## 1. Analysis of Tail-Risk Scenarios (_cr09210) ## Source details **Canonical URL:** [1. Analysis of Tail-Risk Scenarios (_cr09210)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09210.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09210.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09210.pdf.json) --- ### Executive summary: key findings and policy messages - Context and outlook - The global recession derailed Japan’s export-led boom; a sustained recovery depends on an upturn overseas. - Staff projects GDP to fall by a record 6 percent in 2009 and grow by 1¾ percent in 2010. - Inflation is projected to remain negative through 2011. - Over the medium term, potential growth could fall because of challenges reorienting production away from exports and lower investment from tighter corporate financing. - Policy messages - Fiscal policy has provided timely stimulus and should remain flexible to address further downside risks; clarify a medium-term fiscal consolidation strategy once recovery takes hold because of the sharp increase in public debt and aging population. - Monetary policy response has been well-calibrated; additional credit easing measures may be needed if downside risks materialize. - Financial policies should strengthen financial system resilience; promoting corporate restructuring would support a sustained recovery. - Rebalancing growth toward domestic demand is critical to support living standards and fiscal sustainability. ### Economic developments (recent history and transmission) - Activity and investment - After expanding by 2.3 percent in 2007, GDP contracted by 0.7 percent in 2008. - GDP fell by about 14 percent (s.a.a.r.) in both Q4 2008 and Q1 2009. - Industrial production stabilized around March 2009 as inventory adjustment progressed; survey data suggested output could recover in Q2 2009. - Durable goods exports, particularly automobiles, collapsed; advanced manufacturing specialization amplified exposure to the global recession. - Inflation and output gap - CPI inflation eased from 2.3 percent in July 2008 to –0.1 percent y-o-y in April 2009. - Core inflation (staff definition, excluding fuel and food) turned negative. - The output gap widened to about –8 percent—about twice as large as after the 1997 banking crisis. - Short-term inflation expectations appear to have declined considerably. - Labor market and consumption - Cash compensation fell by –2.5 percent y-o-y. - Unemployment rose from 3.8 percent in October 2008 to 5.0 percent in April 2009. - Worsening labor market and heightened uncertainty depressed private consumption. - Exchange rate and external balance - The yen appreciated by about 25 percent in real effective terms since August 2008. - Current account surplus narrowed from 4.8 percent of GDP in 2007 to an annualized 1.4 percent of GDP in Q1 2009. - Financial markets and liquidity - Japanese stock market rebounded since March 2009 but remained about 40 percent below end-2007 levels. - 3-month yen LIBOR-OIS spread declined to near pre-Lehman levels; 6-month TIBOR and negative 5-year basis FX swap spread indicated continued longer-term funding tightness. - Bank lending rates fell after BoJ cuts, but falling inflation pushed up real rates. - Corporate bond spreads narrowed for AA-rated firms but remained sharply higher for lower-rated firms; securitization activity remained dormant. - Bank CDS spreads remained elevated relative to pre-crisis; money market stresses were less pronounced than in other advanced economies. ### Outlook and risks (baseline and directional risks) - Baseline projection and drivers - Baseline: GDP to fall by 6 percent in 2009 and expand by 1¾ percent in 2010. - Recovery in the quarters ahead is expected from inventory adjustment and fiscal stimulus, but a sustained recovery likely to emerge during 2010 and hinge on global financial conditions and trade. - With significant slack, inflation projected to remain negative until 2011. - Short-term current account surplus expected to remain around 1¾ percent of GDP. - Risk assessment - Risks are tilted to the downside: deteriorating labor market, tight domestic financial conditions, and external uncertainties. - On the upside, faster-than-expected growth in China could help manufacturing exports, though benefits may be limited. - Inflation risks are tilted to the downside given growth risks and uncertainty about inflation expectations. ### Tail-risk scenarios: methods and impacts - Methodology - Two downside tail-risk scenarios analyzed using the IMF’s Global Projection Model (GPM). - Severe credit event scenario - Mechanism: intensified global financial strains cause sharp drop in durable-goods exports, repatriation of profits and investment could push up the yen, bank lending attitudes tighten globally (assumed to tighten by about ½ of the cumulative tightening since summer 2007), refinancing difficulties and rising nonperforming loans. - Impact on Japan (model results): - Without further fiscal stimulus, output could fall by about -1½ percent in 2010 (3 percentage points below the baseline). - Growth would remain very weak through 2011. - Inflation would remain negative until 2012. - Policy rate would need to be kept close to zero until the following year to offset deflationary risks. - Loss of market confidence scenario - Mechanism: markets lose confidence in public debt sustainability in several major economies; government bond yields rise sharply reflecting higher inflation expectations and solvency concerns; governments withdraw fiscal stimulus to restore credibility, further undermining domestic demand. - Scenario assumptions: increase in inflation expectations by 2 percentage points and up to a 1 percentage point increase in term premia in the United States and Japan. - Impact on Japan (model results): - Output could contract by around 2 percent in 2010. - Higher inflation expectations could lead to upward pricing pressures despite sizeable slack. - Monetary policy could be forced to tighten during 2011, earlier than in the severe credit event scenario. ### Authorities’ views and forecasts - Bank of Japan (BoJ) projections (April Outlook report) - BoJ Policy Board projected GDP to contract by 3.1 percent in FY2009 and grow by 1.2 percent in FY2010 (fiscal year basis). - The Policy Board forecasted core inflation (excl. fresh food) to remain negative in both years, with the FY2010 central projection at –1 percent. - BoJ assessment of risks - Agreed that growth risks are tilted to the downside, primarily from possible adverse feedback between financial and economic activity domestically and globally. - Considered the inflation outlook highly uncertain because of ambiguities in growth, inflation expectations, and commodity price paths. ### Policy measures to support growth and financial stability - Overview - Authorities provided sizeable fiscal, monetary, and financial measures. - Policy rate cut to close to zero; BoJ used extraordinary measures including asset purchases and liquidity operations. - Fiscal policy provided the bulk of demand support given the zero lower bound on interest rates. - Financial measures aimed to safeguard the banking system and maintain credit flows, especially to distressed SMEs. - Policy priorities (high level) - Maintain flexible fiscal support near-term while clarifying medium-term consolidation plans to secure debt sustainability once recovery begins. - Consider additional credit-easing measures if downside risks materialize. - Continue strengthening financial system resilience and improve financial intermediation efficiency. - Promote corporate restructuring and reforms to rebalance growth toward domestic demand. ### Recent fiscal developments and stimulus - Fiscal deterioration and sizing - Consolidated fiscal deficit projected to widen from 3¼ percent of GDP in FY2007 to about 11½ percent of GDP in FY2009. - Net debt projected to reach 100 percent of GDP this year (220 percent of GDP in gross terms). - Nature and size of the stimulus - Stimulus spending roughly 5 percent of GDP, larger than the G-20 average, focused on cash payments, public works, and employment support. - Many tax measures are one-off and set to expire over the next three years. - Stimulus spending combined with automatic stabilizers is estimated to boost the economy by around 2¾ percent in 2009 and 2 percent in 2010. - Japan's Fiscal Expansion (relative to 2007, in percent of GDP): - Stimulus spending 2009: 2.6; impact on GDP level 1.7 - Stimulus spending 2010: 2.2; impact on GDP level 1.1 - The April 2009 stimulus package: budget size 3.2; impact on GDP level 2.0 - Financial measures 2/: 0.6 - Transfers to local governments: 0.5 - Social securities: 0.4 - Employment support: 0.4 - Subsidies for energy efficient products: 0.3 - Others: 0.9 - Automatic stabilizers 2009: 1.1; 2010: 1.0 - Total fiscal expansion including automatic stabilizers 2009: 2.8; 2010: 2.1 - Market reactions and debt dynamics - 10-year JGB yield picked up by around 30 bps since the beginning of the year. - Gross JGB issuances expected to rise to as high as 30 percent of GDP in FY2009 to help finance the stimulus. - On current trends, net public debt could rise to about 140 percent of GDP (240 percent in gross terms) by 2014. - Government contingent liabilities rising with rapid expansion of SME lending guarantees (budgeted at ¥30 trillion) and other financial support. ### Fiscal policy choices and staff views - Near-term fiscal stance - Fiscal policy has provided a timely and needed boost and should remain flexible to address further downside risks. - If the recession persists longer than expected, additional stimulus could be provided in FY2010, emphasizing targeted and reversible measures. - Medium-term consolidation - Priority to clarify a medium-term consolidation strategy; shift from targeting primary balance to a cap on the public debt ratio is a sensible option. - Staff analysis example: capping net debt at 130 percent of GDP (230 percent of GDP in gross terms) would require an adjustment in the primary balance of around 1.5 percent of GDP annually during 2011–15; after 2015, further measures would be needed to place the debt ratio on a downward path. - Expected elements of consolidation - Expenditure measures (savings in public administration, investment, and health care costs) and comprehensive tax reforms, including a commitment to raise the consumption tax after recovery takes hold. - Pension reforms - Priorities include addressing generational inequalities and securing stable revenues for the central government’s increased contributions to the national pension plan; consider parametric changes (such as increasing the retirement age). ### Monetary policy and credit conditions - BoJ three-pronged strategy - Interest rate policy: late 2008 reductions from 50 to 10 basis points (policy rate effectively hitting the zero bound). - Additional easing: significant liquidity injections; broadening eligible collateral; special funds-supplying operations to facilitate corporate financing; U.S. dollar funds-supplying operations; higher volume of JGB purchases; outright purchases of high-rated commercial paper and corporate bonds. - Financial system backstops: resumed purchases of banks’ stockholdings (limited to date) and offered subordinated loans to banks. - Impact and stance - Borrowing rates have fallen considerably and bank credit growth has picked up as firms shifted from market financing. - Overall financial conditions remain tight due to the strong yen, elevated risk premia, stricter lending attitudes, and low stock prices. - BoJ response judged well-calibrated; monetary policy should remain accommodative given the output gap and downward pressures on prices. - If downside risks materialize, BoJ could expand easing operations by relaxing eligibility criteria for commercial paper and corporate bond purchases, extending maturities of corporate financing operations and FX swap facility, or increasing JGB purchases. - Communication and exit - Enhance publication of two-year forecasts for growth and inflation and more comprehensive risk discussion. - Clarify the time horizon for inflation’s return to a range consistent with the BoJ Policy Board’s understanding of price stability to help anchor medium-term inflation expectations. - BoJ has instruments (issue its own bills, pay interest on reserves) to facilitate an orderly exit; many existing operations will unwind automatically due to pre-set expiration dates or loss of attractiveness once market conditions normalize. ### Balance sheet risks and policy considerations - Balance sheet risks so far appear manageable given the short duration and high quality of its asset purchases. - Trade-off if further easing is needed: weigh macroeconomic benefits against risks of impairing the BoJ balance sheet and distorting market functions. - A simple Taylor rule with a weight of 0.5 on the output gap and 1.5 on the deviation of projected inflation from the median of BoJ Policy Board’s understanding of price stability (headline inflation of 0–2 percent) implies an optimal policy rate of about –5 percent compared with the current rate of 0.1 percent. - In the BoJ’s April Outlook report, the FY2010 forecast of the majority of the BoJ Policy Board members for core inflation (excl. fresh food) was between –0.8 and –1.1 percent. ### Financial sector: current state and vulnerabilities - Bank profitability and capital - In FY2008, both major and regional banks recorded their first aggregate net losses in five years. - Major banks have raised over ¥3 trillion in private capital over the past year, helping to maintain their Tier 1 capital at close to 7¾ percent during FY2008. - The share of preferred stock and hybrid instruments in Tier 1 capital for major banks remains high, at between 20 to 60 percent. - For regional banks, Tier 1 ratios have remained broadly steady at around 8 percent. - Bank equity holdings and market risk - Major banks’ shareholdings halved between FY2001 and FY2004 but still represent nearly half of Tier 1 capital. - Policy support and interventions - Authorities have set aside ¥12 trillion for public capital injections and up to ¥21 trillion for purchases of bank stockholdings (including the BoJ scheme). - Only a handful of regional banks have applied for public capital despite generous terms. - Stress-test numeric outcome - BoJ stress tests suggest some banks could face capital shortfalls under a scenario with GDP growth of –4 percent in FY2009 and the TOPIX falling to the same level as its bottom after the collapse of the bubble economy; Tier 1 capital ratios in FY2009 for the bottom 10 percent of banks would fall below the level in the late 1990s and early 2000s. ### Corporate sector and SMEs - Corporate pressures - Profits of manufacturers have plummeted with the collapse in foreign demand and the stronger yen. - Large corporations with strong balance sheets have increasingly turned to banks for funding; bank lending to SMEs continues to decline despite expanded credit guarantees. - SME-specific measures and exposure - Special credit guarantees of nearly ¥10 trillion have been extended to cover around 490,000 SMEs since October 2008; these guarantees provide 100 percent coverage and for some loans extend for as long as 10 years. - SMEs account for over 50 percent manufacturing shipment and 25 percent of exports and investment; nearly 70 percent of employment. - SMEs have significantly higher leverage and lower profitability than larger firms: debt-equity ratios for SMEs remain nearly three times as high and interest coverage ratios four times lower compared to large firms. - Policy recommendations for corporate sector - Promote restructuring (out-of-court workouts, bankruptcy system use) to strengthen SME balance sheets. - Restart a public asset management company (similar to the IRCJ) to assist banks in working out viable but distressed firms. - Adapt guidelines for out-of-court workouts to assist small and medium-sized cases; streamline court-led restructuring procedures or expand availability of financing to use the Civil Rehabilitation Law. ### Financial policy issues and exit strategy - Strengthening bank capital and profitability: target public funds to help restructure and/or merge weak banks and facilitate raising private capital; consolidation to address low profitability and excess capacity. - Reducing risks from bank equity holdings: gradual reductions under Basel-II applying higher capital charges on bank equity holdings from 2014; possible ring-fencing or partial insurance in exchange for commitments to reduce holdings. - Resolving systemically important nonbanks: establish resolution frameworks for liquidity and solvency problems of life insurers and other nonbanks. - Restarting securitization: issuances fell by 45 percent in FY2008; partial government guarantees on asset-backed securities could help SMEs, REITs, and nonbanks regain access. - Exit strategy principles: - Exceptional interventions must be smoothly unwound as the crisis eases to avoid hindering market discipline and balance sheet adjustments. - For SME guarantees, revert to partial coverage or risk-based schemes and promptly sell defaulted guaranteed companies to the RCC or private sector. - Ensure corporations receiving public capital injections operate on a commercial basis with clear exit criteria. ### Exchange rate, external stability, and rebalancing - Exchange rate assessment - Staff assessment: the current value of the yen is consistent with medium-term fundamentals; IMF CGER methods estimated the yen close to its medium-term equilibrium value as of March 2009. - Real effective exchange rate is currently close to its long-term average since 1990. - Authorities reaffirmed commitment to a market-determined exchange rate and saw no case for intervention so long as conditions remain orderly. - Cross-border exposures and spillovers - Cross-border claims of Japanese banks increased from $800 billion to around $2 trillion since mid-2002, with Western Europe accounting for more than 40 percent of the increase. - Overseas exposures have fallen since the second half of 2008 due to unwinding carry trades and retrenchment of external funding commitments. - Network analysis: No country default would fully deplete Japanese banking sector capital; U.K. and U.S. defaults would inflict significant capital impairment. Failure of the Japanese banking system would not trigger failure of any other banking system but would lead to significant capital losses in Switzerland, France, and Australia. - Rebalancing growth - Medium-term current account balance projected at around 1½ percent of GDP—close to estimated equilibrium (about 1¾ percent). - Rebalancing toward domestic demand is critical given likely prolonged constraints on external demand. - Structural reform priorities: product and labor market liberalization, inward FDI, financial market development, deregulation of agricultural and services sectors, and measures to facilitate SME restructuring. ### Staff appraisal — near-term and medium-term recommendations - Near-term - Continue policies that support growth while preserving financial stability. - Monetary policy: BoJ’s policy response appropriate; remain accommodative and ready to provide further credit easing if outlook deteriorates or financial stresses reappear. - Fiscal policy: remain flexible to address downside risks; emphasize targeted and temporary measures if further stimulus required. - Financial policies: strengthen bank profitability and capital, reduce risks from bank equity holdings, and promote restructuring of distressed but viable firms. - Exit strategy - Prepare an orderly exit from extraordinary policies as economy recovers; outline clear fiscal consolidation strategy to take effect once crisis abates. - Securing medium-term fiscal sustainability likely requires expenditure measures and comprehensive tax reforms, including a commitment to raise the consumption tax after recovery. - Medium-term structural reforms - Deregulate agricultural and services sectors—including medical, child, and elderly care—to create new drivers for growth and job creation. - Encourage inward FDI, financial market development, and product market flexibility to support rebalancing. ### Key macroeconomic and fiscal indicators (selected highlights) - Nominal GDP: US$4,910 billion (2008) - Population: 127.7 million (2008) - GDP per capita: US$38,454 (2008) - Real GDP (percent change): 2008: -0.7; 2009: -6.0; 2010 (proj.): 1.7 - Unemployment rate (annual average): 2008: 4.0; 2009 (proj.): 5.1; 2010 (proj.): 5.8 - CPI (annual average): 2008: 1.4; 2009 (proj.): -1.1; 2010 (proj.): -0.8 - General government balance (percent of GDP, fiscal year): 2008: -6.7; 2009 (proj.): -11.6; 2010 (proj.): -9.4 - Primary balance (percent of GDP): 2008: -5.6; 2009 (proj.): -10.3; 2010 (proj.): -7.9 - Gross public debt (calendar year, percent of GDP): 2008: 196.7; 2009 (proj.): 217.4; 2010 (proj.): 226.3 - Total reserves minus gold (US$ billion): 2006: 879.7; 2007: 952.8; 2008: 1009.4; 2009 (May): 1000.0 - Current account balance (US$ billion): 2008: 157.1; 2009 (proj.): 92.0; 2010 (proj.): 81.5 - Exports of goods and services (US$ billion): 2008: 746.5; 2009 (proj.): 507.5; 2010 (proj.): 549.5 ### Medium-term projections (2009–14) — staff projections and scenarios - Real GDP (percent change): 2009: -6.0; 2010: 1.7; 2011: 2.5; 2012: 3.0; 2013: 2.6; 2014: 2.0 - Unemployment rate (percent): 2009: 5.1; 2010: 5.8; 2011: 5.6; 2012: 5.3; 2013: 4.6; 2014: 4.3 - CPI inflation: 2009: -1.1; 2010: -0.8; 2011: -0.4; 2012: 0.1; 2013: 0.6; 2014: 0.8 - Output gap (percent): 2009: -7.9; 2010: -6.8; 2011: -4.9; 2012: -2.8; 2013: -1.2; 2014: -0.4 - Overall fiscal balance (fiscal years, percent of GDP): 2009: -11.6; 2010: -9.4; 2011: -7.7; 2012: -7.4; 2013: -7.5; 2014: -7.5 - Debt (calendar years, percent of GDP): 2009: 217.4; 2010: 226.3; 2011: 230.4; 2012: 234.0; 2013: 236.8; 2014: 239.3 - Current account balance (percent of GDP): 2009: 1.8; 2010: 1.7; 2011: 2.3; 2012: 2.1; 2013: 1.7; 2014: 1.5 *Source: IMF staff report (Article IV consultation): "1. Analysis of Tail-Risk Scenarios" and associated chapters/annexes (content provided).* ### 1. Analysis of Tail-Risk Scenarios.....................................................................................9 ### 1. Analysis of Tail-Risk Scenarios ### Executive summary: key findings and policy messages - Context and outlook - The global recession derailed Japan’s export-led boom; a sustained recovery depends on an upturn overseas. - Staff projects GDP to fall by a record 6 percent in 2009 and grow by 1¾ percent in 2010. - Inflation is projected to remain negative through 2011. - Over the medium term, potential growth could fall because of challenges reorienting production away from exports and lower investment from tighter corporate financing. - Policy messages - Fiscal policy has provided timely stimulus and should remain flexible to address further downside risks; clarify a medium-term fiscal consolidation strategy once recovery takes hold because of the sharp increase in public debt and aging population. - Monetary policy response has been well-calibrated; additional credit easing measures may be needed if downside risks materialize. - Financial policies should strengthen financial system resilience; promoting corporate restructuring would support a sustained recovery. - Rebalancing growth toward domestic demand is critical to support living standards and fiscal sustainability. ### Economic developments (recent history and transmission) - Activity and investment - After expanding by 2.3 percent in 2007, GDP contracted by 0.7 percent in 2008. - GDP fell by about 14 percent (s.a.a.r.) in both Q4 2008 and Q1 2009. - Industrial production stabilized around March 2009 as inventory adjustment progressed; survey data suggested output could recover in Q2 2009. - Durable goods exports, particularly automobiles, collapsed; advanced manufacturing specialization amplified exposure to the global recession. - Inflation and output gap - CPI inflation eased from 2.3 percent in July 2008 to –0.1 percent y-o-y in April 2009. - Core inflation (staff definition, excluding fuel and food) turned negative. - The output gap widened to about –8 percent—about twice as large as after the 1997 banking crisis. - Short-term inflation expectations appear to have declined considerably. - Labor market and consumption - Cash compensation fell by –2.5 percent y-o-y. - Unemployment rose from 3.8 percent in October 2008 to 5.0 percent in April 2009. - Worsening labor market and heightened uncertainty depressed private consumption. - Exchange rate and external balance - The yen appreciated by about 25 percent in real effective terms since August 2008. - Current account surplus narrowed from 4.8 percent of GDP in 2007 to an annualized 1.4 percent of GDP in Q1 2009. - Financial markets and liquidity - Japanese stock market rebounded since March 2009 but remained about 40 percent below end-2007 levels. - 3-month yen LIBOR-OIS spread declined to near pre-Lehman levels; 6-month TIBOR and negative 5-year basis FX swap spread indicated continued longer-term funding tightness. - Bank lending rates fell after BoJ cuts, but falling inflation pushed up real rates. - Corporate bond spreads narrowed for AA-rated firms but remained sharply higher for lower-rated firms; securitization activity remained dormant. - Bank CDS spreads remained elevated relative to pre-crisis; money market stresses were less pronounced than in other advanced economies. ### Outlook and risks (baseline and directional risks) - Baseline projection and drivers - Baseline: GDP to fall by 6 percent in 2009 and expand by 1¾ percent in 2010. - Recovery in the quarters ahead is expected from inventory adjustment and fiscal stimulus, but a sustained recovery likely to emerge during 2010 and hinge on global financial conditions and trade. - With significant slack, inflation projected to remain negative until 2011. - Short-term current account surplus expected to remain around 1¾ percent of GDP. - Risk assessment - Risks are tilted to the downside: deteriorating labor market, tight domestic financial conditions, and external uncertainties. - On the upside, faster-than-expected growth in China could help manufacturing exports, though benefits may be limited. - Inflation risks are tilted to the downside given growth risks and uncertainty about inflation expectations. ### Tail-risk scenarios (Box 1): methods and impacts - Methodology - Two downside tail-risk scenarios analyzed using the IMF’s Global Projection Model (GPM). - Severe credit event scenario - Mechanism: intensified global financial strains cause sharp drop in durable-goods exports, repatriation of profits and investment could push up the yen, bank lending attitudes tighten globally (assumed to tighten by about ½ of the cumulative tightening since summer 2007), refinancing difficulties and rising nonperforming loans. - Impact on Japan (model results): - Without further fiscal stimulus, output could fall by about -1½ percent in 2010 (3 percentage points below the baseline). - Growth would remain very weak through 2011. - Inflation would remain negative until 2012. - Policy rate would need to be kept close to zero until the following year to offset deflationary risks. - Loss of market confidence scenario - Mechanism: markets lose confidence in public debt sustainability in several major economies; government bond yields rise sharply reflecting higher inflation expectations and solvency concerns; governments withdraw fiscal stimulus to restore credibility, further undermining domestic demand. - Scenario assumptions: increase in inflation expectations by 2 percentage points and up to a 1 percentage point increase in term premia in the United States and Japan. - Impact on Japan (model results): - Output could contract by around 2 percent in 2010. - Higher inflation expectations could lead to upward pricing pressures despite sizeable slack. - Monetary policy could be forced to tighten during 2011, earlier than in the severe credit event scenario. ### Authorities’ views and forecasts - Bank of Japan (BoJ) projections (April Outlook report) - BoJ Policy Board projected GDP to contract by 3.1 percent in FY2009 and grow by 1.2 percent in FY2010 (fiscal year basis). - The Policy Board forecasted core inflation (excl. fresh food) to remain negative in both years, with the FY2010 central projection at –1 percent. - BoJ assessment of risks - Agreed that growth risks are tilted to the downside, primarily from possible adverse feedback between financial and economic activity domestically and globally. - Considered the inflation outlook highly uncertain because of ambiguities in growth, inflation expectations, and commodity price paths. ### Policy measures to support growth and financial stability - Overview - Authorities provided sizeable fiscal, monetary, and financial measures. - Policy rate cut to close to zero; BoJ used extraordinary measures including asset purchases and liquidity operations. - Fiscal policy provided the bulk of demand support given the zero lower bound on interest rates. - Financial measures aimed to safeguard the banking system and maintain credit flows, especially to distressed SMEs. - Policy priorities (high level) - Maintain flexible fiscal support near-term while clarifying medium-term consolidation plans to secure debt sustainability once recovery begins. - Consider additional credit-easing measures if downside risks materialize. - Continue strengthening financial system resilience and improve financial intermediation efficiency. - Promote corporate restructuring and reforms to rebalance growth toward domestic demand. *Source: IMF staff report (Article IV consultation): "1. Analysis of Tail-Risk Scenarios" (chapter content provided).* ### 8. After several years of improvement, the fiscal balance has sharply deteriorated, ### 8. After several years of improvement, the fiscal balance has sharply deteriorated, ### Recent fiscal developments - Consolidated fiscal deficit projected to widen from 3¼ percent of GDP in FY2007 to about 11½ percent of GDP in FY2009. - Main factors: sharp decline in tax revenues (especially corporate tax, which could fall by nearly 2 percent of GDP), sizeable stimulus, and rising social security expenditures including an increase in the central government’s contribution to the national pension system from 1/3 to 1/2 of payouts. - Net debt projected to reach 100 percent of GDP this year (220 percent of GDP in gross terms). ### Nature and size of the stimulus - Stimulus spending roughly 5 percent of GDP, larger than the G-20 average, focused on cash payments, public works, and employment support. - Other measures: subsidies for energy-efficient purchases, higher gift tax exemption, vocational training. - Many tax measures are one-off and set to expire over the next three years. - Stimulus spending combined with automatic stabilizers is estimated to boost the economy by around 2¾ percent in 2009 and 2 percent in 2010. - Japan's Fiscal Expansion (relative to 2007, in percent of GDP): - Stimulus spending 2009: 2.6; impact on GDP level 1.7 - Stimulus spending 2010: 2.2; impact on GDP level 1.1 - The April 2009 stimulus package: budget size 3.2; impact on GDP level 2.0 - Financial measures 2/: 0.6 - Transfers to local governments: 0.5 - Social securities: 0.4 - Employment support: 0.4 - Subsidies for energy efficient products: 0.3 - Others: 0.9 - Automatic stabilizers 2009: 1.1; 2010: 1.0 - Total fiscal expansion including automatic stabilizers 2009: 2.8; 2010: 2.1 - Sources: MoF, CaO and staff estimates. - Note 2/: Includes support for SMEs through capital injection into government affiliated financial institutions. - Note 3/: A large portion is intended to be spent on public investment. ### Market reactions and debt dynamics - 10-year JGB yield picked up by around 30 bps since the beginning of the year on improving risk appetite and prospects for greater JGB supply; increase smaller than for U.S. Treasuries and U.K. gilts. - Gross JGB issuances expected to rise to as high as 30 percent of GDP in FY2009 to help finance the stimulus. - Short-term financing risks appear contained given limited foreign ownership of JGBs and large pool of domestic savings, but market capacity may diminish over time as population aging reduces savings inflows and financial reforms change institutional investor behavior. - On current trends, net public debt could rise to about 140 percent of GDP (240 percent in gross terms) by 2014. - Government contingent liabilities rising with rapid expansion of SME lending guarantees (budgeted at ¥30 trillion) and other financial support. ### Policy issues and staff views — fiscal policy - Near-term fiscal stance: fiscal policy has provided a timely and needed boost and should remain flexible to address further downside risks. If the recession persists longer than expected, additional stimulus could be provided in FY2010, emphasizing targeted and reversible measures (e.g., accelerated depreciation of capital expenditure in high growth potential sectors or tax changes that bring forward consumption). - Medium-term consolidation: given increased public debt and aging-related pressures, priority should be placed on clarifying a medium-term consolidation strategy. A sensible option would be to shift from targeting primary balance to a cap on the public debt ratio over the medium term to put the debt ratio on a downward path and strengthen public awareness of consolidation needs. - Staff analysis example: capping net debt at 130 percent of GDP (230 percent of GDP in gross terms) would require an adjustment in the primary balance of around 1.5 percent of GDP annually during 2011–15; after 2015, further measures would be needed to place the debt ratio on a downward path. - Expected elements of consolidation: expenditure measures (savings in public administration, investment, and health care costs) and comprehensive tax reforms, including a commitment to raise the consumption tax after recovery takes hold. - Pension reforms: priorities include addressing generational inequalities and securing stable revenues for the central government’s increased contributions to the national pension plan. The actuarial update provides an opportunity to reassess finances and consider parametric changes (such as increasing the retirement age). - Public debt management: need for fiscal consolidation underscored by diminishing market absorptive capacity for JGBs amid demographic change and financial sector reform. ### Authorities’ responses and intentions - Authorities expect a significant lift from the stimulus and reaffirm commitment to medium-term fiscal consolidation. - Fiscal stimulus: authorities attach high importance to supporting employment and stressed benefits should extend at least through FY2010 given implementation schedules. The authorities agree the near-term fiscal stance should remain flexible. - Medium-term sustainability and pensions: authorities consider medium-term consolidation critical for market confidence and see greater emphasis on the debt ratio as helpful to raise public support; plan to unveil additional details of new fiscal targets in the June Basic Policies. They do not see an immediate need for parametric pension changes but acknowledge the challenge of raising the compliance rate for contributions from about 60 to 80 percent in the medium term. - Public debt management: authorities view close communication with markets as helpful in facilitating larger issuances of JGBs and stabilizing yields. ### Box 2 — Market challenges to financing the stimulus (summary) - JGB market has so far absorbed new debt with yields below 2 percent over the past 10 years despite net public debt increasing by 40 percent of GDP. Contributing factors: historically high household saving rates, stable institutional investors, and strong home bias; corporate sector financial surpluses may have provided funds via the banking system. - Going forward, absorptive capacity likely to diminish due to rapid population aging lowering household savings and financial reforms allowing institutional investors (e.g., Japan Post Bank, national pension funds) greater flexibility to invest in risky assets and to reduce JGB holdings. - Staff simulation suggests that without policy adjustment, gross public debt would rise sharply and exceed the level of household financial assets within eleven years, implying increasing reliance on other funding sources, including overseas. ### Monetary policy and credit conditions - BoJ three-pronged strategy: policy rate cuts, measures to ensure financial market stability, and steps to facilitate corporate financing. - Interest rate policy: late 2008 reductions from 50 to 10 basis points (policy rate effectively hitting the zero bound). - Additional easing: significant liquidity injections; broadening eligible collateral; special funds-supplying operations to facilitate corporate financing; U.S. dollar funds-supplying operations; higher volume of JGB purchases; outright purchases of high-rated commercial paper and corporate bonds. - Financial system backstops: resumed purchases of banks’ stockholdings (limited to date) and offered subordinated loans to banks. - Impact: borrowing rates have fallen considerably and bank credit growth has picked up as firms shifted from market financing, setting Japan apart from the United States and Euro area. Nevertheless, overall financial conditions remain tight due to the strong yen, elevated risk premia, stricter lending attitudes, and low stock prices. - Policy stance: BoJ response judged well-calibrated; monetary policy should remain accommodative given the output gap and downward pressures on prices. If downside risks materialize, BoJ could expand easing operations by relaxing eligibility criteria for commercial paper and corporate bond purchases, extending maturities of corporate financing operations and FX swap facility, or increasing JGB purchases. - Communication: enhancements include publication of two-year forecasts for growth and inflation and more comprehensive risk discussion. A gap exists between the BoJ Policy Board’s two-year inflation forecast and its medium-term understanding of price stability; clarifying the time horizon for inflation’s return to a range consistent with that understanding could help anchor medium-term inflation expectations. A commitment to maintaining low interest rates until prices recover might help cap longer-term rates. *Source: IMF staff report (chapter/section provided).* ### 16. The BoJ should continue to minimize risks to its balance sheet, while mapping ### 16. The BoJ should continue to minimize risks to its balance sheet, while mapping ### Balance sheet risks and exit strategy - Balance sheet risks so far appear manageable given the short duration and high quality of its asset purchases. - If downside risks materialize, the BoJ will need to weigh macroeconomic benefits from additional easing against risks of impairing the BoJ balance sheet and distorting market functions. - A clear delineation of the role of fiscal and monetary policies would help protect against such risks. - The BoJ has sufficient instruments (such as the ability to issue its own bills and pay interest on reserves) to facilitate an orderly exit. - Many existing operations will unwind automatically due to pre-set expiration dates or a built-in loss of attractiveness once market conditions normalize. - The decision on timing of exit could be complicated by uncertainties about the outlook. Key numeric points: - A simple Taylor rule with a weight of 0.5 on the output gap and 1.5 on the deviation of projected inflation from the median of BoJ Policy Board’s understanding of price stability (headline inflation of 0–2 percent) implies an optimal policy rate of about –5 percent compared with the current rate of 0.1 percent. - In the BoJ’s April Outlook report, the FY2010 forecast of the majority of the BoJ Policy Board members for core inflation (excl. fresh food) was between –0.8 and –1.1 percent. ### The Authorities’ responses and policy intentions (monetary policy) - Monetary policy stance: - The BoJ is paying attention to downside risks to activity and prices and aims to return Japan’s economy to a sustainable growth path with price stability. - Monetary policy should aim to smooth the adjustment and prevent a freefall rather than fully offset the downturn. - Risks and benefits of additional easing measures: - The BoJ assessed financial conditions as “severe” in its recent Outlook report. - Policy measures including CP and corporate bond purchases have helped boost confidence by providing a back-stop for banks to sell their holdings. - If financial conditions deteriorate again, additional policy measures could be considered. - Authorities cautioned that prolonged market interventions risk slowing restructuring and hindering market activity. - Increased purchases of JGBs were not intended to finance the deficit or target long-term yields. - Communication: - Effective communication requires explaining the process for returning to sustainable growth with price stability. - Longer-term definitive forecasts reconciling current deflation projections with the 0–2 percent understanding of price stability would not be reliable and could reduce public confidence. - Committing to low interest rates based only on inflation developments may not be suitable given the need to monitor asset prices and financial system conditions. ### Financial sector: current state and vulnerabilities - Bank profitability and capital: - In FY2008, both major and regional banks recorded their first aggregate net losses in five years due to higher credit costs, lower fee income, and losses on equity holdings. - NPL ratios for major banks rose for the first time in seven years, while falling marginally for regional banks. - Major banks have raised over ¥3 trillion in private capital over the past year, helping to maintain their Tier 1 capital at close to 7¾ percent during FY2008. - The share of preferred stock and hybrid instruments in Tier 1 capital for major banks remains high, at between 20 to 60 percent, but has been declining over time. - Core Tier 1 capital or tangible common equity measures are correspondingly lower. - For regional banks, Tier 1 ratios have remained broadly steady at around 8 percent. - Bank equity holdings and market risk: - Major banks’ shareholdings halved between FY2001 and FY2004 but still represent nearly half of Tier 1 capital and remain a key source of market risk. - Equity stakes mainly reflect cross-shareholdings with key borrowers and related investors; they are relatively long-term investments. - Policy support: - Authorities have set aside ¥12 trillion for public capital injections and up to ¥21 trillion for purchases of bank stockholdings (including the BoJ scheme). - Only a handful of regional banks have applied for public capital despite generous terms and limited conditionality. ### Corporate sector and SMEs - Corporate sector risks: - Profits of manufacturers have plummeted with the collapse in foreign demand and the stronger yen. - Large corporations with strong balance sheets have increasingly turned to banks for funding; bank lending to SMEs continues to decline despite expanded credit guarantees. - SME-specific measures and exposure: - As part of the stimulus plan, special credit guarantees of nearly ¥10 trillion have been extended to cover around 490,000 SMEs since October 2008. - These special guarantees provide 100 percent coverage (up from 80 percent compared to standard guarantees) and for some loans extend for as long as 10 years. - SME vulnerabilities (from Box 3): - SMEs account for over 50 percent manufacturing shipment and 25 percent of exports and investment; nearly 70 percent of employment. - SMEs have significantly higher leverage and lower profitability than larger firms: debt-equity ratios for SMEs remain nearly three times as high and interest coverage ratios four times lower compared to large firms. - Promoting restructuring (out-of-court workouts, bankruptcy system use) could strengthen SME balance sheets and support rebalancing. ### Policy issues and staff views (financial and corporate sector) - Policy focus to strengthen resilience: - Strengthening bank capital and profitability: public funds could be targeted to help restructure and/or merge weak banks and facilitate raising private capital; consolidation could address low profitability and excess capacity. - Reducing risks from bank equity holdings: gradual reductions under Basel-II applying higher capital charges on bank equity holdings from 2014; possible ring-fencing or partial insurance to protect bank balance sheets in exchange for commitments to reduce holdings when prices recover. - Resolving systemically important nonbanks: establish resolution frameworks for liquidity and solvency problems of systemically important nonbanks such as life insurance companies. - Restarting securitization: issuances of securitized products fell by 45 percent in FY2008; steps such as partial government guarantees on asset-backed securities could help SMEs, REITs, and nonbanks regain access. - Promoting corporate restructuring: - Restart a public asset management company (similar to the IRCJ) to assist banks in working out viable but distressed firms by providing financing and resolving creditor disputes. - Adapt guidelines for out-of-court workouts (introduced in 2001) to assist small and medium-sized cases; streamline court-led restructuring procedures for smaller firms or expand availability of financing to use the Civil Rehabilitation Law. - Exit strategy for exceptional interventions: - Exceptional interventions must be smoothly unwound as the crisis eases to avoid hindering market discipline and balance sheet adjustments. - The sizeable increase in SME credit guarantees raises the risk of large fiscal costs while slowing restructuring. - A transparent exit strategy should be implemented as soon as conditions normalize, aiming to protect government solvency while preserving financial stability and promoting restructuring. - Examples: revert to partial coverage or risk-based scheme on SME lending; promptly sell defaulted guaranteed companies to the Resolution and Collection Corporation (RCC) or the private sector; ensure corporations receiving public capital injections operate on a commercial basis with clear exit criteria. Key numeric scenario from stress tests: - BoJ stress tests suggest some banks could face capital shortfalls under a scenario with GDP growth of –4 percent in FY2009 and the TOPIX falling to the same level as its bottom after the collapse of the bubble economy; Tier 1 capital ratios in FY2009 for the bottom 10 percent of banks would fall below the level in the late 1990s and early 2000s. ### The Authorities’ responses and policy intentions (financial and corporate) - Strengthening bank capital and profitability: - Supervisors considered the overall level of bank capital to be sufficient based on their stress tests; policy intention was to ensure credit availability rather than promote restructuring or consolidation. - Authorities believed existing capital injection schemes were working and expected additional smaller banks to apply. - Authorities saw applying tangible common equity measures to Japan as not appropriate at this moment, citing more stable funding, long investment horizons of preferred shareholders, and lower exposure to “toxic assets.” - Reducing risks from bank equity holdings: - Regulatory forbearance on unrealized equity losses at regional banks could be considered a form of ring-fencing, but authorities were skeptical about explicit ring-fencing due to moral hazard and taxpayer risk concerns. - Authorities continue to encourage enhanced risk management and offer to purchase stocks from banks at market prices. - Resolving systemically important nonbanks: - Given generally sound financial positions, authorities saw little urgent need to establish a special framework at this stage but will continue participating in global discussions. - Restarting securitization: - Authorities recognized the importance of reviving securitization and have taken steps to enhance transparency and reliability, including encouraging securities dealers to ensure traceability of securitized products and regulating credit rating agencies. *Source: IMF staff chapter text as provided in the content unit.* ### 27. The authorities broadly agreed with the staff’s assessment of the corporate ### _cr09210 - 27. The authorities broadly agreed with the staff’s assessment of the corporate ### Corporate sector and SME lending - Authorities broadly agreed with staff’s assessment of the corporate sector. - Authorities did not see substantial risks from the SME lending program. - Credit guarantees viewed as crucial for supporting SME employment, which accounts for almost 70 percent of the labor force. - A new law under discussion by the Diet would establish a public asset management company, similar to the ICRJ, to provide financial support for restructuring with a focus on medium-sized firms. - Note: Following a temporary change in capital adequacy requirements in November 2008, regional banks subject to domestic standards are no longer required to deduct unrealized losses on securities from Tier 1 capital. ### Exchange rate and external stability — staff analysis and views - Staff assessment: the current value of the yen is consistent with medium-term fundamentals. - In terms of the IMF’s CGER three analytical methods, the yen’s effective exchange rate was estimated close to its medium-term equilibrium value as of March 2009. - The real effective exchange rate is currently close to its long-term average since 1990. - Exchange rate framework: authorities have not intervened despite rapid appreciation; staff supports market-determined exchange rate with intervention only to counter disruptive movements. - Carry trade and financial spillovers: - Significant unwinding of yen carry trade positions has reduced risks to external stability from financial spillovers. - Vulnerabilities from cross-border exposures—both to and from Japan—do not appear significant and have fallen over time. - A rebound in global risk appetite could reignite carry trades, including among retail investors, and reintroduce these linkages. - Capital flows and FDI: - With a stronger yen, FDI outflows from Japan have picked up, especially to the United States and emerging Asia (notably India, Korea, and Vietnam). - In the short term, a tax exemption on dividends paid by overseas subsidiaries, which took effect in April, could support financial inflows. - Medium-term current account outlook: - Medium-term current account balance projected at around 1½ percent of GDP—close to the estimated equilibrium level (about 1¾ percent). - This is well below levels earlier this decade (3½ percent during 2002–07) owing to lower export demand, reduced asset returns, and population aging. - Narrowing current account surplus will help facilitate global rebalancing, but the severe downturn and possibility of sustained lower external demand point to a need for accelerated reforms to rebalance growth toward domestic demand. ### Assessing risks to external stability from financial spillovers (key findings from Box 4) - Cross-border claims of Japanese banks increased from $800 billion to around $2 trillion since mid-2002, with Western Europe accounting for more than 40 percent of the increase. - Overseas exposures have fallen since the second half of 2008 due to unwinding carry trades and retrenchment of external funding commitments. - Network analysis of an extreme scenario (country default on all cross-border liabilities triggering a global liquidity squeeze) indicates: - Spillovers to Japan: No country default would fully deplete Japanese banking sector capital; U.K. and U.S. defaults would inflict significant capital impairment. Japanese banking sector vulnerability has decreased from its March 2008 peak. - Spillovers from Japan: Failure of the Japanese banking system would not trigger failure of any other banking system but would lead to significant capital losses in Switzerland, France, and Australia. Japan has the fourth largest impact on the U.S. banking system after the U.K., France, and Germany. ### Authorities’ views on exchange rate - Authorities noted difficulties identifying factors behind recent exchange rate movements. - Reaffirmed commitment to a market-determined exchange rate and saw no case for intervention so long as conditions remain orderly, consistent with the G-7 stance. - Voiced skepticism about current account–based estimates of “equilibrium” exchange rates, arguing these do not adequately account for structural capital flows (e.g., declining home bias). ### Policies to rebalance growth in the medium term — background and policy issues - Rebalancing toward domestic demand is critical given likely prolonged constraints on external demand. - IMF Multilateral Consultation (2006–07) priorities: product and labor market liberalization, inward FDI, and financial market development to boost domestic demand; reform progress has been slow. - Recent reform steps: - Liberalizing product markets: EPAs with Vietnam and Switzerland; limited opening of protected markets such as nursing. - Labor reforms: relaxing eligibility criteria for employment insurance; minimum overtime pay to be raised from April 2010; compensatory leave option in lieu of higher overtime payments to be introduced at firms upon agreement with employees. - Growth and potential: - On current policies, potential growth could fall from about 1¾ percent in 2007 to close to 1 percent over the medium term as investment rates decline and structural rigidities impede reallocation of labor and capital. - Short-term reform emphasis: - Focus on reforms creating new investment and job opportunities. - Further deregulation of agricultural and services sectors—including medical, child, and elderly care—could create new drivers for growth and job creation. - Further reforms in inward FDI, financial market development, and measures to facilitate SME restructuring could support rebalancing. - Given sharp increase in unemployment, difficult labor market reforms could be delayed, but pressures to reduce market flexibility should be resisted. ### Authorities’ responses and policy intentions - Authorities recognize need to become less dependent on export-led growth and to maintain competitiveness, including through reforms to secure fiscal sustainability. - Social safety net measures: improving protection of nonregular workers, partial coverage of corporate payroll expenses, expanding retraining programs. Government to announce further steps in June Basic Policies to provide better safety net and vocational programs without reducing labor market flexibility. - Medium-term priorities: structural reforms to boost household incomes; remove supply-side constraints in social services (child care, long-term elderly care) to boost potential output; promote green, low-carbon technology including through current stimulus package to increase domestic value added and potentially create new export industries. ### Staff appraisal — near-term and medium-term policy recommendations - Near-term: - Continue policies that support growth while preserving financial stability. - Monetary policy: BoJ’s policy response (policy rate cuts, market-stability measures, measures to facilitate corporate financing) has been timely and effective; monetary policy should remain accommodative with BoJ ready to provide further credit easing if outlook deteriorates or financial stresses reappear. - Fiscal policy: remain flexible to address downside risks; 2008 and 2009 stimulus packages provided valuable support; further measures may be necessary if downturn proves protracted, emphasizing targeted and temporary measures. - Financial policies: strengthen bank profitability and capital, reduce risks from bank equity holdings, and promote restructuring of distressed but viable firms. - Exit strategy: - The extraordinary nature of policies calls for an orderly exit when the economy recovers. - Given rapid rise in public debt and aging-related fiscal pressures, outline a clear fiscal consolidation strategy to take effect once crisis abates, including new targets to put the debt ratio on a downward path. - Securing medium-term fiscal sustainability will likely require expenditure measures and comprehensive tax reforms, including a commitment to raise the consumption tax after recovery. - BoJ has instruments to facilitate an orderly exit from monetary and credit easing; many market operations are set to unwind automatically when conditions normalize. - Exit from financial sector interventions should be guided by preserving financial stability, protecting government solvency, and promoting needed restructuring; timing and conditions for withdrawal are the key challenge. - Medium-term structural reforms: - Deregulate agricultural and services sectors—including medical, child, and elderly care—to create new drivers for growth and job creation. - Encourage inward FDI, financial market development, and product market flexibility to support rebalancing and help Japan adjust to global economic changes. *Source: IMF staff report content from the provided PDF chapter/section.* ### 40. It is recommended that the next Article IV consultation take place on the ### _cr09210 - 40. It is recommended that the next Article IV consultation take place on the ### Scheduling recommendation - It is recommended that the next Article IV consultation take place on the standard 12-month cycle. ### Key macroeconomic and fiscal indicators (selected highlights) - Nominal GDP: US$4,910 billion (2008) - Population: 127.7 million (2008) - GDP per capita: US$38,454 (2008) - Real GDP (percent change): 2008: -0.7; 2009: -6.0; 2010 (proj.): 1.7 - Unemployment rate (annual average): 2008: 4.0; 2009 (proj.): 5.1; 2010 (proj.): 5.8 - CPI (annual average): 2008: 1.4; 2009 (proj.): -1.1; 2010 (proj.): -0.8 - General government balance (percent of GDP, fiscal year): 2008: -6.7; 2009 (proj.): -11.6; 2010 (proj.): -9.4 - Primary balance (percent of GDP): 2008: -5.6; 2009 (proj.): -10.3; 2010 (proj.): -7.9 - Gross public debt (calendar year, percent of GDP): 2008: 196.7; 2009 (proj.): 217.4; 2010 (proj.): 226.3 - Total reserves minus gold (US$ billion): 2006: 879.7; 2007: 952.8; 2008: 1009.4; 2009 (May): 1000.0 - Current account balance (US$ billion): 2008: 157.1; 2009 (proj.): 92.0; 2010 (proj.): 81.5 - Exports of goods and services (US$ billion): 2008: 746.5; 2009 (proj.): 507.5; 2010 (proj.): 549.5 ### Fiscal tables and projections (high-level findings) - General government operations (fiscal year basis, percent of GDP): - Total revenue: 2008: 30.1; 2009 (proj.): 30.6; 2010 (proj.): 31.1 - Total expenditure: 2008: 36.8; 2009 (proj.): 42.2; 2010 (proj.): 40.5 - Structural balance (excl. bank support): 2008: -5.2; 2009 (proj.): -8.4; 2010 (proj.): -6.6 - Calendar year presentation (percent of GDP): - Total revenue: 2008: 30.1; 2009 (proj.): 30.7; 2010 (proj.): 31.0 - Total expenditure: 2008: 35.9; 2009 (proj.): 41.0; 2010 (proj.): 41.2 - Balance (calendar): 2008: -5.8; 2009 (proj.): -10.3; 2010 (proj.): -10.3 - Debt (calendar year): Gross debt: 2008: 196.6; 2009 (proj.): 217.4; 2010 (proj.): 226.3 ### External and financial sector indicators (selected) - Real exports (percent change): 2008: 1.8 - Real imports (percent change): 2008: 0.9 - Terms of trade (percent change): 2008: -9.6 - Total reserves minus gold (US$ billion): 2008: 1009.4; 2009 (latest): 1000.0 - Foreign assets of DMBs (US$ billion): 2008: 1369.9; 2009 (latest): 1662.4 - Net international investment position (US$ billion): 2008: 2125.0; 2009 (latest): 2181.8 - Interest rates (end-year): 3-month general collateral repo rate: 2008: 0.22; 2009 (latest): 0.18 - Stock market index (TOPIX, percent change, end-year): 2008: -41.8; 2009 (latest): -36.2 ### Balance of payments (selected) - Current account (US$ billion): 2008: 157.1 - Trade balance (US$ billion): 2008: 38.4 - Exports (US$ billion): 2008: 746.5 - Imports (US$ billion): 2008: 708.0 - Reserve assets (change, US$ billion): 2008: -30.8 ### Medium-term projections (2009–14) — staff projections and scenarios - Real GDP (percent change): 2009: -6.0; 2010: 1.7; 2011: 2.5; 2012: 3.0; 2013: 2.6; 2014: 2.0 - Unemployment rate (percent): 2009: 5.1; 2010: 5.8; 2011: 5.6; 2012: 5.3; 2013: 4.6; 2014: 4.3 - CPI inflation: 2009: -1.1; 2010: -0.8; 2011: -0.4; 2012: 0.1; 2013: 0.6; 2014: 0.8 - Output gap (percent): 2009: -7.9; 2010: -6.8; 2011: -4.9; 2012: -2.8; 2013: -1.2; 2014: -0.4 - Overall fiscal balance (fiscal years, percent of GDP): 2009: -11.6; 2010: -9.4; 2011: -7.7; 2012: -7.4; 2013: -7.5; 2014: -7.5 - Debt (calendar years, percent of GDP): 2009: 217.4; 2010: 226.3; 2011: 230.4; 2012: 234.0; 2013: 236.8; 2014: 239.3 - Current account balance (percent of GDP): 2009: 1.8; 2010: 1.7; 2011: 2.3; 2012: 2.1; 2013: 1.7; 2014: 1.5 ### Appendix I — BoJ and public sector support measures (recent financial and corporate sector measures) - BoJ monetary policy and market-stability actions: - Reduced policy rate from 0.5 to 0.1 percent. - Broadened eligible collateral (including REIT-issued debt, loans on deeds to municipal governments, some FX-denominated foreign government bonds). - Added linkers, floaters, and ultra-long JGBs as eligible collateral for JGB repo operations. - Introduced unlimited U.S. dollar funds-supplying operations at a fixed rate via a swap line with the Fed. - Increased purchases of JGBs from ¥14.4 trillion to ¥21.6 trillion per year. - Started remunerating bank reserves and made significant liquidity injections at the turn of calendar and fiscal years. - Measures to facilitate corporate financing: - Introduced short-term unlimited fund supplying operations against corporate debt collateral. - Increased frequency, size, and range of eligible instruments for CP repo and corporate debt operations (minimum eligible collateral rating broadened from A to BBB). - Adopted direct “credit easing” by buying eligible commercial paper (grade a-1 or better; up to ¥3 trillion) and corporate bonds (rated A or above, residual maturity < 1 year; up to ¥1 trillion) directly from banks. - Offered ¥1 trillion in subordinated loans to banks and re-started purchases of bank-owned stocks of up to ¥1 trillion. - Government and other public institution actions: - Set aside ¥12 trillion to recapitalize weak banks and will offer to purchase banks’ stockholdings worth up to ¥20 trillion. - Relaxed accounting rules on unrealized losses on securities holdings for domestic banks. - Supported SME financing through ¥30 trillion in budgeted new guarantees and around ¥15 trillion in loan support. - Provided additional funds to DBJ: ¥10 trillion for loans, ¥2 trillion in public capital for injection into nonfinancial corporations, and ¥2 trillion for CP purchases. - The MoF will lend ¥500 billion in foreign exchange reserves to JBIC to help Japanese companies meet overseas funding needs. - FSA applying moral suasion for banks not to cut back lending to healthy corporations. ### Appendix II — Public sector debt sustainability analysis (background, scenarios, sensitivities) - Background and authorities’ targets: - In 2002 target: achieve primary balance of general government (excluding social security fund) by early 2010s. - Basic Policies 2006 announced FY2011 target for primary balance and planned expenditure cuts of Y11–14 trillion (2–3 percent of GDP) over 5 years. - After FY2008 deterioration, authorities abandoned the target of primary balance but committed to take necessary legislative action by FY2011 to implement—conditional on economic recovery—comprehensive revenue reforms including a consumption tax hike. - Staff scenarios: - Baseline scenario: authorities’ current policies with no increase in the consumption tax. - Policy adjustment scenario: consumption tax increased by 5 percentage points starting in 2011 (3 percentage points in 2011 and 2 percentage points in 2014), plus additional expenditure cuts of about 1.0 percent of GDP relative to the baseline between 2014–15, and a further adjustment of 1.5 percent of GDP after 2015. - Key debt sustainability outcomes: - Under the baseline scenario, net public debt is projected to continue rising and the debt/GDP ratio exceeds 150 percent in 2018. - Under the policy adjustment scenario, the debt/GDP ratio would peak at around 130 percent in 2015 and then decline; the adjustment scenario targets the debt/GDP ratio of 130 percent in 2015 and achieves overall balance around 2020. - Sensitivity analysis highlights: - With a permanent 1 percentage point decline in GDP growth from 2012 or a permanent 100 basis point increase in interest rates from 2012 (each with unchanged primary balance), net public debt is projected to reach 200 percent of GDP by 2025 in the baseline scenario. - Under the policy adjustment scenario, net debt would stabilize under those shocks. - Medium-term macroeconomic assumptions used in DSA: - Nominal interest rate on public debt: 2.9 - Real GDP growth: 1.2 - Inflation rate: 1.0 - DSA table highlights (selected rows, percent of GDP unless otherwise indicated): - Net public sector debt: 2008: 88.1; 2009: 104.1; 2010: 114.7; 2011: 121.6; 2012: 128.0; 2013: 133.8; 2014: 139.5 - Primary deficit (percent of GDP): 2008: 4.8; 2009: 8.8; 2010: 8.8; 2011: 6.4; 2012: 5.6; 2013: 5.3; 2014: 5.1 - Revenue and grants (percent of GDP): 2008: 30.1; 2009: 30.7; 2010: 31.0; 2011: 31.8; 2012: 32.2; 2013: 32.5; 2014: 32.9 - Primary (noninterest) expenditure (percent of GDP): 2008: 34.9; 2009: 39.6; 2010: 39.8; 2011: 38.2; 2012: 37.8; 2013: 37.8; 2014: 38.0 - Gross financing need (percent of GDP): 2008: 42.4; 2009: 45.8; 2010: 46.4; 2011: 48.0; 2012: 49.9; 2013: 51.9 *Prepared by the Asia and Pacific Department (Informational Annex, Staff Report for the 2009 Article IV Consultation, June 16, 2009).* ### ANNEX I. JAPAN—STATISTICAL ISSUES ### ANNEX I. JAPAN—STATISTICAL ISSUES ### Statistical coverage and data quality - Economic and financial data provided to the Fund are considered adequate for surveillance purposes. - Japan subscribes to the Special Data Dissemination Standard (SDDS) and meets the SDDS specifications for coverage, periodicity, and timeliness of data. - The Japanese authorities hosted a data module mission for a Report on the Observance of Standards and Codes (data ROSC) in September 12–28, 2005. - The Report on Observance of Standards and Codes - Data Module, Response by the Authorities, and Detailed Assessments Using the Data Quality Assessment Framework (DQAF) were published March 17, 2006. ### Table of Common Indicators Required for Surveillance (as of June 8, 2009) — key metadata - Exchange Rates: Date of Latest Observation June 2009; Date Received June 2009; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D. - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of Latest Observation May 2009; Date Received June 2009; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M. - Reserve/Base Money: Date of Latest Observation May 2009; Date Received June 2009; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M. - Broad Money: Date of Latest Observation May 2009; Date Received June 2009; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M. - Central Bank Balance Sheet: Date of Latest Observation 5/31/09; Date Received 6/2/09; Frequency of Data Every 10 days; Frequency of Reporting Every 10 days; Frequency of Publication Every 10 days. - Consolidated Balance Sheet of the Banking System: Date of Latest Observation Apr 2009; Date Received June 2009; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M. - Interest Rates: Date of Latest Observation June 2008; Date Received June 2008; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D. - Consumer Price Index: Date of Latest Observation May 2009; Date Received May 2009; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M. - Revenue, Expenditure, Balance and Composition of Financing – General Government: Date of Latest Observation 2007; Date Received Feb 2009; Frequency of Data A; Frequency of Reporting A; Frequency of Publication A. - Revenue, Expenditure, Balance and Composition of Financing – Central Government: Date of Latest Observation 2007; Date Received Feb 2009; Frequency of Data A; Frequency of Reporting A; Frequency of Publication A. - Stocks of Central Government and Central Government-Guaranteed Debt: Date of Latest Observation Mar 2009; Date Received May 2009; Frequency of Data Q; Frequency of Reporting Q; Frequency of Publication Q. - External Current Account Balance: Date of Latest Observation Apr 2009; Date Received June 2009; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M. - Exports and Imports of Goods and Services: Date of Latest Observation Apr 2009; Date Received June 2009; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M. - GDP/GNP: Date of Latest Observation 2009 Q1; Date Received May 2009; Frequency of Data Q; Frequency of Reporting Q; Frequency of Publication Q. - Gross External Debt: Date of Latest Observation Mar 2009; Date Received June 2009; Frequency of Data Q; Frequency of Reporting Q; Frequency of Publication Q. Notes from the table: - Footnote 1: Includes reserve assets pledged or otherwise encumbered as well as net derivative positions. - Footnote 2: Both market-based and officially-determined, including discount rates, money market rates, rates on treasury bills, notes and bonds. - Footnote 3: Foreign, domestic bank, and domestic nonbank financing. - Footnote 4: The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds) and state and local governments. - Footnote 5: Including currency and maturity composition. - Footnote 6: Daily (D); weekly (W); monthly (M); quarterly (Q); annually (A); irregular (I); and not available (NA). - Footnote 7: Reflects the assessment provided in the data ROSC or the Substantive Update (published on May 17, 2006... ). The assessment indicates whether international standards concerning concepts and definitions, scope, classification/sectorization, and basis for recording are fully observed (O); largely observed (LO); largely not observed (LNO); not observed (NO); and not available (NA). - Footnote 8: Same as footnote 7, except referring to international standards concerning source data and its assessment, statistical techniques, assessment and validation of intermediate data and statistical outputs, and revision studies. ### Recent staff statement and key macroeconomic findings (July 6, 2009) - Recent data indicate economic activity rebounded in the second quarter; exports and industrial production grew strongly in May (by over 5 percent m-o-m). - Public works increased sharply and consumer spending is edging up; sizeable fiscal and monetary stimulus should help maintain positive growth in the next few quarters. - The June Tankan survey shows improvement in business sentiment mostly among large manufacturers; SMEs remain under difficult conditions. - Corporate downside risks include overcapacity, tight corporate financing, and external uncertainties. - Core inflation excluding food and energy has fallen to –½ percent (y-o-y). - Bank of Japan target rate was unchanged at 0.1 percent at the June 15–16 meeting. - Benchmark 10-year JGB yield fell by about 20 bps since mid-June. ### Fiscal stance and government medium-term targets - The government released its FY2009 Basic Policies on June 23. - Commitments: - New medium-term target of halving the primary deficit (excluding the social security fund) within 5 years. - Achieving primary balance within 10 years. - Stabilize the debt-to-GDP ratio by the mid-2010s and put it on a downward path during the early 2020s. - No numerical targets for the debt ratio were specified. - Fiscal projection by the Council on Economic and Fiscal Policy: raising the consumption tax by 7 percentage points would imply an adjustment of 3½ percent of GDP in the primary balance. - IMF staff’s preferred scenario assumed a 5 percent of GDP deficit adjustment (primarily due to larger spending cuts). - Other reform agenda: enhance social safety net (broader eligibility for health care and unemployment benefits) and boost support to green industries to raise potential growth. ### 2009 Article IV Consultation summary — main assessments and projections - Economic contraction: After expanding by 2.3 percent in 2007, GDP contracted by 0.7 percent in 2008; GDP fell by about 14 percent SAAR in both Q4 2008 and Q1 2009. - Unemployment rate jumped to 5.2 percent in May 2009. - Financial markets: stock market rebounded since March but remains about 40 percent below end-2007 levels; yen appreciated by about 20 percent in real effective terms since August 2008. - BoJ measures: policy rate cut from 50 to 10 basis points in late-2008; significant liquidity injections; broadened accepted collateral; larger volume of JGB purchases; U.S. dollar funds-supplying operations; measures to improve corporate financing including unlimited funds-supplying operations against corporate debt collateral and outright purchases of high-quality commercial paper and corporate bonds; purchases of banks’ stockholdings resumed; subordinated loans offered to banks. - Fiscal outlook: overall fiscal deficit projected to widen to about 11½ percent of GDP in FY2009; net debt projected to reach 100 percent of GDP in 2009 (220 percent of GDP in gross terms). - Staff projections: - GDP to fall by 6 percent in 2009, before expanding by 1¾ percent in 2010. - Inflation projected to remain negative until 2011. - Current account surplus expected to fall to 1½ percent of GDP in the short term. - Potential growth could fall from about 1¾ percent in 2007 to close to 1 percent over the medium term under current policies. ### Executive Board views and policy recommendations - Near-term: focus on supporting growth and preserving financial stability; flexibility to address further downside risks; additional targeted and reversible fiscal measures could be warranted if recession deepens. - Medium-term fiscal consolidation: welcomed authorities’ medium-term consolidation strategy; recommended that strategy will likely require expenditure cuts and comprehensive tax reform, including an increase in the consumption tax after recovery. - Monetary policy: accommodative stance appropriate given output gap and deflationary pressures; most Directors supported additional credit easing measures if downside risks materialize or financial stresses resurface, while minimizing risks to the BoJ balance sheet. - Exit strategy: assess appropriate timing, speed, and conditions for unwinding exceptional policy interventions; many BoJ credit easing measures are set to expire automatically, and communicating an orderly exit strategy is important. - Exchange rate: Directors supported market-determined exchange rate; following sharp appreciation during the crisis, the yen appears in line with its longer-term equilibrium value according to IMF staff estimates. - Financial sector: continue to strengthen resilience by bolstering bank profitability and capital and reducing risks from equity holdings; promote restructuring of viable but distressed firms; guide exit from interventions to preserve financial stability and government solvency and to facilitate restructuring. - Structural reforms: press ahead with deregulating the agricultural and service sectors, enhancing product market flexibility, further developing financial markets, and encouraging inward foreign direct investment; reforms have increased urgency post-crisis to rebalance growth toward domestic demand. - Social safety net: Directors welcomed recent steps to strengthen the social safety net. ### Japan: Selected Economic Indicators (annual or period averages as presented) - Real GDP: 2005 1.9; 2006 2.0; 2007 2.3; 2008 -0.7; 2009 Proj. -6.0 - Private consumption: 2005 1.3; 2006 1.5; 2007 0.7; 2008 0.6; 2009 Proj. -1.0 - Nonresidential investment: 2005 9.2; 2006 2.3; 2007 5.7; 2008 -4.0; 2009 Proj. -21.4 - Residential investment: 2005 -1.5; 2006 0.5; 2007 -9.7; 2008 -7.6; 2009 Proj. -5.2 - Public investment: 2005 -10.1; 2006 -5.7; 2007 -7.3; 2008 -6.9; 2009 Proj. 12.9 - Public consumption: 2005 1.6; 2006 0.4; 2007 1.9; 2008 0.8; 2009 Proj. 2.9 - Stockbuilding (contribution to growth): 2005 -0.1; 2006 0.2; 2007 0.3; 2008 -0.2; 2009 Proj. -0.2 - Foreign balance (contribution to growth): 2005 0.3; 2006 0.8; 2007 1.1; 2008 0.2; 2009 Proj. -2.9 - Exports of goods and services: 2005 7.0; 2006 9.7; 2007 8.4; 2008 1.8; 2009 Proj. -29.3 - Imports of goods and services: 2005 5.8; 2006 4.2; 2007 1.5; 2008 0.9; 2009 Proj. -16.2 - GDP deflator: 2005 -1.2; 2006 -0.9; 2007 -0.7; 2008 -0.9; 2009 Proj. 1.0 - CPI (SA) 1/: 2005 -0.6; 2006 0.2; 2007 0.1; 2008 1.4; 2009 Proj. -1.1 - CPI (NSA) 1/: 2005 -0.3; 2006 0.2; 2007 0.1; 2008 1.4; 2009 Proj. -1.1 - Unemployment rate (period average, percent): 2005 4.4; 2006 4.1; 2007 3.9; 2008 4.0; 2009 Proj. 5.1 - Current account balance (Billions of U.S. dollars): 2005 165.7; 2006 170.4; 2007 211.0; 2008 157.1; 2009 Proj. 92.0 - Current account balance (Percent of GDP): 2005 3.6; 2006 3.9; 2007 4.8; 2008 3.2; 2009 Proj. 1.8 - General government balances (percent of GDP, FY) Balance including social security: 2005 -4.5; 2006 -3.4; 2007 -3.3; 2008 -6.7; 2009 Proj. -11.6 - Balance excluding social security: 2005 -4.8; 2006 -3.4; 2007 -3.0; 2008 -5.5; 2009 Proj. -10.2 - Structural balance 2/: 2005 -4.3; 2006 -3.3; 2007 -3.3; 2008 -5.2; 2009 Proj. -8.4 - Money and credit (12-month growth rate; end period) Base money: 2005 1.0; 2006 -20.0; 2007 0.4; 2008 1.8; 2009 Proj. 6.4 (June 2009) - M2 (period average): 2005 1.9; 2006 0.7; 2007 2.1; 2008 1.8; 2009 Proj. 2.5 (June 2009) - Bank lending 4/: 2005 1.1; 2006 2.8; 2007 0.8; 2008 4.6; 2009 Proj. 3.1 (June 2009) - Exchange and interest rates (period average) Yen/dollar rate: 2005 110.2; 2006 116.3; 2007 117.8; 2008 103.4; 2009 Proj. 94.2 (July 8, 2009) - Yen/euro rate: 2006 137.3; 2007 146.0; 2008 161.4; 2009 Proj. 152.1; 2009 Proj. 131.2 (July 8, 2009) [as presented] - Real effective exchange rate 6/: 2005 70.8; 2006 63.2; 2007 58.3; 2008 64.7; 2009 Proj. 72.8 (Figure for 2009 is as of May) - 3-month CD rate: 2005 0.06; 2006 0.22; 2007 0.51; 2008 0.51; 2009 Proj. 0.33 (July 8, 2009) - 10-year government bond yield: 2005 1.39; 2006 1.74; 2007 1.68; 2008 1.49; 2009 Proj. 1.30 (July 8, 2009) *Source: IMF staff report and associated Annexes (as contained in the supplied content).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09210.pdf_