For growth, downside risks include a ### Risks to growth and inflation are broadly balanced. ### Risks to growth - Downside risks: - Slowdown in the global economy (including in China). - Deepening geoeconomic fragmentation. - More volatile food and energy prices. - Domestic: weak consumption related to negative real wage growth. - Domestic: more acute labor shortages that could constrain activity. - Domestic: a return to a zero-inflation environment. - Domestic: potential price correction amidst signs of overheating in parts of the real estate markets. - Upside risks: - Additional recovery of inbound tourism. - A stronger global economy. ### Risks to inflation - Upside risks: - Backward-looking inflation expectations. - Significantly stronger-than-expected wages following the spring wage negotiations. - Uncertainty relating to exchange rate pass through in a new positive inflation regime. - Downside risks: - A faster decline in global goods and import prices (Annex II). ### Per capita growth and inflation persistence - On a per capita basis Japan’s growth is expected to remain close G7 average in the medium term. - Evidence (Liu and others, forthcoming) that core inflation will remain persistent based on: - Positive output gap. - Continued strength in tourist arrivals. - Sticky inflation expectations (which remain above 2 percent). ### Fiscal effects of higher inflation (channels) - Higher spending in response to inflation. - Higher income taxes due to the bracket creep effect. - More favorable real interest rate-growth dynamics supporting lower debt levels in the near term. - Higher policy interest rates later to contain inflation, which will raise the cost of borrowing and worsen debt dynamics. ### Authorities’ views on outlook and risks - Broad agreement with Fund staff’s assessment on the economic outlook and near-term risks. - Expectation that real GDP growth will decelerate in 2024 as one-off factors from 2023 fade, but remain above potential supported by stronger consumption and investment before converging to medium-term potential. - Expect higher wage increases in this year’s Shunto negotiations. - Emphasis on domestic factors driving inflation and a projection that inflation will decline in 2024 as external supply shocks fade. - Concurrence with preliminary assessment that Japan’s 2023 external position was broadly in line with medium-term fundamentals and desirable policies. ### Fiscal policy: assessment and concerns - Given a closed output gap and high debt-to-GDP, the large, not-well-targeted fiscal stimulus in the November package was not warranted. - Additional expenditure should be better targeted and offset by higher revenues or savings elsewhere. - The proposed reduction in income tax and local residential tax is untargeted; with the tax cut temporary (for one year) and households’ low propensity to consume (households having excess savings of about 10 percent of GDP from pandemic-related measures), the untargeted income tax cut is expected to have a limited impact on growth while worsening debt dynamics. - Energy subsidies can distort energy consumption and hamper decarbonization initiatives and should be replaced with targeted transfers to vulnerable households. - Under current policies, the public debt-to-GDP ratio will increase steadily in the long term to accommodate age-related spending pressures. - Additional planned spending on defense, GX, DX and children-related policies are expected to weigh on the fiscal balance and should be offset by sustainable revenues. - Impact on debt-to-GDP from FY2024 budget: defense approximately 1.3 percent of GDP, GX 0.1 percent of GDP, children-related 0.2 percent of GDP. - Budget allocation to the Digital Agency in FY23 (initial and supplementary budget) is about 0.1 percent of GDP. - Sovereign risk and debt sustainability analysis: gross financing needs are elevated, but rollover risks mitigated by large domestic investor base and debt profile; overall risks of debt distress assessed as moderate (Annex III). ### Fiscal consolidation: staff recommendations - Fiscal consolidation is needed to rebuild fiscal buffers and ensure debt sustainability; staff recommends a significantly faster fiscal consolidation than the baseline. - Options to achieve consolidation include limiting untargeted transfers with low fiscal multipliers or phasing out pandemic-related measures and energy subsidies, while mobilizing revenues to offset additional expenditure policies. Japan: Fiscal Policy — Baseline and Staff Recommendations (selected measures) - Revenue mobilization options to consider: - Unifying and increasing the consumption tax rate. - Strengthening financial income taxation for high-income earners. - Reinforcing property taxation by eliminating preferential treatment for residential land. - Rationalizing allowances and deductions in personal income taxation. - Unifying the lower corporate income tax rate for SMEs with the standard rate. - Increasing premiums for social insurance. - Health expenditure containment measures: - Increase copayments for high-income or wealthy seniors. - Higher usage of generic or over-the-counter drugs. - Increased adoption of prescription refilling. - Enhanced preventative medical care. - More targeted covered services and drugs. - Children-related spending: - Limited evidence that untargeted cash transfers are effective in supporting fertility. - Improve efficiency via expansion of childcare facilities and workstyle and labor market reforms to close gender gaps. - SME support: - Comprehensive assessment of pandemic-related and legacy subsidies to rationalize expenditure and improve productivity. - Note: non-targeted transfer measures to households are estimated to have a fiscal multiplier of 0.1 and other transfer measures mostly at around 0.2. ### Strengthening the medium-term fiscal framework - Recommendations: - Ground fiscal planning in more realistic assumptions on growth, revenue, and expenditure; consider an independent fiscal council to evaluate macro-projections and monitor progress. - Discipline the formulation of supplementary budgets; reform the budget process so expansionary supplementary budgets are limited to unexpected large economic shocks. - Strengthen governance of state funds: set a clear exit plan for each state fund and strengthen execution oversight and reporting; roughly one-third of state funds do not have a specified termination point. ### Authorities’ fiscal stance - Authorities noted Japan has not faced sovereign risk events for a long time. - On 2024 tax cuts, they emphasized need to support households amid negative real wage growth. - Over the medium to long term, they highlighted need to ensure sustainable revenues to offset higher expenditures in defense, GX, and childcare, and to contain rising health and long-term care expenditures. - Authorities remain committed to meeting the FY2025 fiscal target while noting challenges; achieving the primary balance target by FY2025 will require substantial consolidation over the next two years. - Basic Policy on Economic and Fiscal Management and Reform 2023 indicates authorities will examine and verify progress of integrated economic and fiscal reforms in FY2024. ### Monetary policy and inflation path - Inflation expected to converge in the medium term to BoJ’s two-percent target, reflecting: - Higher inflation expectations for a prolonged period for the first time in decades. - 2023: highest base wage growth since 1995; projected even higher base pay wage growth in 2024 amid strong corporate earnings and intensifying labor shortages supporting private demand. - Historical high degree of monetary policy accommodation—with a real interest rate much lower than the estimated neutral. - Staff welcomes BoJ’s recent policy shifts aligned with Fund staff recommendations: - Anchor inflation and inflation expectations at 2 percent. - Allow yield curve to be driven by market forces and underlying economic factors, though large BoJ JGB holdings continue to put downward pressure on yields. - BoJ owns close to 85 percent of outstanding 10-year JGBs and 54 percent of all JGBs. - Support financial institutions’ profitability and stability by reducing incentives for risk-seeking in search of yields. - Allow smoother transition to a neutral monetary policy stance. - Nominal neutral rate estimates for Japan range from 1 to 2 percent. ### Policy guidance for BoJ - If baseline inflation forecast bears out, BoJ should continue to gradually raise the policy rate over its policy horizon (three years). - Given balanced risks to inflation and mixed recent data signals, a gradual and cautious pace/timing of policy rate increases is recommended, with clear communication to anchor market expectations and minimize spillovers to other sovereign debt markets. - Recent data notes: - Industrial production fell sharply in January. - Retail sales growth edged down to 2.4 percent y/y in January (from 5 percent y/y in November). - Consumer and business sentiment trending up in recent months. ### BoJ balance sheet and asset strategy - Recent policy shifts likely reduce size and lower risks to BoJ’s balance sheet. - BoJ balance sheet at 126 percent of GDP. - Government bonds constitute close to 80 percent of the BoJ’s balance sheet as of February 2024. - Annual redemptions of BoJ’s JGB holdings are in the range of 70-80 trillion yen. - Plan to continue JGB monthly purchases at broadly the same amount as before (currently about 6 trillion yen) could see BoJ's holdings of JGBs roughly stay constant in nominal terms. - Commercial paper and corporate bonds constitute close to 1.1 percent of BoJ’s assets and would roll off as they mature. - ETFs and J-REITs constitute 5 percent and less than 0.1 percent of BoJ’s balance sheet, respectively; BoJ should consider a strategy to eventually unload ETFs. - Continuing reinvesting close to the same amount as maturing JGBs will help avoid abrupt shifts in bond-market supply-demand conditions and sharp increases in term premiums, while avoiding further balance sheet accommodation. - State-contingent purchases of JGBs in case of a rapid rise in long-term rates would help maintain financial stability. - Recommendation: BoJ should formulate a concrete strategy on how to eventually unwind some of its bond holdings over the medium to long term while minimizing related financial market disruptions. - Note: BoJ values government bond holdings using the amortized cost method; valuation losses only affect the balance sheet if bonds are sold before maturity. ### Exchange rate regime and intervention - Japan’s longstanding commitment to a flexible exchange rate regime will help absorb shocks and support monetary policy’s focus on price stability and maintain an external position in line with fundamentals. - Foreign exchange intervention (FXI) should be limited to exceptional circumstances (e.g., when economies are vulnerable to sharp currency fluctuations because of unhedged exposures, shallow markets, or risk of de-anchoring inflation expectations). - FXI may be useful to mitigate adverse effects of excessive exchange rate movements that pose significant risks to macroeconomic and financial stability, including if markets turn disorderly. ### Authorities’ views on monetary policy - BoJ emphasized future rate hikes will be very gradual and accommodative monetary conditions are needed for the time being given the outlook for activity and prices. - With better-than-expected results from first round of Shunto wage negotiations, BoJ officials expect real wages to turn positive going forward, supporting private consumption and keeping inflation at target. - BoJ cautious about downside risks to inflation given long history of deflationary mindset and sees low near-term risk of inflation accelerating. - BoJ credited consistent and well-telegraphed communication strategy for effective, non-disruptive policy transition; committed to keep policy accommodative and continue purchases of maturing JGBs. - BoJ officials would limit increases in JGB purchases only in case of rapid rise in long-term interest rates and largely leave yield curve formation to markets; they do not see discontinuing purchases of other risk assets as significantly affecting market conditions. *Source: 1jpnea2024010 - PDF chapter content.* ### 32. The authorities expressed concerns about the one-sided and rapid pace of yen ### 32. The authorities expressed concerns about the one-sided and rapid pace of yen ### Preserving Financial Stability - Systemic risks to financial stability remain broadly unchanged since last year, reflecting robust economic activity and financial institutions maintaining adequate capital and liquidity buffers. - Key macro-financial risks: - An abrupt slowdown in global growth and a surge in inflationary pressures that could lead to a potential increase in foreign and domestic interest rates and financial market volatility. - Interaction with three FSAP-identified vulnerabilities: sizable holdings by financial institutions of securities under mark-to-market accounting; some banks’ notable foreign currency exposures; signs of overheating in parts of the real estate markets. - Policy responses and buffers: - A gradual pace of increase in domestic short-term interest rates, if /when conditions warrant (¶ 26), and BOJ’s commitment to increase the amount of JGB purchases in case of a rapid increase in long-term rates (¶ 28) will provide greater flexibility for financial institutions to adjust after decades-long ultra-low rates. - FSAP systemic risk analysis findings: - Banks and insurers, in aggregate, are well able to maintain solvency positions under a hypothetical adverse scenario with low global growth and a sharp rise in interest rates, though some may be susceptible to stress. - Liquidity risks for banks are contained at the system level due to ample liquidity in yen, but some banks could face liquidity shortfalls under a stress scenario because of sizeable liability-side foreign-currency (FX) exposures and undrawn FX commitments. - Investment funds generally appear able to accommodate severe but plausible redemption shocks, but less-liquid funds could amplify stress in financial markets. - Domestic contagion risks based on bilateral exposures appear limited due to strong capital and liquidity positions of major financial institutions; broader changes in market sentiment or valuation changes in common asset holdings could exacerbate such risks. - Cross-border spillovers could be sizeable, given Japan’s large creditor status. - Climate risk analysis suggests banks have notable exposures to emission intensive sectors but at a system level may be resilient to a transition to net zero emissions by 2050. ### Real Estate and Macroprudential Policy - FSAP household stress testing indicates vulnerabilities in the real estate sector that warrant further risk oversight and macroprudential response. - The house price-to-income ratio is 30 percent higher than its long-term trend, indicating deterioration in affordability. - Model estimates suggest that both the residential and commercial real estate markets appear overvalued by, on average, 17 and 30 percent, respectively. - The loan-to-income (LTI) ratio, the share of households with a high debt-service-ratio, and the share of floating rate mortgages have been rising steadily. - Recommended policy actions: - Borrower-based macroprudential measures would help households be more resilient to potential adverse macro-financial shocks, with a mild adverse impact on aggregate credit growth, and can complement the industry practice of the 5-year/125 percent rule. - Continued close monitoring of domestic CRE markets given banks’ more material exposure to domestic than overseas CRE markets; supervisors should remain mindful of exposures to different CRE segments and potential spillovers from overseas CRE markets. - Authorities should remain vigilant to potential risks from possible price corrections in the event of adverse shocks. ### Financial Sector Oversight and Crisis Framework - Supervisory and regulatory improvements needed: - The Financial Services Agency (FSA) should develop a revised supervisory risk methodology to draw a complete risk profile of institutions for tracking risks and adjusting resources more effectively. - Revamp the Early Warning System (EWS) with more forward-looking metrics, especially for credit and liquidity risks, and establish quantitative minimum liquidity requirements for non-internationally active banks. - Grant supervisors the power to set and adjust individual bank capital ratios above minimum requirements in response to a bank’s specific risk profile and financial position. - Explicit provision in law to ensure the priority of financial safety and stability in FSA’s mandate. - For insurance supervision: transition to a more comprehensive, risk-based, pro-active approach. - Ensure a more in-depth and forward-looking assessment of the investment fund sector, broaden on-site inspections, and conduct stress testing. - Enhance regulatory and supervisory frameworks for cybersecurity. - Increase resources significantly to facilitate these improvements. - Systemic risk assessment and macroprudential coordination: - Strengthen inter-agency coordination on risk monitoring and data sharing, including by establishing the Financial Monitoring Council. - Continue to enhance the “Common Data Platform” breadth. - Assign a formal mandate to the Council for Cooperation on Financial Stability (CCFS) to clarify accountability and enhance transparency in decision making. - Financial safety net and crisis management: - More banks should be subjected to recovery and resolution planning requirements. - Ensure effective recovery and resolution planning regime for systemic-in-failure insurers and central counterparties (CCPs) consistent with international standards. - Consider expanding the scope of institutions eligible to receive emergency liquidity assistance (ELA) to systemic NBFIs, prioritizing CCPs. ### Authorities’ Views on Financial Stability Measures - Authorities broadly agreed on sources of vulnerabilities but highlighted nuances: - Japanese banks have remained resilient to foreign currency funding risks and have been more cautious in expanding overseas lending recently. - Banks actively manage rising interest rate risks via portfolio rebalancing and hedging. - Signs of overheating in parts of the real estate markets; office demand has been solid compared to overseas CRE markets. - Authorities do not assess risks to housing loans as an immediate concern, noting low historical credit costs and the industry practice of the 5-year/125-percent rule. - On FSAP recommendations: - Authorities broadly concurred with most recommendations but expressed reservations in some areas. - They assess the current institutional framework for macroprudential policy as effective and do not see a need to assign a formal mandate to the CCFS. - Cautioned about potential adverse effects of borrower-based macroprudential measures given historical experience with quantitative restrictions on real-estate related loans. - Noted that the Act on the establishment of the FSA does not include economic growth or international competitiveness as a policy goal; FSA prioritizes financial safety and stability through practice and policies. - Welcomed positive assessment on crisis readiness progress and committed to further strengthening the framework. ### Alternative Scenario: Deteriorating Market Confidence - Scenario assumptions: - Sizable additional fiscal stimulus in FY2024 and FY2025 (without revenue offsetting measures) that causes the primary balance to deteriorate by close to 5 percent of GDP relative to the baseline. - In 2024, the primary deficit would be about two standard deviations above the baseline. - Context: closed output gap and high debt and gross financing needs, with deterioration in market confidence driven by size and persistence of fiscal deficits (over a five-year horizon). - Projected market outcomes: - Long-term (10-year) government bond yields would reach around 3.5 percent (more than 200-basis point increase compared with the baseline), coupled with an initial depreciation of the yen. - Deterioration of market confidence would be mostly manifested as a sharp rise in the sovereign risk premium. - Transmission and macro-financial implications: - Increased fiscal spending would raise inflation and inflation expectations initially, prompting the BoJ to raise short-term interest rates at a faster pace. - Higher term premium and tighter monetary conditions would affect growth negatively, increase government borrowing costs and gross financing needs, worsen interest rate-growth dynamics, and put pressure on the debt trajectory. - Given Japan’s highly backward-looking formation of inflation expectations, inflation would stay higher for a few years and need a strong monetary response initially. - Financial stability implications if interest rates rise sharply: - Valuation losses on yen-denominated securities and potential elevation in credit costs given prevalence of floating-rate loans could weigh on banks. - Improved net interest margins from yield curve steepening would mitigate some risk. - Japanese NBFIs do not engage in liability-driven investment, but vigilance is warranted. - Policy implication: - The scenario underscores the importance of fiscal discipline and the need to tighten fiscal spending in the near term. - The scenario illustrates a possible tail risk event; unfunded fiscal stimulus coupled with tax cuts have led to loss of market confidence in other advanced economies, sometimes with more severe outcomes. ### Structural Policies to Support Growth Potential - Overarching goal: further structural reforms to support fertility, promote female leaders, advance a more equal society, accelerate startups and innovation, and transition to a green economy, with labor market reforms at the forefront. - Fertility and family support: - Japan’s fertility rate: 1.26 in 2022. - The “Future Strategy for Children” (December 2023) aims to increase children-related spending by 3.6 trillion yen (approximately 0.6 percent of GDP) per year by FY2028. - Government plans to double the budget allocation for the Children and Families Agency or that per child by early 2030s. - Strategy includes promoting co-parenting and expanding childcare facilities. - Female leadership and labor market participation: - Women spend more than five times of hours on unpaid work than men (based on OECD data). - Work culture expectations of long office hours and prevalence of part-time/non-career track employment limit career advancement for women. - Recommended actions: - Expand childcare facilities and resources, particularly for children aged 0-2; attract foreign workers to address nursery-teacher shortages. - Offer stronger incentives for the use of paternity leave. - Reform employment practices to expand telework and flexible working schedules. - Labor market reforms to reduce dualism, encourage merit-based promotions, and facilitate job mobility. - Reducing inequality and targeting social transfers: - Market income inequality has increased and is now close to the OECD average. - Labor income inequality drives more than 80 percent of overall income inequality across households. - With high public debt limiting scope for broad-based social spending, social transfers should be better targeted to protect the most vulnerable. - Reforms to reduce labor market dualism and remove social security disincentives that limit working hours are more sustainable ways to achieve a more equal society. - Startups and innovation: - Japan’s startup ecosystem has grown gradually but startups tend to be smaller with relatively low venture capital equity funding as a share of GDP. - Large Japanese corporations play a critical role through corporate venture capital (CVC) units. - The Japan Investment Corporation launched a 200-billion-yen venture growth fund in 2023 to support later stage startups and target early-stage startups beyond deep tech and life sciences. *Source: 1jpnea2024010 - 32. The authorities expressed concerns about the one-sided and rapid pace of yen* ### 52. Improving access to equity funding, ### 52. Improving access to equity funding, ### Startups, equity funding, labor markets, and firm dynamism - Better access to equity funding is crucial for startups to grow, innovate, and exit successfully (reference to 2024 Japan Article IV Selected Issues Paper “Startups and Venture Capital in Japan: How to Grow?”). - Dynamic firm entry and exit can encourage entrepreneurship, innovation, and more efficient allocation of resources. - A more flexible labor market and a shift away from the lifelong employment system could: - encourage talented individuals to consider setting up startups; - give individuals a second chance in case they fail. - Reform options mentioned: - Introduce a Single Open-Ended Contract for all newly hired workers, complemented by a model combining labor market flexibility and security (as suggested in Aoyagi and Ganelli (2013)). - Industry engagement: - PitchBook (2023), “The State of CVCs in Japan” is cited in relation to corporate venture capital activity. ### Transitioning to a Green Economy - Japan’s commitments and contributions: - Japan is the seventh largest emitter of global Greenhouse Gas (GHG). - Interim target: a 46 percent reduction in GHG emissions by 2030, relative to 2013 levels. - Japan proposed establishment of the “Article 6 Implementation Partnership Center” at the G7 to develop institutional arrangements for high integrity carbon markets. - Japan is one of the biggest contributors to the United Nation’s Green Climate Fund: $1.5 billion. - Japan contributed to the IMF’s Resilience and Sustainability Trust: $6.6 billion. - Japan has pledged to end new construction of domestic unabated coal power plants. - The Financial Services Agency (FSA) and the Bank of Japan (BoJ) have actively engaged with the Bank of International Settlements (BIS) on climate finance. - Policy needs to meet climate targets: - Expanding carbon pricing and introducing carbon credits trading are broadly in line with previous staff advice (IMF, 2022), but further details of the plans are needed. - A policy mix comprising additional infrastructure investment, green subsidies, and carbon prices would likely be required to meet Japan’s NDC target. - Given potentially adverse distributional effects of carbon pricing, it is crucial to protect the vulnerable population (e.g., through targeted cash transfers) in the transition to a green economy (Annex IV). - Phasing out untargeted subsidies for gas, electricity, and fuel would support the transition. ### Continuing other structural reforms - Digitalization and corporate governance: - The Digital Agency should continue to coordinate and implement policies to digitalize the public sector. - Better data sharing between central and local governments and standardizing local government IT systems can improve targeting of transfers to the most vulnerable households. - Ensuring effective corporate governance practices and improved disclosure standards are needed. - Trade and industrial policy: - Japan should continue to strengthen the rules-based multilateral trading system, promote open, stable, and transparent trade policies at the WTO and in regional trade agreements. - The U.S.-Japan Critical Minerals Agreement is cited as an example of finding common ground on trade issues between close partners. - Trade agreements should be used to further integration among members and not as tools that discriminate across trade partners or worsen geoeconomic fragmentation. - Industrial policies (IP) should be pursued cautiously and remain narrowly targeted where externalities or market failures prevent effective market solutions, and aim to minimize trade and investment distortions. - Japan initiated the “New Direction of Economic and Industrial Policy” in 2021 to promote GX, DX, economic security, startups, and SMEs; latest fiscal stimulus includes subsidies to support advanced technology R&D. - Risks of widespread IP competition among advanced economies: strains in global supply chain, technological fragmentation, rising input costs, increased trade tensions, and reduced international cooperation. - Anti-corruption and beneficial ownership: - Japan has updated guidelines on combating foreign bribery and enhancing engagement with the private sector and should continue to implement the OECD Phase 4 recommendations (Annex V). - Authorities should require all companies to file with the beneficial ownership registry introduced in 2022, ensure implementation of customer due diligence requirements on new key gatekeepers, and clarify obligations of foreign politically exposed persons and corporate customers. - Context: Out of the world’s 500 largest multinational enterprises, 27 are headquartered in Japan; Japan has a significant outward FDI position, including in high-risk jurisdictions. ### Authorities’ views - Fertility and female leadership: - Authorities agreed on importance of supporting fertility and promoting female leaders via expansion of childcare facilities, more flexible work arrangements, and reducing labor market dualism. - Past progress in expanding childcare facilities contributed to stabilizing the fertility rate in Japan compared with other advanced Asian economies. - “Acceleration Plan for Child and Childrearing Support” (about 3.6 trillion yen annually) was intended to show strong commitment to supporting fertility. - Inequality: - Authorities’ analyses indicate ageing and capital gains are key drivers of recent income inequality in Japan. - Using a more comprehensive dataset than staff’s analysis, they find top 1 percent and 10 percent income shares in Japan are lower than these for the U.S. and at similar levels to European countries in 2019. - Increases in female/elderly labor force participation have been an income equalizing force; divergence in wage income has not been the main driver of recent inequality. - Startups, GX, and industrial/trade policy: - Authorities reiterated commitment to strengthen funding for startups, diversify exit strategy, promote open innovation, and further develop human resources as outlined in the “Startup Development Five-Year Plan”. - On GX, they agreed with staff’s emphasis on carbon pricing and underscored importance of determining the appropriate carbon price level. - On industrial and trade policies, authorities highlighted efforts to promote open, stable, and transparent trade policies while emphasizing supply chain resilience. ### Staff appraisal: projections, risks, and policy recommendations - Growth and inflation outlook: - Core inflation will decline gradually as the effect of higher import prices wanes but is projected to stay above the two-percent target until the second half of 2025. - The output gap is expected to be slightly positive until 2025. - Growth is expected to continue, with risks broadly balanced. - Fiscal policy and debt sustainability: - The primary fiscal deficit is expected to remain elevated, reflecting the impact of the latest fiscal stimulus package. - Fiscal consolidation is needed to rebuild fiscal buffers and ensure debt sustainability, underpinned by both revenue and expenditure measures. - Although Japan still has some fiscal space in the near term, recent stimulus measures narrow that space. - Any new spending should be offset by higher revenues or savings elsewhere in the budget given a closed output gap and high debt-to -GDP. - Under current policies, the public debt-to -GDP ratio will increase steadily in the long term to accommodate age-related spending pressures. - Recommendation: Growth-friendly fiscal consolidation supported by a strengthened and more disciplined medium-term fiscal framework. - Monetary policy: - The BoJ’s recent policy shift will help anchor inflation at the 2 percent target and facilitate a smoother transition towards a neutral stance. - Given balanced risks to inflation and mixed signals in recent data, further hikes in the short-term policy rate should proceed at a gradual pace. - The BoJ’s state-contingent purchases of JGBs will help mitigate excessive shifts in yields that could undermine financial stability during this historic policy transition. - A clear and effective communication strategy that underscores factors supporting a gradual and cautious pace of policy rate increases will be key. - Japan’s longstanding commitment to a flexible exchange rate will help absorb shocks and support monetary policy’s focus on price stability. - Financial sector risks and oversight: - The financial system is broadly resilient, but close monitoring is warranted for: - sizeable securities holdings of financial institutions; - some banks’ notable foreign currency exposures; - potential vulnerabilities in the real estate sector. - Further actions needed to improve risk-based supervision. - Systemic risk assessment and institutional arrangement for macroprudential policy coordination should be further strengthened, including by assigning a formal mandate to the CCFS. - The financial safety net and crisis management framework should be enhanced. - Structural reforms priority: - Further expansion of childcare facilities and progress on workstyle and labor market reforms to improve career prospects for women and support fertility. - Reducing labor market dualism and better targeting existing social benefit programs to advance a more equal society. - Improving access to equity funding, more flexibility in labor markets, and greater firm dynamism to support startups and innovation. - Additional policies and further clarifications on planned measures would be needed to reach Japan’s climate targets. - Administrative note: - It is recommended that the next Article IV consultation take place on the standard 12-month cycle. *Source: 1jpnea2024010 - 52. Improving access to equity funding,* ### 0.6 percent in 2023. The income balance declined to 5.9 percent from a historic high of 6.2 percent of GDP in ### 1jpnea2024010 - 0.6 percent in 2023. The income balance declined to 5.9 percent from a historic high of 6.2 percent of GDP in ### Current Account, Income Balance, and Medium-Term Projections - The income balance declined to 5.9 percent of GDP in 2023 from a historic high of 6.2 percent of GDP in 2022. - The lower primary income balance is more than offset by a 2 percent of GDP improvement in overall trade (goods & services) balance. - In the medium term, the CA balance is projected to average 3.4 percent of GDP. - 2023 (% GDP) summary: - CA: 3.4 - Cycl. Adj. CA: 3.6 - EBA Norm: 4.0 - EBA Gap: -0.4 - Staff Adjustors: 0.0 - Staff Gap: -0.4 - Assessment: - The 2023 cyclically adjusted CA is 3.6 percent of GDP. - The cyclically adjusted CA norm is 4 percent of GDP (with a range between 2.9 and 5.1 percent of GDP). - The 2023 CA gap midpoint is assessed at -0.4 percent of GDP, with a range between −1.5 and 0.7 percent of GDP. - The unexplained residual may reflect structural impediments and country-specific factors not included in the model, such as investment bottlenecks, including entrepreneurship entry barriers and corporate savings distortions. ### Real Exchange Rate (REER) - Background: - The REER continued to depreciate in 2023 by close to 5 percent, following a depreciation of 14 percent in 2022. - Depreciation reflects relatively higher inflation in Japan’s major trading partners combined with the yen’s nominal depreciation against major currencies as a result of widening real interest rate differentials amid global monetary tightening. - Assessment: - The IMF staff CA gap implies a REER gap of 2.1 percent in 2023 (with an estimated elasticity of 0.18 applied). - The EBA REER level and index models deliver gaps of −32.4 and −35.8 percent, respectively. - Consistent with the IMF staff CA gap, the REER gap is assessed to be in the range of −4.2 to 8.4 percent, with a midpoint of 2.1 percent. ### Capital and Financial Accounts: Flows and Policy Measures - Background: - The financial account recorded net outflows in 2023, mirroring the CA surplus, and increased to 3.9 percent of GDP in 2023 from 1.1 percent in 2022. - Net FDI outflows at 3.8 percent of GDP are primarily driven by outward FDI flows to Asia, Europe, and North America. - Net portfolio outflows at 4.7 percent of GDP, in comparison to net inflows of 3.4 percent of GDP in 2022, reflect lower demand for yen-denominated assets due to divergence in monetary policy. - Assessment: - Vulnerabilities are limited. - Inward investment tends to be equity based, and the home bias of Japanese investors is strong. - So far, outward spillovers from Japan’s policies to financial conditions in other economies (interest rates, credit growth) are contained. - IMF staff recommendation (footnoted): - Allow the estimated credit-to-GDP gap to decline gradually over the medium-term from its currently estimated level of 16.5 percent (14.4 percent net of corporate savings) with a corresponding policy setting (P*) for the credit-to-GDP gap in five years of 7.3 percent of GDP. ### FX Intervention and Reserves Level - Background: - Reserves stood at $1.1 trillion, or about 26 percent of GDP, at the end of 2022. - Reserves have remained broadly unchanged in 2023. - Assessment: - The exchange rate is free floating and there have been no FX interventions in 2023. - FX interventions should be isolated and limited to addressing disorderly market conditions. - As a safe-haven currency, yen appreciation may offset recent depreciation; no policy response unless disorderly market conditions merit FX intervention. ### Risk Assessment Matrix — Key Risks, Likelihoods, Impacts, and Recommended Actions - Intensification of regional conflict(s). - Likelihood: High - Source: External - Expected Impact: Medium - Main impacts: Disrupt trade (energy, food, tourism, critical supply chains), remittances, FDI and financial flows, payment systems; refugee flows. - Recommended policy: Continue to pursue open market policies and enhance supply chain resilience. - Commodity price volatility - Likelihood: High - Source: External - Expected Impact: Medium - Recommended policy: Allow pass-through of commodity prices while mitigating impact on the most vulnerable with targeted policies. - Abrupt global slowdown or recession - Likelihood: Medium - Source: External - Expected Impact: High - Recommended policy: Fiscal and monetary easing to support aggregate demand. - Monetary policy miscalibration - Likelihood: Medium - Source: External - Expected Impact: High - Recommended policy: BOJ adjusts short-term rate in line with achieving its inflation target. - Systemic financial instability - Likelihood: Medium - Source: External - Expected Impact: Medium - Recommended policy: BOJ adjusts macroprudential buffers to reduce stress on domestic banks. - Sovereign debt distress - Likelihood: Medium - Source: External - Expected Impact: Low - Recommended policy: As a safe-haven currency, yen appreciation may offset recent depreciation; no policy response unless disorderly market conditions merit FX intervention. - Deepening geoeconomic fragmentation - Likelihood: High - Source: External - Expected Impact: High - Recommended policy: Continue to pursue open market policies and enhance supply chain resilience. - Extreme climate events - Likelihood: Medium - Source: External - Expected Impact: High - Recommended policy: Strengthen climate adaptation and mitigation efforts and provide relief to affected households. - Cyberthreats - Likelihood: Medium - Source: External - Expected Impact: High - Recommended policy: Take pre-emptive measures to prevent cyberattacks and do contingent planning to build resilience. - Social discontent - Likelihood: Medium - Source: External - Expected Impact: Low - Recommended policy: Fiscal policy uses targeted transfers to support low-income households. - Disorderly energy transition - Likelihood: Medium - Source: External - Expected Impact: Medium - Recommended policy: Reduce uncertainty with clear communication, clarify further planned measures on carbon pricing and carbon credits trading, scale up clean energy projects, diversify energy suppliers, and protect the vulnerable population. - Labor shortages constrain activity - Likelihood: Medium - Source: Domestic - Expected Impact: Medium - Recommended policy: Strengthen policies to support female labor force participation, improve visa access for migrant workers. - Bond market stress from a reassessment of sovereign risk - Likelihood: Medium - Source: Domestic - Expected Impact: High - Recommended policy: Adopt a credible medium-term fiscal consolidation to put debt on a downward path. ### Sovereign Risk and Debt Sustainability Analysis (DSA) — Findings and Policy Implications - Fiscal policy stance and recent measures: - Fiscal policy remains accommodative following sizeable fiscal responses over the last three years and a fiscal stimulus announced in November totaling 2.5 percent of GDP. - Headline inflation reached levels not seen since 1990. - By mid-November, the yen had weakened by about 16 percent against the U.S. dollar due to diverging monetary policies. - Baseline projections: - The baseline is based on the budget for FY2023 and the fiscal package adopted in November 2023. - Under the baseline, the primary deficit will remain elevated in 2023-4 before the effect of policy support is phased out in 2025. - Gross public debt is projected to fall from 257 percent of GDP in 2022 to 250 percent of GDP in 2032. - Realism and risk assessment: - Historical forecasts point to some pessimism in staff’s projections for the primary deficit and public debt, but the projected debt path is within the normal historical range observed in peer countries. - High and rising debt levels erode fiscal buffers and expose Japan to a range of shocks. - Mitigating factors include a long average maturity of close to 9 years and a large domestic investor base. - The projected rise in the effective interest rate on debt is less than half that of the projected increase in the yield on 10-year JGBs over the same horizon. - JGB holdings composition: BoJ (52 percent), banks (13 percent), insurance companies (23 percent), pension funds (3 percent), foreign investors (6.5 percent). - Long-term risks and policy recommendations: - Japan’s aging population places significant pressure on GFN and debt levels in the long term, particularly via rising healthcare costs. - A credible medium-term fiscal adjustment containing social security spending and a revenue-enhancing tax reform is warranted to put public debt on a downward path in the long term. - Structural reforms to contain age-related spending and policies to boost labor market participation are recommended. *International Monetary Fund — Japan country material excerpt* ### 5. Debt consolidation across sectors: ### 5. Debt consolidation across sectors ### Public debt structure and composition - Domestic creditors held more than 90 percent of public debt in 2021. - The Bank of Japan increased its holdings from 12 percent in 2012 to 43 percent in 2022. - All public debt is governed by domestic law. - Debt is mostly long term, with an average residual maturity above 8 years. - Indicators shown on a consolidated public sector perimeter for currency composition and by holder; general government perimeter for instruments and maturity. ### Baseline scenario: projections and key fiscal aggregates (percent of GDP unless indicated) - Public debt: 2022: 257.2; 2023: 252.4; 2024: 254.6; 2025: 252.6; 2026: 251.3; 2027: 251.0; 2028: 251.0; 2029: 251.9; 2030: 250.8; 2031: 250.0; 2032: 249.6 - Change in public debt: 2022: 3.3; 2023: -4.8; 2024: 2.2; 2025: -1.9; 2026: -1.3; 2027: -0.3; 2028: 0.0; 2029: 0.9; 2030: -1.1; 2031: -0.8; 2032: -0.4 - Primary deficit: 2022: 3.9; 2023: 5.6; 2024: 6.4; 2025: 3.0; 2026: 2.7; 2027: 2.8; 2028: 2.8; 2029: 2.9; 2030: 3.2; 2031: 3.2; 2032: 3.4 - Noninterest revenues: 36.5 (2022), 35.4 (2023), 34.7 (2024), 35.5 (2025), 35.5 (2026), 35.5 (2027), 35.6 (2028), 35.6 (2029), 35.6 (2030), 35.6 (2031), 35.6 (2032) - Noninterest expenditures: 40.5 (2022), 41.0 (2023), 41.1 (2024), 38.5 (2025), 38.2 (2026), 38.3 (2027), 38.4 (2028), 38.5 (2029), 38.8 (2030), 38.8 (2031), 39.0 (2032) - Automatic debt dynamics: 2022: -1.7; 2023: -12.8; 2024: -6.5; 2025: -7.2; 2026: -6.1; 2027: -5.2; 2028: -4.8; 2029: -4.1; 2030: -4.3; 2031: -4.1; 2032: -3.7 - Real interest rate and relative inflation (labelled together): 2022: 0.7; 2023: -7.9; 2024: -4.4; 2025: -4.6; 2026: -4.1; 2027: -3.7; 2028: -3.4; 2029: -3.0; 2030: -3.1; 2031: -2.9; 2032: -2.6 - Real interest rate (repeated): 2022: 0.7; 2023: -7.9; 2024: -4.4; 2025: -4.6; 2026: -4.1; 2027: -3.7; 2028: -3.4; 2029: -3.0; 2030: -3.1; 2031: -2.9; 2032: -2.6 - Other identified flows: 2022: 1.1; 2023: 2.3; 2024: 2.3; 2025: 2.2; 2026: 2.1; 2027: 2.1; 2028: 2.0; 2029: 2.1; 2030: 0.0; 2031: 0.0; 2032: 0.0 - (minus) Interest Revenues: -1.1 (2022), -1.1 (2023), -1.1 (2024), -1.0 (2025), -1.0 (2026), -0.9 (2027), -0.9 (2028), -0.9 (2029), -0.9 (2030), -0.9 (2031), -0.9 (2032) - Other transactions: 2022: 2.2; 2023: 3.4; 2024: 3.3; 2025: 3.2; 2026: 3.1; 2027: 3.0; 2028: 2.9; 2029: 3.0; 2030: 0.9; 2031: 0.9; 2032: 0.9 - Contribution of residual: 0.0 for all years shown - Gross financing needs: 2022: 58.3; 2023: 48.4; 2024: 52.7; 2025: 58.7; 2026: 58.9; 2027: 62.3; 2028: 67.0; 2029: 67.3; 2030: 66.6; 2031: 69.8; 2032: 71.7 - of which: debt service: 55.4 (2022), 43.9 (2023), 47.3 (2024), 56.7 (2025), 57.1 (2026), 60.5 (2027), 65.1 (2028), 65.4 (2029), 64.3 (2030), 67.5 (2031), 69.3 (2032) - Local currency debt service equals total; foreign currency debt service reported as 0.00 across the baseline. - Memo: - Real GDP growth (percent): 1.0 (2022), 1.9 (2023), 0.9 (2024), 1.0 (2025), 0.8 (2026), 0.6 (2027), 0.6 (2028), 0.4 (2029), 0.5 (2030), 0.5 (2031), 0.5 (2032) - Inflation (GDP deflator; percent): 0.3 (2022), 3.8 (2023), 2.3 (2024), 2.3 (2025), 2.1 (2026), 2.0 (2027), 2.0 (2028), 2.1 (2029), 2.1 (2030), 2.1 (2031), 2.1 (2032) - Nominal GDP growth (percent): 1.3 (2022), 5.7 (2023), 3.1 (2024), 3.4 (2025), 3.0 (2026), 2.6 (2027), 2.6 (2028), 2.4 (2029), 2.6 (2030), 2.6 (2031), 2.6 (2032) - Effective interest rate (percent): 0.6 (2022), 0.5 (2023), 0.5 (2024), 0.5 (2025), 0.5 (2026), 0.5 (2027), 0.6 (2028), 0.7 (2029), 0.8 (2030), 0.9 (2031), 1.1 (2032) - Commentary on baseline: "Public debt will fall over the medium term following strong gorwth in 2023 and negative real interest rates but continue to rise after 2028 reflecting a primary deficit that is larger than the debt stabilizing level by 1.4 percentage points on average over the next two decades." ### Medium-term risk assessment and financeability - Debt fanchart module: - Fanchart width: 60.2 0.9 (percent of GDP) - Probability of debt non-stabilization: 20.8 0.2 (percent) - Terminal debt-to-GDP x6 1.4 1.3 - Debt fanchart index (DFI): 2.4 - Risk signal: High (per source thresholds: low if DFI < 1.13; high if DFI > 2.08) - Gross Financing Needs (GFN) module: - Average baseline GFN: 58.0 19.8 (percent of GDP) - Initial Banks' claims on the gen. govt (pct bank assets): 10.3 3.3 - Change in banks' claims in stress (pct banks' assets): 0.5 0.2 - GFN financeability index (GFI): 23.3 - Risk signal: High (per source thresholds: low if GFI < 7.6; high if GFI > 17.9) - Final assessment: - Final Medium-term index: High - Prob. of missed crisis, 2023-2028, if stress not predicted: 54.5 pct. - Prob. of false alarms, 2023-2028, if stress predicted: 3.4 pct. - Commentary: Both the Debt Fanchart and GFN Financeability Modules point to high risk. High financing risk reflects high average GFNs and significant bank financing in the baseline. A sharp exchange rate depreciation would increase GFNs in the medium term. The FX stress test is triggered but, due to low FX debt, results are highly similar to the baseline. ### Realism of baseline assumptions and forecast track record - Realism analysis indicates a large median forecast error for medium-term primary deficit and public debt projections, suggesting a pessimistic bias. - Explanation: bias largely reflects unwinding of exceptional pandemic support measures and the sharp rise in inflation following the war in Ukraine and global supply disruptions. - Historical indicators used: forecast track record for public debt to GDP, primary deficit, r - g; distributions of 3-year debt reduction and 3-year cyclically-adjusted primary balance adjustment; implied spread via Laubach (2009) rule referenced. ### Triggered modules and long-term risks - Triggered modules include pensions and health; key variable signals: - Long-term risk assessment flagged "Large Amortization" because high debt-to-GDP implies large amortization and rollover needs. - Commentary: Rising interest rates to levels not seen in the past two decades would exacerbate long-term risks through large amortizations. - Medium-term extrapolation scenarios include baseline with t+5 and baseline with t+5 and DSPB (debt-stabilizing primary balance). ### Demographics: Pensions and health (long-term fiscal implications) - Pensions: - Pension system assets were 38 percent of GDP in 2023. - Automatic adjustment of pension benefits following 2004 pension reforms ensures the pension system remains fully funded. - Commentary: Japan faces significant long-term pressures from an aging population; these pressures are greatly ameliorated by the sizable pension assets and automatic adjustment mechanisms. - Health: - Demographics are projected to push up already high GFN in the long term, rising above 100 percent of GDP by 2038 under the demographic baseline. - If additional excess cost growth (ECG) occurs at the standard 1.4 percent, GFN would be about 25 pp higher by 2052. - Commentary: Demographics significantly raise long-term GFN; health cost growth magnifies the fiscal pressure. ### Distributional impacts of a carbon tax (Annex IV) - Policy simulated: economy-wide carbon tax applying to all greenhouse gas (GHG) emissions, rising in equal annual increments starting from 2026 (first rate increase) to reach US$ 75/ton carbon dioxide equivalent (CO2e) in 2030. - Emissions and mitigation: - In 2030, the modeled carbon tax reduces GHG emissions by 17.6 percent relative to BAU. - This reduction amounts to 81 percent of Japan’s Nationally Determined Contribution (NDC) requirement. - Abatement consistent with fully meeting the NDC would likely require complementary policies. - Fiscal impact: - The simulated carbon tax would raise substantial revenues of around 1 percent of GDP. - Without recycling of these revenues for compensation, Japanese households are, on average, expected to lose around over 2 percent of their total consumption in 2030. - Incidence and regressivity: - Most consumption losses are attributed to higher electricity bills ("direct effect") rather than higher bills for other energy-intensive goods and services ("indirect effect"). - The carbon tax is only moderately regressive: - Mean losses for deciles 2 and 3 are roughly 20 percent higher than those of deciles 8 and 9. - The distributional pattern likely reflects the relatively large share of direct energy (particularly electricity and natural gas) consumption in poorer households' budgets. - Methodology notes: - Results aggregated at population-weighted per capita consumption decile level using the IMF-World Bank Climate Policy Assessment Tool (CPAT). - Household budget shares calculated using 2017 Japan Household Panel Survey (JHPS/KHPS) microdata. - CPAT reports that energy-related CO2 emissions represent approximately 90 percent of Japan’s total 2020 GHG emissions (excluding LULUCF), with coal 47 percent, natural gas 24 percent, diesel 12 percent, gasoline 11 percent, kerosene 3 percent, LPG 2 percent, and jet fuel 1 percent. - Largest CO2-emitting sector: power generation 43 percent; transport 19 percent; industry 14.5 percent; buildings 12 percent; non-power transformation 11.5 percent. - Price-pass-through assumptions: full passthrough from firms to households assumed for sectoral indirect effects; household behavioral responses adjusted using consumption item-specific price elasticities of demand (USDA data). *Source: IMF staff estimates and projections (chapter: 5. Debt consolidation across sectors).* ### 6. Compensating households by using (“recycling”) a portion of the revenues raised via ### 6. Compensating households by using (“recycling”) a portion of the revenues raised via the carbon tax ### Modeled revenue recycling scenario and implementation - Assumption: Half of the modeled carbon tax revenues (around 0.5 percent of GDP) are recycled into new, targeted cash transfers to the bottom 20 percent of the consumption distribution; the rest allocated to, e.g., the general budget. - Targeting: Revenues recycled were divided by the population of the targeted deciles (i.e., deciles 1-2, assuming no leakage or under-coverage) and expressed in percent of decile-specific household per-capita consumption. - Policy-design note: The modeled transfers are cash transfers targeted to deciles 1-2 (the bottom 20 percent). ### Main incidence and distributional findings - Net consumption impacts for poorest households: - Deciles 1-2 could enjoy net increases in consumption of over 15 percent, on average. - Redistribution effect: - Recycling carbon tax revenues into the modeled targeted cash transfers reduces household consumption-based inequality. - The household consumption-based Gini coefficient decreases by approximately 3 percent under the post-recycling scenario. - Broader distributional pattern: - Relative (net) gains occur for the bottom 2 deciles and losses for the top 8 deciles in the modeled scenario. ### Macroeconomic implications - Growth effects: - Revenues recycled would more than offset the initially negative impact of the carbon tax on real GDP growth, attenuating potential equity-efficiency tradeoffs from carbon pricing. - Model specification note: - The scenario modeled a Real 2021 US$ 75 Carbon Tax/Ton CO2e on GHG emissions in Year 2030 (incidence effects shown for 2025-2030 in associated figures). ### Key channels and technical points - Consumption shares driving incidence: - The pattern of distributional impacts is largely driven by the high household budget share for electricity of around 5.5 percent of total household consumption, on average across all deciles. - Modeling simplifications and scope limitations: - The simulation used available revenues as a proxy for the gross (monetary) household gain from revenue recycling. - The annex focuses on first-order household consumption incidence effects; more complex incidence passthrough to producers, capital owners, or labor (via downward pressure on producer prices, profits, returns to capital, or wages) is outside the scope of the annex and not modeled here. ### Policy considerations and caveats - Opportunity cost and efficiency: - Overcompensating low-income households through carbon tax revenue recycling would have to be well substantiated because it may come at an opportunity cost in terms of diverting revenues from potentially more productive purposes (e.g., cutting distortionary taxes). - Alternative approaches to redistribution: - If there is a strong case for redistribution in Japan, it may be more efficient to achieve this through adjustments to the entire tax-benefit system rather than through climate mitigation policy per se. - Illustrative nature: - The modeling scenario was chosen to provide illustrative evidence of the impacts of carbon tax revenue recycling for the purposes of this Annex. *Source: IMF staff analysis in Annex V (Incidence Effects of a Simulated Carbon Tax) from the Japan — Staff Report (Informational Annex).* ### 2018. It also started disseminating quarterly General Government Operations in line with SDDS Plus ### 1jpnea2024010 - 2018. It also started disseminating quarterly General Government Operations in line with SDDS Plus ### Data standards and statistical frameworks - Since April 18, 2016, Japan has adhered to the IMF’s Special Data Dissemination Standard (SDDS) Plus and meets the SDDS Plus specifications for coverage, periodicity, and timeliness of data. - Japan is progressing in the implementation of the G-20 Data Gaps Initiative (DGI-3) recommendations. - The last mission on the Observance of Standards and Codes (data ROSC) took place in 2005; the report was published in March 2006. - Monetary and Financial Statistics (MFS): Japan reports MFS to the IMF’s Statistics Department based on the standardized report form (SRF) for the central bank, other depository corporations (ODCs), and other financial corporations (OFCs) with sufficient granularity. Compilation methodologies are broadly in line with the Monetary and Financial Statistics Manual and Compilation Guide (MFSMCG). - Financial Access Survey (FAS): Japan reports data on some key series of the FAS, including series on SMEs and the two indicators adopted by the UN to monitor SDG Target 8.10: "commercial bank branches per 100,000 adults" and "ATMs per 100,000 adults." - Financial Soundness Indicators (FSIs): Japan disseminates FSI data quarterly in line with the SDDS Plus standard. Semi-annual submission to IMF includes 12 core indicators and 6 additional indicators for deposit takers as well as additional FSI for the real estate sector. - External Sector Statistics: MOF and BOJ compile BOP, merchandise trade, IIP, external debt statistics, and the template for international reserves and foreign currency liquidity; they participate in the CDIS and CPIS providing core and some encouraged items. These datasets are based on BPM6 and consistent with each other. ### Table of Common Indicators — selected latest observations and reporting frequencies (As of March 29, 2024) - National Accounts: Date of latest observation 2023Q4; Date received Mar. 11, 2024; Frequency of data Q; Frequency of reporting Q; Frequency of publication Q. - Consumer Price Index: Date of latest observation Feb. 2024; Date received Mar. 22, 2024; Frequency M / M / M. - International Reserve Assets and Reserve Liabilities of the Monetary Authorities 1/: Date of latest observation Feb. 2024; Date received Mar. 6, 2024; Frequency M / M / M. - Reserve/Base Money 1/: Date of latest observation Feb. 2024; Date received Mar. 3, 2024; Frequency M / M / M. - Broad Money 1/: Date of latest observation Feb. 2024; Date received Mar. 3, 2024; Frequency M / M / M. - Central Bank Balance Sheet: Date of latest observation Feb. 2024; Date received Mar. 4, 2024; Frequency M / M / M. - Consolidated Balance Sheet of the Banking System: Date of latest observation Jan. 2024; Date received Mar. 3, 2024; Frequency M / M / M. - Interest Rates 2/: Date of latest observation Mar. 29, 2024; Date received Mar. 29, 2024; Frequency D / D / D. - Exchange Rates: Date of latest observation Mar. 29, 2024; Date received Mar. 29, 2024; Frequency D / D / D. - Revenue, Expenditure, Balance and Composition of Financing 3/ – General Government 4/: Date of latest observation 2023Q1; Date received Jan. 24, 2024; Frequency Q / Q / Q. - Revenue, Expenditure, Balance and Composition of Financing 3/ – Central Government: Date of latest observation 2023Q4; Date received Mar. 22, 2024; Frequency Q / Q / Q. - Stocks of Central Government and Central Government-Guaranteed Debt 5/: Date of latest observation 2023Q4; Date received Feb. 9, 2024; Frequency Q / Q / Q. - External Current Account Balance: Date of latest observation Jan. 2024; Date received Mar. 8, 2024; Frequency M / M / M. - International Investment Position: Date of latest observation 2023Q4; Date received Mar. 8, 2024; Frequency Q / Q / Q. - Exports and Imports of Goods and Services: Date of latest observation Jan. 2024; Date received Feb. 28, 2024; Frequency M / M / M. - Gross External Debt: Date of latest observation 2023Q4; Date received Mar. 7, 2024; Frequency Q / Q / Q. - Frequency notation legend: Daily (D); weekly (W); monthly (M); quarterly (Q); annually (A); irregular (I); and not available (NA). - Footnotes retained in original wording: 1/ Includes reserve assets pledged or otherwise encumbered as well as net derivative positions. 2/ Both market-based and officially determined, including discount rates, money market rates, rates on treasury bills, notes, and bonds. 3/ Foreign, domestic bank, and domestic nonbank financing. 4/ The general government consists of the central government (budgetary funds and extra budgetary funds), local governments, and social security funds. 5/ Including currency and maturity composition. ### Recent economic developments and outlook - Recovery and momentum: Japan’s economy is recovering at a moderate pace, although the recovery recently appears to be pausing. Improvement in consumer confidence has not fully translated into stronger private consumption; private consumption pick-up appears to be pausing amid weak automobile sales due to production suspension in some companies. Business investment continues to strengthen, while export growth appears to be on halt. Consumer prices have been rising moderately as the employment situation improves. - BOJ outlook (April 2024): The BOJ’s “Outlook for Economic Activity and Prices” projects Japan’s economy to continue growing at a pace above its potential growth rate. The BOJ’s growth projection for FY 2024 is lower than staff’s projection, due in part to base effects. Private consumption is projected to increase moderately, reflecting the rise in wage growth and improvement in consumer sentiment. - Wages and inflation: Preliminary wage settlements from the annual spring wage negotiations registered a notable 5.2 percent increase in nominal terms, the highest in three decades. The BOJ projects core inflation to be in the range of 2.5 to 3.0 percent (y/y) in FY 2024, gradually falling to around 2 percent in FY 2025 and 2026 (y/y). Underlying inflation, still somewhat below 2 percent, is expected to increase gradually on the back of an improving output gap and rising medium- to long-term inflation expectations as a virtuous cycle between wages and prices intensifies. - Risks: External and domestic risks remain. Uncertainties include effects of prolonged tight global monetary policy, deepening geopolitical tensions, and firms’ wage- and price-setting behavior. ### Fiscal policy and public finances - Policy objectives: The government aims for sustainable growth led by private demand and the virtuous cycle of growth and distribution, guided by the FY 2023 Comprehensive Economic Measures and the FY 2024 budget. Key priorities include mitigating high-price impacts, facilitating structural wage increases, increasing children-related and defense spending, and promoting GX investment financed through carbon pricing. - Temporary measures and subsidies: FY 2023 supplementary budget prioritized temporary energy subsidies and measures to facilitate wage increases by SMEs. Electricity and gas subsidies were reduced in early May and will expire at the end of May. One-time income and local residential tax cuts will be put in place in June 2024. The government is considering exit strategies for fuel subsidies. - State funds and transparency: The government reviewed all state funds in April 2024 and set a termination point and a quantitative goal, where appropriate. - Debt metrics and consolidation: The general government debt-to-GDP ratio is projected to reach 252.4 percent in 2023. The government agrees further fiscal consolidation efforts are warranted, will work to normalize the budget spending structure from pandemic-era expansionary fiscal stance, ensure temporary spending does not continue beyond necessity, and further rationalize spending. The government remains committed to achieving the fiscal target of a primary surplus of the central and local governments in FY 2025. The government reviewed the progress of integrated policy and fiscal reforms in March 2024. ### Monetary policy - BOJ framework change: The BOJ normalized its monetary policy framework. In the March monetary policy meeting it discontinued large-scale monetary easing measures, including the negative interest rate policy and yield curve control, and introduced a new framework guiding the short-term interest rate as the prime policy tool, with the target continuing to be attainment of 2 percent inflation in a sustainable manner. - Asset purchases and communication: For the time being, the BOJ continues purchases of JGBs with broadly the same amount as before and remains prepared to respond swiftly to any rapid increase in long-term interest rates by increasing JGB purchases. The BOJ emphasized external communication to ensure the change is not perceived as a discontinuation of accommodative stance. - Data-driven approach and forward guidance: The BOJ will continue data-driven monetary policy supplemented by anecdotal information, closely monitor wage and price trends including among SMEs, consider further adjustments as deemed appropriate, and will begin to reduce JGB purchases at an unspecified time in the future (extent undetermined). It will also take time to consider actions regarding ETFs it holds. ### Financial sector and stability - Resilience: The authorities welcome staff’s FSAP view that Japan’s financial system has remained resilient to recent shocks. Government and BOJ analyses suggest sufficient buffers to withstand stress. - Regulatory and crisis preparedness: Staff highlighted progress on financial regulation and supervision, expansion of crisis preparedness, resilience of the ELA framework, and enhanced interagency coordination. The government and BOJ will continue strengthening efforts to ensure financial system resilience, taking staff recommendations into account. - Vulnerabilities: Authorities broadly agree on sources of vulnerabilities underlying the financial system, with nuanced views on some (including real estate markets). ### External sector and exchange rate developments - Yen movements: The yen depreciation has been rapid and one-sided since the beginning of 2024, with speculative trading cited among factors. The government is paying close attention with serious concern. - Policy stance on exchange rates: The government remains committed to a flexible exchange rate regime while reiterating that excess volatility and disorderly movements can have adverse implications for economic and financial stability. Should a market turn disorderly, the government would take appropriate actions in line with international agreements including in G20, G7 and the IMFC. ### Alternative scenario and fiscal confidence - Market confidence: Japan has maintained market confidence in fiscal sustainability for a long time, even during global crises including the pandemic. Authorities welcome staff’s analysis pointing to the potential risk of a crisis caused by deterioration in market confidence and broadly agree strong fiscal discipline and near-term fiscal consolidation efforts are warranted. - Probability and transmission: Authorities note the probability that the risk scenario materializes appears very low and that propagation channels under the risk scenario are uncertain. ### Growth strategy and structural reforms - Grand Design and Action Plan: In June 2023, the government revised the “Grand Design and Action Plan for a New Form of Capitalism” to accelerate public-private efforts to solve social challenges and achieve economic growth. The strategy targets wage increases by boosting human capital investment, labor market reforms, increasing GX and DX investment, and improving the business environment for start-ups. - Demographics and labor: Commitment to reverse declining birthrate trends and promote female leadership. The “Future Strategy for Children” (December 2023) focuses on strengthening economic support for households with children and promoting wage increases among the young, advancing co-parenting, facilitating parental leave, narrowing the gender wage gap, and supporting women’s labor market participation and representation in senior leadership. - Inequality: Reducing inequality is a priority; the government will implement labor market reforms including raising the minimum wage, addressing the wage gap between regular and non-regular workers, and increasing re-skilling support. The authorities request a more detailed IMF analysis of the impact of capital gains on inequality in Japan. - Climate and GX: Government commitment to reduce greenhouse gas emissions by 46% before 2030 and achieve net-zero by 2050. Decarbonization initiatives include promoting energy efficiency and making renewable energy the main source of electricity. Japan Climate Transition Bonds were issued in 2024 to support GX investments. Carbon pricing will be introduced with a necessary transition period. - Digital transformation and start-ups: Increasing investment in DX and start-up support are key to enhancing growth potential. The government is facilitating DX investment across sectors including SMEs, medical care, and the public sector. The “Startup Development Five-Year Plan” (November 2022) guides efforts to improve the business environment to increase investment in start-ups. - Trade and supply chains: Japan supports rules-based multilateral trading systems with WTO at its core, will promote international rules and norms to facilitate trade, strengthen economic resilience, and make global supply chains more resilient, sustainable, and reliable. ### Conclusion - Authorities value close collaboration with the Article IV and FSAP teams and IMF Management and staff, and look forward to continuing cooperation on domestic and international macroeconomic challenges. *Source: Statement by Jun Mizuguchi, Shuntaro Hara, Motofumi Umemura, Keigo Ando, and Yui Matsui — May 6, 2024.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1jpnea2024010.pdf_