## _cr12208 ## Source details **Canonical URL:** [_cr12208](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12208.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12208.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12208.pdf.json) --- ### Background and context - March 2011 Great East Japan earthquake: widespread destruction, supply-chain disruption, reduced electricity supply; all 54 nuclear power plants shut for safety inspection (they supply about ¼ of Japan’s electric power). One plant reopened and another set to reopen in coming weeks. - Late 2011 Thailand floods further weighed on recovery and affected exports via supply linkages. - Policy response: comprehensive reconstruction package; supply chains repaired within months; conservation limited disruption from nuclear shutdowns. - Long-term challenges: high public debt amid low growth, persistent deflation, rapidly aging population. - Authorities plan to raise the consumption tax as a crucial step toward fiscal sustainability; further consolidation, structural measures to raise growth, and stronger anti-deflation efforts are needed. ### Recovering from recent shocks — Recent developments - Real GDP - 2011: contracted by ¾ percent. - Q1 2012: grew 4¾ percent (s.a.a.r.). - Q1 2012 growth led by consumption (temporary subsidies for environmentally-friendly automobiles and reconstruction spending); private investment declined in early 2012. - Inflation - Core inflation (ex food & energy): -0.6 percent in May (y/y). - Headline inflation: 0.2 percent in May (y/y). - Labor market - Employment: grew by about 1/3 percent in year to April 2012; still about 3 percent below 2007 levels. - Unemployment: fluctuated around 4½ percent over the past year. - Real employee compensation: relatively flat over the past year. - Trade and current account - Trade balance: moved into deficit in 2011; deficit widened to about 1 percent of GDP in Q4 2011; remained around 1 percent of GDP in early 2012. - Current account: surplus at 1½–2 percent of GDP in 2011 and early 2012. - Financial markets - Since mid-2011: equity prices declined ~10 percent; 10-year JGB yields fell to 80–85 bps (near historic lows). - Yen: appreciated about 6 percent in nominal effective terms and appears moderately overvalued. - Financing: overall accommodative; SME conditions tight. ### Outlook and risks - Growth projections - 2012: real GDP expected to expand by almost 2½ percent, supported by reconstruction spending of around 1½ percent of GDP. - 2013: growth forecast to slow to 1½ percent as reconstruction winds down. - Medium-term: growth expected to converge to staff’s estimated potential rate of 1 percent. - Near-term drags - Higher energy costs from shift to thermal generation and conservation projected to detract about ¼ percentage point from growth in 2012. - Inflation and output gap - Output gap early 2012: about 3 percent of GDP; expected to narrow only gradually, not closing until 2015/16. - Core inflation projected to rise slowly, turning slightly positive by mid-2013. - Headline inflation expected near zero next two years; staff forecast inflation to reach 1 percent by 2017. - Downside risks - Escalation of European turmoil or sharper-than-expected Chinese slowdown would hurt exports and growth. - Intensification of flight to safety could appreciate the yen further, worsen trade balance, depress equities and confidence. - Closure of almost all nuclear plants combined with an unusually hot summer could disrupt activity. - Extreme scenario (DSA, Appendix II): severe shocks to growth, inflation, and real interest rates, coupled with limited fiscal adjustment, could see public net debt rise to over 300 percent of GDP by 2030. ### Box — Outlook for electricity supply (key findings and implications) - All 54 reactors were shut; electricity supply problems expected less severe in 2012 than 2011. - Kanto region (40 percent of GDP): sufficient capacity due to thermal expansions, tariff increases, conservation. - Kansai region (16 percent of GDP): more uncertain; drew half of electricity from nuclear in recent years; government measures: demand restrictions on businesses, transfers from surplus regions, conservation encouragement. - Reopening of one reactor and planned reopening of another will help Kansai. - Staff estimate: real GDP growth in 2012 could be ¼ percentage point slower due to energy problems. - Longer-term recommendations: develop alternative energy sources, possible electricity sector deregulation to encourage regional trading, targeted subsidies, increase carbon tax to incentivize conservation and alternative energy. --- ### Japan’s fiscal problems are deep — Fiscal position and vulnerabilities - Net public debt: increased nearly ten-fold over two decades to more than 125 percent of GDP. - Drivers: rapid rise in social security spending from aging; weak growth and deflation depressed tax revenues; capital spending has fallen substantially. - Fiscal vulnerability: net public debt higher than almost all other advanced countries and projected to rise further absent adjustment. - JGB ownership: domestic investors hold >90 percent of outstanding stock. - Shock sensitivity: - If JGB yields rose by 100 bps over next 5 years, long-term net public debt-to-GDP would remain high at 150 percent, even after a 10 percentage points of GDP adjustment in the structural fiscal balance. - A sharp rise in yields could reduce Japan’s output by 6–10 percent after 10 years relative to baseline; potential global impacts include up to 1 percent output decline in the United States and about 2–3 percent in Emerging Asia and the Euro area. ### Fiscal stance and authorities’ measures (2012) - 2012 reconstruction spending: capital and current spending equivalent to 1½ percent of GDP (within a multi-year package of 4 percent of GDP). - Fiscal deficit: expected to widen to about 10 percent of GDP in 2012. - Structural primary deficit: projected to rise slightly to 7½ percent of GDP in 2012. - Authorities’ tax legislation: Lower House approved bill to increase consumption tax to 8 percent in April 2014 and 10 percent in October 2015; Upper House considering the bill. - Staff estimate of current consolidation plan: including consumption tax increase, withdrawal of crisis stimulus, and curbs to non-social security spending would achieve a 5 percent of GDP adjustment and reduce primary deficit to 2½ percent of GDP by 2020. ### Staff recommended additional consolidation and composition - Additional recommended adjustment: 5 percent of GDP (for total 10 percent of GDP over next decade), to: - achieve a primary surplus of about 3 percent of GDP by early 2020s; - put public-debt-to-GDP on a clear downward path. - Suggested composition (between end-2011 and 2020, excluding reconstruction spending): - ~2½ percent of GDP from additional expenditure restraint (curb growth in nominal spending). - Adopt clear timeframe for further revenue increases beyond 2015 for remaining adjustment. - Specific revenue measures recommended (preserve text terminology and estimates where given): - Increase consumption tax to a uniform rate of at least 15 percent. - Cut corporate tax rate further, beyond planned reduction to 35 percent in 2015 (text table notes options cutting effective rate to around 25–30 percent or around 30–35 percent in various options). - Broaden personal income tax base (estimated revenue gains shown as 0.5, 0.75, 0.5 in text table). - Eliminate preferential tax treatment for pension benefit income (savings estimate ¼). - Collect contributions from dependent spouses covered by Employees' Pension Insurance (savings estimate ¼). - Raise inheritance/gift tax (noted with checkmarks). - Introduce carbon tax (savings assumed around 0.1 percentage points of GDP or lower in footnote). - Specific expenditure measures recommended: - Withdraw financial crisis fiscal stimulus: 1.0 percentage point of GDP. - Curb nominal non-social security spending: options shown of 1.5 or 2.5 percentage points of GDP. - Limit annual nominal growth in non-pension social security spending at 1–1½ percent (1.0 percentage point of GDP savings). - Raise pension eligibility age to 67 (savings estimate ¼). - Reduce benefits for wealthy retirees (savings estimate ¼). - Reduce pension payroll tax (noted as -0.5 in text table, implying a revenue cost to be offset elsewhere). - Total savings in policy adjustment scenarios shown as 5.0, 10.0, 10.0, and 10.0 percentage points of GDP across different columns in text table. ### Impact on growth and design considerations - Short-term growth cost: consolidation would lower real GDP by about ½ percent annually in the short-term. - Pace: recommended pace over next 5–6 years is quicker than most advanced countries, deemed necessary given large public debt. - Pre-announced consumption tax increases could bring forward household spending, limiting near-term impact. - Coupling consolidation with structural reforms could boost confidence, private consumption and investment over longer-term. - Design emphasis: contain social security spending, improve incentives to work and invest, combine social security reforms with revenue measures to limit intergenerational harm. ### Debt projections and scenarios (staff) - Policy adjustment scenario (10 percentage points of GDP improvement between end-2011 and 2020): net public debt stabilizes around 150 percent of GDP by mid-decade and falls to 125 percent of GDP by 2030. - Upside scenario (higher long-term growth): net public debt ~115 percent of GDP by 2030. - Authorities’ current plan (consumption tax to 8% in 2014 and 10% in 2015) insufficient to stabilize debt. ### Intergenerational implications (OLG simulations) - Cabinet Office (based on 2003 policy): PDV of lifetime net burden for future generations = 50 million yen per household (~10 times household annual disposable income); 100 million yen heavier than for those aged 60+. - OLG results: - 10 percentage points of GDP fiscal adjustment: raises lifetime net burden substantially for young generations, minimally for older generations. - For age 20–29, net PDV burden from 10 percentage point consolidation could be as much as 400 percent of current per household wage income (before taxes); combined with 2003 policy burden could reach 1600 percent. - To limit intergenerational inequality: - Include social security spending reforms in consolidation (e.g., 1.5 percentage point of GDP adjustment from social security reforms reduces burden for young by 15 percent of current household wage income relative to no social security reform). - Avoid excessive reliance solely on social security cuts; combine with revenue measures. - Delaying adjustment by 3 years would worsen intergenerational inequality: a 3-year delay raises PDV lifetime burden for those currently 20–29 by 15–20 percentage points of current per household wage income (before taxes) relative to no-delay. --- ### To sustain a decade-long adjustment — Fiscal framework and structural reform recommendations - Fiscal framework recommendations - Adopt medium-term budget framework with strict overall spending limit, ministry-by-ministry spending targets, restrictions on supplementary budgets. - Greater disclosure of tax expenditures. - Once consolidation on track, consider legally-binding fiscal rule targeting a primary surplus. - Maintain discipline via rolling multi-year expenditure frameworks with caps on non-interest primary spending while preserving flexibility. - Authorities’ fiscal objectives and views - Commitments: halve primary deficit by FY2015; achieve primary surplus by FY2020 at latest; reduce public debt-to-GDP over time. - Authorities view doubling consumption tax as critical; will examine corporate tax cut impacts before further corporate tax reform. - Authorities see rolling three-year expenditure framework as effective but caution rigid ministry-by-ministry limits could weaken flexibility. - Structural reform rationale and potential - Need higher growth to create jobs, reduce public debt, improve shock resilience. - A far-reaching package needed to raise long-term GDP growth to 2 percent. - Increasing female labor participation to G-7 average, raising old-age employment, boosting immigration could raise potential growth by as much as ½ percentage point. - Staff structural reform recommendations (selected) - Increase labor force: expand childcare (including deregulation); eliminate tax deduction for dependent spouses; raise retirement age above 65; introduce uniform regular employment contract; broaden points-based immigration to include lower-skilled immigrants (long-term care, childcare). - Raise productivity and investment: ease regulations limiting services (health, old-age care); reform electricity and agriculture; encourage FDI and pursue high-quality FTAs (including Trans Pacific Partnership). - Improve financial intermediation and risk capital: scale down government-backed guarantees for SME loans; phase out SME Financing Facilitation Act by March 2013; fully privatize Japan Post; encourage asset-based lending; refocus public asset management company for SME restructuring; with reform, public pension funds could become investment capital source. - Defeating deflation: diagnosis and monetary policy advice - Deflation has depressed private investment and consumption, sustained high real interest rates, raised real debt, reduced tax revenue. - Staff: forceful monetary easing a key element to defeat deflation; structural reforms needed to boost confidence and demand; strong fiscal consolidation over medium-term could facilitate additional monetary accommodation. - Specific monetary actions advised: - Expand Asset Purchase Program substantially beyond current plans to increase likelihood of achieving 1 percent inflation goal by end-2014 under staff baseline. - Extend maturity of JGB purchases beyond 3 years. - Purchase private assets (corporate bonds, equities, highly-rated securitized SME loans). - Enhance BoJ communication: extend inflation forecast to 3+ years; clarify readiness to react; emphasize 1 percent inflation goal not a ceiling; consider raising inflation goal once inflation approaches 1 percent. - Recent BoJ actions and staff projections - BoJ in February adopted medium- to long-term price stability goal of 1 percent. - BoJ expanded Asset Purchase Program by ¥15 trillion in 2012 and extended JGB purchase maturities to 1–3 years. - Combined monetary expansion totals about 5 percent of GDP over next year. - Staff inflation forecast: ½ percent in 2014; 1 percent by 2017. - Staff: additional effective easing could reduce lending rates, raise inflation expectations, and help depreciate exchange rate. - BoJ: cautioned further JGB purchases expose balance sheet to risk and could be viewed as monetization absent fiscal reforms. --- ### The BoJ emphasized — Communication, structural reforms, contingency policies, external assessment, and financial stability - BoJ communication and inflation goal - Clarified medium- to long-term inflation goal in February; Governor’s speeches effective in guiding expectations. - BoJ will regularly review goal and could consider raising it as structural reforms progress. - BoJ will look through temporary factors (e.g., consumption tax increase) when assessing policy stance. - Structural reforms and policy coordination - Authorities and staff agree structural reforms important to defeat deflation. - Ministerial council set priority areas to combat deflation via regulatory and structural reforms. - Responding to a downside scenario - If growth outlook worsens sharply: further monetary easing beyond baseline advisable; fiscal policy could play a role though constrained by limited fiscal space. - Maintain medium-term fiscal target while allowing automatic stabilizers; use small targeted fiscal measures in severe downturn if JGB yields remain low. - Staff: do not delay consumption tax legislation; consider providing additional liquidity if markets disrupted. - External stability, current account, yen, and intervention - Current account surplus expected around 2¼ percent of GDP in 2012; surplus narrowed from almost 5 percent of GDP in 2007. - Yen: appreciated in real effective terms by 27 percent since Lehman (late 2008). - Oct/Nov 2011 FX intervention: about US$120 billion. - Foreign exchange reserves (ex gold): US$1,258 billion by end-2012. - Staff advice: allow market to determine exchange rate; use intervention to counter volatile/disorderly conditions. - Staff assessment: external position moderately weaker than fundamentals; current account norm estimated around 3–4 percent of GDP; gap ~1–2 percent implies yen moderately overvalued medium-term. - Financial stability: resilience and risks - Financial system weathered shocks; exposures to peripheral Europe small (<1 percent of banks’ total assets) but indirect exposures to core Europe significant. - FSAP findings: steps taken since 2003; high compliance with international core principles. - Key vulnerabilities and stress-test findings: - Banks’ core profitability low: average return on assets 0.3 percent (FY2011). - Nonperforming loans: 3 percent of total loans in early 2011; BoJ estimates could rise by ~1 percentage point if SMEs with restructured loans fail to improve. - Interest rate risk: banks’ holdings of JGBs ~one-fifth of assets; major banks average JGB maturity ~2½ years. - If interest rates rise 1 percentage point across all maturities: major banks’ exposure ~10 percent of Tier 1 capital; regional banks’ exposure ~1/3 of Tier 1 capital. - Market risk from equities: equity holdings by banks ~almost 40 percent of total capital; non-life insurers ~20 percent of assets. - Cross-border expansion raises supervisory challenges; coordinated oversight and liquidity management (esp. dollar funding for securities firms) important. --- ### Basel III implementation, FSSA recommendations, and authorities’ views - Basel III implementation intentions - Authorities intend to implement Basel III for internationally-active banks. - Immediate full application of Basel III capital definition with Basel II RWA would reduce Tier 1 ratios by about 2¼ percentage points (from 12¾ percent in March 2011 under Basel II). - Applying more prudent risk weights (Basel III phase-in as of Sep 2011) would further reduce ratio by about 1 percentage point for three mega banks. - Resulting ratio would remain above Basel III minimum requirement rising to 6 percent by 2015. - FSSA main recommendations (selected) - Risk monitoring: thematic risk assessments; formalize BoJ–FSA information sharing; increase collaboration with foreign supervisors. - Prudential framework: tighten large exposure limits; raise capital requirements for domestic-oriented banks (they account for ~40 percent of bank assets and currently face 4 percent RWA requirement); encourage profitability improvements; for insurers, move to economic valuation solvency assessment; strengthen corporate pension supervision and establish mandatory guarantee fund for DB pensions. - Crisis resolution: improve framework for systemically-important nonbank financial institutions. - Global reform agenda: FSA review adequacy of skills and resources for implementation. - Authorities’ views and actions - Authorities welcomed FSSA findings and broadly agree with recommendations. - Ongoing monitoring via inspections and stress tests, review of large exposure limits by Financial System Council. - Implementation timing: new Basel III rules to begin in FY2013 per G-20 timeline. - Resource adjustments: FSA increased workforce and budget; further increases may be considered. - Concerns: potential adverse impacts of extraterritorial application of global reforms (e.g., Volcker rule) on market-making and JGB market liquidity. - Staff appraisal — macro and financial policy implications (summary) - Growth: recovery underway though risks tilted to downside (Europe, China). - Fiscal: reducing public debt requires 10 percent of GDP adjustment over a decade; passage of legislation to double consumption tax to 10 percent by 2015 is crucial; additional 5 percent of GDP adjustment needed to put debt on clear downward path. - Structural reform: speedy far-reaching reforms essential to raise growth—focus on labor force participation, immigration, productivity-enhancing deregulation, financial intermediation reforms. - Monetary policy: further monetary easing should be key to defeat deflation; expand BoJ asset purchases beyond current plans; enhance communication. - External: external position moderately weaker than medium-term fundamentals; yen moderately overvalued. - Financial stability: system stable but can be strengthened by better systemic risk monitoring, tighter large exposure limits, higher capital for domestic-oriented banks, refined insurer solvency valuations, improved crisis resolution. --- ### Public Sector Debt Sustainability Analysis (Appendix II) — Baseline, scenarios, and sensitivities - Baseline macro assumptions - Real GDP growth and inflation converge to 1 percent long-term. - Nominal GDP growth ~2 percent per year next 10 years. - Nominal interest rate growth differential converges to 1 percent long run. - Average nominal interest rate assumed to rise to 3 percent (from ~1 percent currently). - Scenarios and outcomes (net public debt-to-GDP by 2030, selected exact figures are preserved) - No adjustment scenario - Assumptions: stimulus expires (1 percent of GDP), modest expenditure adjustment (1½ percent of GDP), no consumption tax increase between end-2011 and 2020. - Structural primary balance improves by 2½ percent of GDP over next decade. - Outcome: net debt rises to about 245 percent of GDP (335 percent gross) by 2030. - Authorities’ current plan (staff estimate) - Consumption tax to 8 percent in 2014 and 10 percent in 2015; with expenditure adjustments, structural primary improves by 5 percent of GDP. - Outcome: net public-debt-to-GDP around 200 percent (290 percent gross) by 2030. - Policy adjustment scenario - Assumes 10 percent of GDP improvement in structural primary between end-2011 and 2020 (1 percent from stimulus withdrawal; 9 percent from additional measures: 5 points from consumption tax rise starting 2014; 4 points from other reforms). - Baseline interest rate growth differential = 1.0 percent. - Outcome: net public-debt-to-GDP declines to 124 percent by 2030 (214 percent gross). - Upside scenario - Higher long-term growth: real GDP 2 percent; GDP deflator 1½ percent. - Outcome: net public-debt-to-GDP declines to 115 percent by 2030 (205 percent gross). - Sensitivity and stochastic analysis (selected entries preserved exactly) - No adjustment scenario net debt by 2030: - Differential = 1.0: 245 - Differential = 2.0: 266 - Differential = 4.0: 318 - Policy adjustment scenario net debt by 2030: - Differential = 1.0: 124 - Differential = 2.0: 137 - Differential = 4.0: 172 - Returning net debt to pre-crisis level by 2030 would require adjustment between 13–15½ percent of GDP depending on interest rate growth differential. - Stochastic simulations: staff adjustment prevents debt explosion in most cases but severe macro shocks could still cause rising debt even under adjustment. - Contingent liabilities - Including government guaranteed bonds increases broader general government net debt by ~10 percentage points of GDP. - Contingent liabilities for TEPCO (maximum support 1.9 percent of GDP = 9 trillion yen) and regional banks (0.75 percent of GDP) add modest additional impact (1–3 percentage points). - Selected table excerpts (net public debt by 2030, exact entries): - No adjustment excluding contingent liabilities, baseline 1.0: net debt = 245. - No adjustment including government guaranteed bonds, baseline 1.0: net debt = 335. - Policy adjustment excluding contingent liabilities, baseline 1.0: net debt = 124. - Policy adjustment including government guaranteed bonds, baseline 1.0: net debt = 214. - Key DSA findings - Without additional adjustment, net public debt could rise to ~245 percent of GDP (335 percent gross) by 2030. - Authorities’ current plan (consumption tax to 10 percent by 2015) improves structural primary by 5 percent of GDP but insufficient to stabilize debt (net ~200 percent by 2030). - A comprehensive 10 percent of GDP structural primary improvement over next decade could place debt on declining path (net ~124 percent by 2030 baseline). - Higher nominal GDP growth materially aids debt dynamics; inflation alone has limited long-run payoff given average debt maturity ~6 years. - Contingent liabilities and guarantees materially worsen headline debt metrics and should be integrated into fiscal risk management. --- ### Statistical issues, data adequacy, and Fund relations (selected) - Data adequacy: Japan meets SDDS specifications; data considered adequate for surveillance. - Data module mission: Report on Observance of Standards and Codes (data ROSC) hosted Sep 12–28, 2005; Report published Mar 17, 2006. - Table of Common Indicators (as of June 20, 2012): latest observations and frequencies specified for Exchange Rates (June 2012), International Reserve Assets (6/10/2012), Reserve/Base Money (May 2012), Broad Money (May 2012), International Investment Position (2012 Q1), Central Bank Balance Sheet (6/10/2012), Banking System consolidated balance sheet (Apr 2012), Interest Rates (June 2012), CPI (April 2012), General Government revenue/expenditure (2010), Stocks of central government debt (Mar 2012), External current account (Apr 2012), Exports & Imports (Apr 2012), GDP/GNP (2012 Q1), Gross External Debt (Mar 2012). - Fund relations (as of May 31, 2012) - Membership: Joined 8/13/1952; Article VIII. - Quota: 15,628.50 SDR (100.00 percent). - Fund holdings of currency: 12,920.74 SDR (82.67 percent); Reserve Tranche Position: 2,708.15 SDR (17.33 percent). - SDR Department net cumulative allocation: 12,284.97 SDR; holdings: 12,903.57 SDR (105.04 percent). - Outstanding purchases and loans: None; Latest financial arrangements: None. - Projected obligations to Fund (Charges/Interest): 0.14 (2012), 0.14 (2013), 0.14 (2014), 0.14 (2015). - Exchange rate arrangement: free floating; interventions since 2011 Article IV: Aug 4, 2011 purchase 4.5 trillion yen; Oct 31–Nov 4, 2011 purchase 9.1 trillion yen. - AML/CFT: 2008 mutual evaluation highlighted deficiencies in customer due diligence, criminalization of terrorist financing, and freezing of terrorist assets; measures reported in 2010–2012 to address deficiencies. --- ### Recommendation; Key macroeconomic indicators and projections (selected exact figures) - Recommendation: next Article IV consultation on standard 12-month cycle. - Key indicators (selected exact figures) - Nominal GDP: US$ 5,867 billion (2011). - Population: 127.8 million (2011). - GDP per capita: US$ 45,900 (2011). - Real GDP growth (percent change): 2007: 2.2; 2008: -1.0; 2009: -5.5; 2010: 4.4; 2011: -0.7; 2012: 2.4; 2013: 1.5. - CPI inflation (annual average): 2007: 0.1; 2008: 1.4; 2009: -1.3; 2010: -0.7; 2011: -0.3; 2012: 0.2; 2013: 0.0. - Unemployment rate (annual average): 2007: 3.8; 2008: 4.0; 2009: 5.1; 2010: 5.1; 2011: 4.6; 2012: 4.5; 2013: 4.4. - General government revenue (percent of GDP): 2007: 31.2; 2008: 31.6; 2009: 29.6; 2010: 29.6; 2011: 30.6; 2012: 30.9; 2013: 31.4. - General government expenditure (percent of GDP): 2007: 33.3; 2008: 35.7; 2009: 40.0; 2010: 39.0; 2011: 40.7; 2012: 40.9; 2013: 39.9. - General government balance (percent of GDP): 2007: -2.1; 2008: -4.1; 2009: -10.4; 2010: -9.4; 2011: -10.1; 2012: -9.9; 2013: -8.6. - Public Debt, gross (percent of GDP): 2007: 183.0; 2008: 191.8; 2009: 210.2; 2010: 215.3; 2011: 229.9; 2012: 234.5; 2013: 240.0. - Medium-term projections (selected exact figures) - Real GDP (percent change): 2012: 2.4; 2013: 1.5; 2014: 1.5; 2015: 1.2; 2016: 1.1; 2017: 1.1. - CPI inflation (percent): 2012: 0.2; 2013: 0.0; 2014: 0.5; 2015: 0.7; 2016: 0.8; 2017: 1.0. - Overall fiscal balance (percent of GDP): 2012: -9.9; 2013: -8.6; 2014: -7.8; 2015: -7.5; 2016: -7.5; 2017: -7.4. - General Government Debt, gross (percent of GDP): 2012: 234.5; 2013: 240.0; 2014: 244.4; 2015: 248.6; 2016: 252.4; 2017: 255.7. - External Current Account Balance (percent of GDP): 2012: 2.2; 2013: 2.7; 2014: 2.6; 2015: 2.3; 2016: 2.1; 2017: 1.9. *Italicized: IMF Staff Report content excerpt.* ### 1. Japan Selected Economic Indicators, 2007-13 ___________________________________________________ 28 ### 1. Japan Selected Economic Indicators, 2007-13 ### Background and context - The March 2011 Great East Japan earthquake caused widespread human toll and destruction, disrupted supply-chains, and reduced electricity supply; all 54 nuclear power plants—that supply about ¼ of Japan’s electric power—were shut down for safety inspection. One plant has recently been reopened and another is set to reopen in coming weeks. - Severe floods in Thailand in late 2011 further weighed on the recovery and affected Japan’s export sector through supply linkages. - Policy response: a comprehensive reconstruction package was approved; supply chains were repaired within a few months; large conservation efforts limited disruption from nuclear plant shutdowns. - Long-term challenges highlighted: high public debt burden amid low growth, persistent deflation, and a rapidly aging population. - The government’s plan to raise the consumption tax is described as a crucial step toward fiscal sustainability; further consolidation, structural measures to raise growth, and stronger efforts to defeat deflation are needed. ### Recovering from recent shocks — Recent developments - Real GDP: - After contracting by ¾ percent in 2011 because of the earthquake and Thai floods, real GDP grew at a brisk 4¾ percent (s.a.a.r.) in Q1 2012. - Contributions to Q1 2012 growth: led by strong consumption supported by temporary subsidies for environmentally-friendly automobiles and reconstruction spending; private investment declined in early 2012 following two quarters of recovery. - Inflation: - Core inflation, excluding food and energy, was -0.6 percent in May (y/y). - Headline inflation reached 0.2 percent in May (y/y), partly due to higher fresh food prices. - Labor market: - Employment grew by about 1/3 percent in the year to April 2012, but employment remained about 3 percent below 2007 levels. - The unemployment rate fluctuated around 4½ percent over the past year. - Real employee compensation remained relatively flat over the past year. - Trade and current account: - The trade balance moved into deficit in 2011; the deficit widened to about 1 percent of GDP in Q4 2011, marking Japan’s first annual trade deficit since 1980. - The trade deficit remained around 1 percent of GDP in early 2012. - The current account remained in surplus—at 1½-2 percent of GDP in 2011 and early 2012—thanks to income from large net foreign assets. - Financial markets: - Since mid-2011, equity prices declined by about 10 percent and yields on 10-year JGBs fell to near historic lows of 80-85 basis points. - The yen appreciated by about 6 percent in nominal effective terms and appears moderately overvalued. - Overall financing conditions remained accommodative, although conditions for SMEs remained tight. ### Outlook and risks - Growth projections: - Real GDP is expected to expand by almost 2½ percent in 2012, supported by public reconstruction spending of around 1½ percent of GDP and robust consumer demand. - Reconstruction-related growth impulses are projected to slow, and growth is forecast to slow in 2013 to 1½ percent as reconstruction winds down. - Over the medium-term, growth is expected to converge to staff’s estimated potential rate of 1 percent. - Near-term drags: - Higher energy costs from the shift to thermal electricity generation and conservation efforts over the summer are projected to detract about ¼ percentage point from growth in 2012. - Inflation and output gap: - The output gap in early 2012 was estimated at about 3 percent of GDP and is expected to narrow only gradually, not closing until 2015/16. - Core inflation (excluding food and energy) is projected to rise slowly, turning slightly positive by mid-2013. - Headline inflation is expected to remain near zero over the next two years; staff forecast inflation to reach 1 percent by 2017. - Downside risks (shifted decidedly to the downside): - Escalation of the European turmoil or a sharper-than-expected slowing of the Chinese economy would hurt Japanese exports and growth. - Intensification of the flight to safety could further appreciate the yen, worsen the trade balance, and depress equity prices and confidence. - Closure of almost all nuclear power plants combined with an unusually hot summer could disrupt activity (mitigated by conservation efforts). - Extreme scenario: - Debt sustainability analysis (Appendix II) indicates that severe shocks to growth, inflation, and real interest rates, coupled with limited fiscal adjustment, could see public net debt rise to over 300 percent of GDP by 2030. ### Authorities’ views and monetary stance - Authorities broadly agreed with staff’s assessment and were particularly concerned about the possibility of a further rise of the yen. - Authorities viewed the direct effects of a European slowdown as manageable but were concerned about knock-on effects to China and combined effects with yen appreciation on profitability of tradable sectors. - Bank of Japan (BoJ) vs. staff: - The BoJ expects a stronger pick-up of inflation than staff and assumes a smaller output gap in early 2012; the BoJ expects inflation may reach 1 percent sooner under current settings. - Staff estimate of potential growth prior to the crisis is almost 1½ percent per annum versus the BoJ’s estimate of about 1 percent, contributing to differing output gap assessments. ### Box — Outlook for electricity supply (key findings and implications) - All 54 reactors (one-quarter of supply) were shut down after the nuclear disaster; electricity supply problems are expected to be less severe in 2012 than in 2011. - Kanto region (accounts for 40 percent of Japan’s GDP) has sufficient capacity to meet demand due to expansion of thermal power plants, tariff increases, and conservation efforts. - Kansai region (accounts for 16 percent of GDP) is more uncertain because it drew half of its electricity from nuclear power in recent years; government measures include demand restrictions on businesses, transfers from surplus regions, and conservation encouragement. - Reopening of one reactor and planned reopening of another in coming weeks will help address potential Kansai shortfalls. - Staff estimate: real GDP growth in 2012 could be ¼ percentage point slower as a result of energy problems. - Longer-term recommendations: develop alternative energy sources, possible deregulation of the electricity sector to encourage regional trading, targeted subsidies, and an increase in the carbon tax to incentivize conservation and alternative energy production. *Italicized: IMF Staff Report content excerpt.* ### 15. Japan’s fiscal problems are deep ### 15. Japan’s fiscal problems are deep ### Fiscal position and trends - Net public debt has increased nearly ten-fold over the last two decades to more than 125 percent of GDP. - Social security spending has risen rapidly due to population aging, while persistently weak growth and deflation have depressed tax revenues. - Growth in other spending has been relatively slow, with capital spending having fallen substantially. - Japan’s tax revenue is relatively low (see text figure on General Government Tax Revenue (2010)). ### Fiscal vulnerabilities and risks - Japan’s net public debt is higher than in almost all other advanced countries and, unlike in many other advanced countries, is projected to rise further. - Even a relatively small increase in the sovereign risk premium would: - make fiscal consolidation more difficult, - pose challenges to financial institutions, - harm growth prospects in Japan, - and could spill over to global risk premia and growth (Box 2). - Without significant policy adjustment, outstanding gross general government debt could reach 250 percent of GDP over the medium term (Box 2). - Ownership of JGBs is dominated by domestic investors, who hold more than 90 percent of the outstanding stock. - If JGB yields rose by 100 bps over the next 5 years, the long-term net public debt-to-GDP ratio would remain high at 150 percent of GDP, even after a 10 percentage points of GDP adjustment in the structural fiscal balance (Box 2). - A sharp rise in government bond yields could reduce Japan’s output by 6-10 percent after 10 years, relative to the baseline, depending on contagion to global risk premia (Box 2). Potential global impacts include up to 1 percent output decline in the United States and about 2-3 percent in Emerging Asia and the Euro area (Box 2). ### Policy issues and staff’s views - Japan’s fiscal deficit is set to increase in 2012 to support reconstruction and the broader recovery. - Capital and current reconstruction spending equivalent to 1½ percent of GDP in 2012 (as part of a multi-year reconstruction package of 4 percent of GDP) will widen the fiscal deficit to about 10 percent of GDP in 2012. - The structural primary deficit will rise slightly to 7½ percent of GDP in 2012. - Staff welcomed the authorities’ intention to raise the consumption tax: - The Lower House approved a tax bill to increase the consumption tax to 8 percent in April 2014 and 10 percent in October 2015; the Upper House is considering the bill. - Passage of the tax legislation is crucial to demonstrate commitment to fiscal reform and sustain investor confidence. - Staff estimate the authorities’ current consolidation plan, including: - the increase in the consumption tax, - withdrawal of the financial crisis stimulus, - and curbs to non-social security spending, would achieve a 5 percent of GDP adjustment and reduce the primary deficit to 2½ percent of GDP by 2020. ### Additional consolidation recommended by staff - Staff advised an additional 5 percent of GDP adjustment to achieve an overall fiscal consolidation of 10 percent of GDP over the next decade. This would: - achieve a primary surplus of about 3 percent of GDP by the early 2020s, - and put the public-debt-to-GDP ratio on a clear downward path. - Recommended composition of the 10 percentage points of GDP adjustment (between end-2011 and 2020, excluding reconstruction spending): - About half the adjustment (2½ percent of GDP) from additional expenditure restraint over the next decade by curbing growth in nominal spending. - Adopt a clear timeframe for further revenue increases beyond 2015 to achieve the remaining adjustment. - Staff recommended specific reform elements (many already debated publicly): - Revenue measures: - Increase the consumption tax to a uniform rate of at least 15 percent. - Cut the corporate tax rate further, beyond the planned reduction to 35 percent in 2015 (text table notes cutting the effective rate to around 25-30 percent or around 30-35 percent in various options). - Broaden the personal income tax base (estimated revenue gains shown as 0.5, 0.75, 0.5 in the text table). - Eliminate preferential tax treatment for pension benefit income (savings estimate ¼ in text table). - Collect contributions from dependent spouses of workers covered by the Employees' Pension Insurance (savings estimate ¼ in text table). - Raise inheritance/gift tax (noted with checkmarks in text table). - Introduce carbon tax (savings assumed to be around 0.1 percentage points of GDP or lower in footnote). - Expenditure measures: - Withdraw financial crisis fiscal stimulus: 1.0 percentage point of GDP. - Curb growth rate of nominal non-social security spending (excluding interest payments): options shown of 1.5 or 2.5 percentage points of GDP. - Limit annual nominal growth in non-pension social security spending at 1–1½ percent (1.0 percentage point of GDP savings). - Raise pension eligibility age to 67 (savings estimate ¼ in text table). - Reduce benefits for wealthy retirees (savings estimate ¼ in text table). - Reduce pension payroll tax (noted as -0.5 in text table, implying a revenue cost to be offset elsewhere). - Total savings in the policy adjustment scenarios are shown as 5.0, 10.0, 10.0, and 10.0 percentage points of GDP across different columns in the text table. ### Impact on growth and design considerations - The consolidation recommended by staff would have a negative impact on real GDP growth of about ½ percent annually in the short-term. - The proposed pace of consolidation over the next 5-6 years is quicker than in most advanced countries, which is needed given Japan’s large public debt. - Pre-announced increases in the consumption tax could bring forward household spending, limiting the near-term impact of the tax increase. - Coupling consolidation with structural reforms to support growth could boost confidence and help raise private consumption and investment over the longer-term. - Careful design of consolidation measures could reduce negative growth impacts; staff advised a broad range of reforms to: - contain social security spending, - improve incentives to work and invest, - and combine social security spending reforms with revenue measures. ### Debt projections and scenarios - Staff project that by steadily improving the fiscal balance over a decade: - net public debt would stabilize at around 150 percent of GDP by mid decade (policy adjustment scenario), - and then fall gradually to 125 percent of GDP by 2030 (policy adjustment scenario with 10 percentage points of GDP improvement between end-2011 and 2020). - Upside scenario (assumes higher long-term growth rates of real GDP (2 percent) and GDP deflator (1½ percent), and currency depreciation toward medium-term equilibrium) would push down net public-debt-to-GDP ratio to around 115 percent of GDP by 2030. - Staff note staff estimates of authorities' current plan assume consumption tax increases to 8 percent in 2014 and 10 percent in 2015 (text figure footnote). ### Intergenerational implications - Intergenerational resource inequality in Japan is significant: - The Cabinet Office estimated that based on government policy in 2003, the present discounted value (PDV) of the lifetime net burden for future generations would be 50 million yen per household (about 10 times household annual disposable income), and 100 million yen heavier than for those aged 60 years or older. - Fiscal consolidation generally worsens intergenerational inequality from current levels, as younger cohorts face longer-term declines in net benefits. - OLG model simulations show: - A fiscal adjustment of 10 percentage points of GDP would raise the lifetime net burden substantially for young generations but minimally for older generations. - For those aged 20–29, the net PDV burden from a 10 percentage point consolidation would be as much as 400 percent of current per household wage income (before taxes), with the total net burden reaching 1600 percent combined with the burden implied by policy as of 2003. - To minimize deterioration in intergenerational inequality, OLG simulations highlight: - Including social security spending reforms in a consolidation package could help correct the large intergenerational imbalance (e.g., a 1.5 percentage point of GDP adjustment from social security reforms would reduce the burden for young generations by 15 percent of current household wage income relative to a scenario without such reforms). - However, excessive reliance on social security spending reforms could harm seniors’ welfare, arguing for a combination of social security spending reforms and revenue measures. - Delaying fiscal adjustment by 3 years would be costly and worsen intergenerational resource inequality: a 3-year delay would raise the PDV lifetime burden for those currently 20-29 by 15-20 percentage points of current per household wage income (before taxes), while reducing the burden for older generations relative to a no-delay scenario. *Source: _cr12208 - 15. Japan’s fiscal problems are deep (IMF Article IV Staff Report text provided).* ### 24. To sustain a decade-long adjustment, ### _cr12208 - 24. To sustain a decade-long adjustment, ### Fiscal framework and consolidation: staff recommendations - Adopt a medium-term budget framework with: - a strict overall spending limit; - ministry-by-ministry spending targets; - restrictions on the use of supplementary budgets. - Greater disclosure of tax expenditures to increase transparency. - Once consolidation is on track, consider a legally-binding fiscal rule that could target a primary surplus. - Maintain discipline via rolling multi-year expenditure frameworks with caps on non-interest primary spending while preserving flexibility for resource allocation. ### Authorities’ fiscal objectives and views - Commitments and targets: - Halve the primary deficit by FY2015. - Achieve a primary surplus by FY2020 at the latest. - Reduce the public debt-to-GDP ratio over time. - Views on instruments and sequencing: - The authorities view the doubling of the consumption tax rate as a critical first step. - They are considering a number of options (including staff proposals) and are working toward concrete proposals. - Before further corporate tax reform, they will examine the impact of the corporate tax cut started in FY2012 and international competitive conditions. - On fiscal rules and limits: - The authorities see the current rolling three-year expenditure framework, with caps on non-interest primary spending, as effective. - They cautioned that rigid ministry-by-ministry medium-term spending limits could weaken budget flexibility, citing experience with the 1997 Fiscal Structural Reform Act. ### Structural reforms to raise growth: rationale and potential - Rationale: - Higher growth is essential to create more jobs, reduce public debt and improve resilience to shocks. - Japan had strong productivity growth over the past decade, but a decline in the working age population and weak investment slowed overall growth. - Demographic effects will continue; the population is expected to age quicker than in most other countries. - Potential gains: - A far-reaching package would be needed to reach the authorities’ goal of raising long-term GDP growth to 2 percent. - Increasing female labor participation to the G-7 average, raising old-age employment in line with long life expectancy, and boosting immigration could raise potential growth by as much as ½ percentage point. ### Policy issues and staff’s structural reform recommendations - Increase the labor force: - Expand childcare facilities (including through deregulation). - Eliminate the tax deduction for dependent spouses. - Raise the retirement age to above 65 years. - Introduce a uniform regular employment contract which phases in employment protection to facilitate mobility and fairness. - Broaden the recently introduced points-based immigration system to include lower-skilled immigrants to meet labor shortages (e.g., long-term care and childcare). - Raise productivity and encourage investment: - Ease regulations that limit development of services (health and old-age care). - Reform electricity and agricultural sectors. - Encourage FDI and pursue high-quality free trade agreements and regional integration (including Trans Pacific Partnership) to catalyze reforms in services and agriculture. - Improve financial intermediation and risk capital availability: - Scale down government-backed guarantees for SME loans as the recovery takes hold. - Phase out the temporary SME Financing Facilitation Act by March 2013. - Reduce the role of government in channeling credit, including by fully privatizing Japan Post. - Encourage asset-based lending for inventories and accounts receivable. - Consider refocusing the public asset management company to advance SME restructuring. - With reform and financial strengthening, public pension funds could become an additional source of investment capital. ### Authorities’ views on structural reforms - Recognition that structural reforms are vital, but the challenge is more daunting due to rapid population aging and already-high productivity growth. - The government’s Growth Strategy includes measures to increase participation of women, the young, and the aged. - Officials agree further measures are needed: promote employment of highly-skilled foreigners, restructure SMEs, and deregulate protected sectors (healthcare, childcare, electricity, agriculture). - Officials note financial sector reforms could improve capital allocation but may not by themselves raise growth much while credit demand is low. ### Defeating deflation: diagnosis and policy advice - Diagnosis: - Mild deflation for over a decade has contributed to lower private investment and consumption by sustaining high real interest rates and raising real levels of debt. - Deflation reduced tax revenue and made it harder to contain real spending, contributing to rising public debt-to-GDP. - An exit from deflation is essential to support recovery and facilitate fiscal consolidation. - Staff’s monetary guidance: - Forceful monetary easing should be a key element of a comprehensive package to defeat deflation. - Structural reforms are also important to boost confidence, raise domestic demand, and accelerate output gap closure. - Strong fiscal consolidation over the medium-term could help facilitate additional monetary accommodation. - Specific monetary actions advised: - Expand the Asset Purchase Program substantially beyond current plans to increase the likelihood of achieving the 1 percent inflation goal by end-2014 under staff’s baseline outlook. - Extend the maturity of JGB purchases beyond 3 years to help reduce medium-term lending rates. - Purchase private assets (corporate bonds, equities, highly-rated securitized SME loans) to stimulate activity by boosting asset prices. - Enhance BoJ communication: - Extend the inflation forecast to 3 years or beyond. - Clarify readiness to react to changes in the baseline economic outlook. - Emphasize that the current inflation goal of 1 percent is not a ceiling and that a higher inflation rate could be allowed when food and energy prices rise temporarily or the consumption tax rate is increased. - Once inflation approaches 1 percent, consider increasing the inflation goal to create a larger buffer against deflationary shocks. ### Recent BoJ actions, staff projections, and BoJ views - Recent BoJ actions: - Adopted in February a medium to long-term price stability goal of 1 percent. - Expanded its Asset Purchase Program by ¥15 trillion this year in two steps. - Extended the maturity of JGB purchases from 1–2 years to 1–3 years. - Together with earlier commitments this is a sizeable monetary expansion, totaling about 5 percent of GDP over the next year. - Staff inflation forecast: - Inflation projected to rise only to ½ percent in 2014 because of the negative output gap. - Inflation projected to reach the goal of 1 percent by 2017. - Staff advice on further easing: - Additional effective easing could reduce lending rates, raise inflation expectations, and help depreciate the exchange rate. - BoJ’s stance: - The BoJ agreed recovery was in train and viewed the current policy stance as appropriate. - The BoJ emphasized monetary policy alone cannot defeat deflation and highlighted the need for structural reforms plus monetary easing. - The BoJ cautioned that further purchases of JGBs and other assets would expose its balance sheet to risk and that, absent fiscal reforms, additional JGB purchases could be viewed as monetization of the fiscal deficit and push interest rates up. *Source: _cr12208 - 24. To sustain a decade-long adjustment,* ### 40. The BoJ emphasized the ### _cr12208 - 40. The BoJ emphasized the ### BoJ communication and medium- to long-term inflation goal - The BoJ emphasized the effectiveness of their communication. - Clarification of their goal in February and the Governor’s recent speeches had been effective in guiding market expectations. - The BoJ explained that its medium- to long-term inflation goal will be regularly reviewed and going forward the BoJ could consider raising its goal, as structural reforms to strengthen growth potential proceed, though such consideration depends on how fast these reforms make progress. - The BoJ stressed that they would look through temporary factors, such as an increase of the consumption tax rate, when assessing whether the policy stance was appropriate to achieve the medium-term inflation goal. ### Structural reforms and policy coordination - Authorities shared staff’s view that structural reforms are important to defeat deflation. - A recently established ministerial council laid out priority areas for policies to combat deflation including through regulatory and structural reforms. ### Responding to a downside scenario (policy options) - If the outlook for growth worsens sharply in the near term: - Staff noted that further easing of monetary policy would be advisable, beyond that recommended in the baseline scenario. - Fiscal policy could also play a role, although it is constrained by the limited fiscal space. - While maintaining the medium-term fiscal target, automatic stabilizers could be allowed to work. - In case of a severe downturn small and targeted fiscal measures could be introduced, as long as JGB yields remain low. - Staff stressed that it would not be advisable to delay legislation of the increase in the consumption tax given its importance as a signal of commitment to consolidation. - If financial markets were disrupted by heightened global turmoil, the authorities could consider providing additional liquidity together with other tailored actions to address market disruptions. - Authorities’ views: - Authorities broadly agreed with staff’s advice. - They emphasized that their commitment to fiscal reform over the medium-term was an essential stabilizing factor that would provide markets with confidence during a downturn. - The BoJ agreed that further easing of monetary policy could play a role if the outlook for growth worsened sharply. ### Assessing external stability: current account, yen, and intervention - Current account and yen developments: - Japan’s current account surplus remains sizeable. - The current account surplus has narrowed from almost 5 percent of GDP in 2007 and is expected to be around 2¼ percent of GDP in 2012. - The yen has appreciated in real effective terms by 27 percent since the Lehman event in late 2008. - The yen’s appreciation initially resulted from an unwinding of carry trades and later from safe haven flows during periods of global financial distress. - Foreign exchange intervention and reserves: - The intervention in Oct/Nov 2011 was sizable (at about US$120 billion). - Foreign exchange reserves (excluding gold) increased to US$1,258 billion by end-2012. - Staff guidance on exchange rate policy: - Staff advised that Japan, like other advanced economies, should allow the market to determine the exchange rate, although intervention could be used to counter volatile or disorderly market conditions. - Assessment of external position and REER: - Japan’s external position appears moderately weaker than that consistent with underlying fundamentals. - The current account has averaged about 3 percent of GDP over the last decade and is expected to remain around 2 percent of GDP over the medium-term, as population aging begins to reduce private saving. - After taking into account desirable fiscal consolidation and structural policies, the current account’s normal level (“the norm”) is estimated by staff to be around 3 to 4 percent of GDP, leaving the gap between the current level and the norm at around 1 to 2 percent of GDP. - This implies that the current account position is moderately weaker than suggested by the fundamentals (i.e, that the yen is moderately overvalued from a medium-term perspective). - Assessing the exchange rate against long-run averages suggests the yen is moderately overvalued: - The real effective exchange rate (REER), measured using relative consumer prices, is close to its 20-year average. - The REER is about 10-15 percent more appreciated than the 20-year average when measured using relative unit labor costs. - Authorities’ views on the yen: - Authorities expressed concern about the yen’s volatility and disorderly movements caused by speculation. - They agreed with staff that the yen was overvalued, but believed the overvaluation was “substantial” rather than “moderate.” - They noted safe-haven capital inflows had likely led to an over-shooting of the exchange rate and emphasized that the REER had appreciated sharply since the fall of 2008, including a strengthening by about 40–60 percent against the Euro and the Korean won in real terms. - Authorities pointed to the burden of recovery from the severe earthquake, a challenging fiscal situation, and a shift of the trade balance into deficit. ### Securing financial stability: resilience and risks - Recent shocks and exposures: - The financial system has weathered recent shocks well, although strains from the European debt crisis have risen. - The earthquake and spillovers from the Thai floods led to significant economic disruptions but had only a limited effect on financial stability. - Rising dollar funding costs in late 2011 were contained through coordinated central bank action, but costs have risen again in recent weeks as a result of uncertainty in Europe. - Direct exposures of Japanese financial institutions to peripheral European countries are small (less than 1 percent of banks’ total assets), but indirect exposures through financial ties to core European countries are significant. - FSSA and regulatory progress: - The FSSA found important steps were taken to strengthen the financial system since the last assessment in 2003. - Financial regulation and supervision have been effective in encouraging large banks to strengthen their capital positions and building the resilience of insurers to shocks. - Japan has a high level of compliance with international core principles. - Key vulnerabilities and stress-test findings: - The FSAP stress tests suggest that in the near term banks and insurers would be resilient to severe economic stress and moderate market shocks, but challenges remain. - Banks’ low core profitability and large holdings of JGBs and equities raise concerns about financial stability. - Specific findings: - Despite improvement in banks’ net income during FY2011 due to large trading gains, core profitability remains low, with an average return on assets of only 0.3 percent due to a narrowing of the interest margin. - Banks’ nonperforming loans ratio has stayed low (at 3 percent of total loans in early 2011), but the BoJ estimates this could rise by about 1 percentage point if SMEs with restructured loans fail to improve their business conditions. - Interest rate risk has increased since the global financial crisis; banks’ holdings of JGBs have grown to about one-fifth of their assets, most as available-for-sale securities in the banking book. - Major banks (comprising over 40 percent of total bank assets) have contained interest rate risk by holding short maturities, averaging 2½ years. - If interest rates rise by 1 percentage point across all maturities, major banks’ exposure to interest rate risk would be about 10 percent of Tier 1 capital. - Regional banks’ interest rate risk would be about 1/3 of their Tier 1 capital in such a scenario. - In the unlikely event of a prolonged growth shock combined with a sharp rise in government bond yields, financial stability might be challenged. - Market risk from equities has declined but remains sizable: equity holdings by banks (almost 40 percent of total capital) and non-life insurers (20 percent of assets) imply substantial potential losses if stock prices fell sharply. - Looking forward, expansion of financial institutions overseas presents supervisory challenges in monitoring cross-border exposures. - Box 4: Potential financial spillovers from the European debt crisis (summary) - Key downside risk: escalation of the Euro area debt crisis could intensify spillovers to Japan and Asia. - Losses from overseas exposures of Japanese financial institutions are likely limited if the crisis is contained to peripheral European countries: - Japanese banks hold about 12 percent of their assets as foreign claims, of which about ¼ are on Europe. - The majority of banks’ claims on Europe are on the nonfinancial sector (about 60 percent) in core countries. - Insurance companies invest about 15–20 percent of their assets in foreign securities; direct exposures to peripheral European countries had been unwound and were negligible as of end-2011. - More severe outcomes would follow if the crisis impacted U.S. and U.K. banks or hit claims on the nonfinancial sector in core European countries: - Assuming sizeable credit and funding shocks (100 percent of loss given default and 50 percent discount on asset liquidation) on cross-border banking claims and no policy response by country authorities, such shocks would impair substantially the tier 1 capital of Japanese banks, based on network analysis prepared for the FSAP update. - U.S. dollar funding conditions are likely to remain favorable for Japanese banks owing to their large holdings of collateral needed to access central bank facilities, but Japanese securities firms need careful day-to-day dollar liquidity management due to reliance on wholesale funding. - On the upside, an orderly deleveraging by European banks is providing opportunities for Japanese financial institutions: - Japanese banks’ cross-border exposures have doubled since 2004 to reach US$2.7 trillion as of December 2011 for banks, supporting expansion overseas and potentially mitigating impacts from a retreat of European banks on syndicated loans and trade finance. *Italic: IMF staff report extract (2012 Article IV Staff Report — Japan).* ### 52. The authorities intend to implement ### _cr12208 - 52. The authorities intend to implement ### Basel III implementation and capital impact - The authorities intend to implement Basel III for internationally-active banks. - Estimated impacts on Tier 1 capital ratios: - Applying immediately and in full the Basel III capital definition while keeping the Basel II definition of RWA would reduce Tier 1 capital ratios by about 2¼ percentage points (from 12¾ percent in March 2011 under Basel II). - Applying more prudent risk weights (in line with the Basel III phase-in as of September 2011) would further reduce the ratio by about 1 percentage point for the three mega banks. - The resulting ratio would remain above the Basel III minimum requirement that will rise to 6 percent by 2015. ### Financial System Stability Assessment (FSSA) — main recommendations - Risk monitoring - Put in place thematic risk assessments to monitor financial institutions’ readiness to manage systemic risks. - The BoJ and Financial Services Agency (FSA) could consider formalizing arrangements to intensify information sharing and oversight of systemically relevant financial institutions, markets and infrastructure. - Increase collaboration between FSA and foreign supervisory authorities (for example through active use of Memoranda of Understanding) in light of increased cross-border activities. - Prudential framework - Tighten large exposure limits on lending by banks. - Raise capital requirements for domestic-oriented banks. - Note: The domestic-oriented banks (mostly regional and shinkin banks) account for about 40 percent of bank assets and are currently subject to a capital requirement of 4 percent of risk-weighted assets, lower than their internationally-active peers. As of June 2012, there is no plan to subject these banks to Basel III requirements. - Encourage these banks to improve profitability to enhance growth-supporting role and build resilience to shocks. - For insurers, move solvency assessment to an economic valuation taking into account the full time horizon of insurance contracts (rather than just up to 10 years as required under current regulations). - Strengthen supervision of private pension funds by requiring participants’ representation on boards of corporate pension plans and establishing a mandatory guarantee fund for defined benefit pensions. - Crisis resolution - Explore improvements in the crisis resolution framework to ensure orderly resolution for systemically-important nonbank financial institutions. - Global regulatory reform agenda - FSA should review adequacy of its skills and resources given workload involved in implementing the global regulatory reform agenda. ### Authorities’ views - Authorities welcomed FSSA findings and broadly agreed with most recommendations. - Ongoing practices: - Continue monitoring risks closely through inspections and stress tests (including scenarios with a rise in interest rates). - FSA monitors cross-border activities and intends to develop closer ties with regional supervisory agencies. - Concerns noted: - Potential adverse impact of some global regulatory reforms on financial markets (example: extraterritorial application of the Volcker rule might lead to withdrawal of foreign institutions from market-making activities in Japan and adversely affect liquidity and pricing in the JGB market). - Implementation and resources: - New rules on Basel III to begin in FY2013 in line with G-20 timeline. - Review of large exposure limits by Japan’s Financial System Council. - FSA and BoJ report close communication and frequent information exchange in practice. - FSA comfortable with soundness of domestic-oriented banks at present but will consider further action if necessary. - FSA has continued to increase workforce and budget despite overall reductions in government personnel and budget; further increases may need consideration while improving efficiency. - Authorities committed to working with the Financial Stability Board on resolution regimes. ### Staff appraisal — macro and financial policy implications - Growth and risks - Japan’s economy is set to recover despite a worsening global outlook; reconstruction activity likely to offset external headwinds. - Risks tilted to the downside, primarily from possible escalation of turmoil in Europe and sharper-than-expected slowing of the Chinese economy. - Risk of electricity shortages from closure of most nuclear power plants appears manageable. - Fiscal adjustment - Reducing public debt burden requires fiscal adjustment of 10 percent of GDP over a decade. - Passage of legislation to double the consumption tax rate to 10 percent by 2015 is crucial. - Putting public-debt-to-GDP ratio on a clear downward path will require an additional 5 percent of GDP adjustment. - Design of adjustment: - Raise consumption tax (less distortionary and fairer). - Use room to cut distortionary taxes such as the corporate tax. - Increase incentives to work by eliminating tax deduction for dependent spouses and raising pension retirement age. - Introduce targeted transfers to lower-income households to address regressivity of consumption tax. - Delaying fiscal adjustment could be costly and worsen intergenerational equity. - Structural reform - Speedy implementation of far-reaching structural reforms essential to raise growth. - Reforms should focus on increasing labor force participation (women and the old-aged) and boosting immigration. - Increase productivity by easing regulations and entering high-quality free trade agreements (including the Trans Pacific Partnership). - Improve financial intermediation by reducing government role in channeling credit and increasing availability of risk capital. - Monetary policy - Further monetary easing should be a key element to defeat deflation. - Additional effective easing could be delivered by expanding the BoJ’s asset purchase program substantially beyond current plans to accelerate achievement of the 1 percent inflation goal. - Enhance communication by emphasizing that the inflation goal is not considered a ceiling and that a higher inflation rate could be allowed in response to temporary price shocks. - If growth outlook worsens sharply, further monetary easing beyond the baseline would be advisable; fiscal policy could support through automatic stabilizers though constrained by limited fiscal space. It would not be advisable to delay legislation to increase the consumption tax. - External position - Japan’s external position appears moderately weaker than that consistent with medium term fundamentals. - The current account surplus narrowed to 2 percent of GDP in 2011; the yen now appears moderately overvalued from a medium-term perspective. - Financial stability - Financial system is stable but could be further strengthened by improving monitoring of systemic risks and bolstering the financial stability framework. - FSSA recommendations emphasize: - Thematic risk assessments, especially for large holdings of JGBs and equities. - Tightening large exposure limits, raising capital requirements for domestic-oriented banks, and refining solvency assessments for insurers. - Improving crisis resolution framework for systemically-important nonbank financial institutions. *Source: JAPAN 2012 ARTICLE IV STAFF REPORT, INTERNATIONAL MONETARY FUND* ### 64. It is recommended that the next ### _cr12208 - 64. It is recommended that the next ### Recommendation - It is recommended that the next Article IV consultation take place on the standard 12-month cycle. ### Key macroeconomic indicators (selected) - Nominal GDP: US$ 5,867 billion (2011) - Population: 127.8 million (2011) - GDP per capita: US$ 45,900 (2011) - Real GDP growth (percent change): 2007: 2.2; 2008: -1.0; 2009: -5.5; 2010: 4.4; 2011: -0.7; 2012: 2.4; 2013: 1.5 - CPI inflation (annual average): 2007: 0.1; 2008: 1.4; 2009: -1.3; 2010: -0.7; 2011: -0.3; 2012: 0.2; 2013: 0.0 - Unemployment rate (annual average): 2007: 3.8; 2008: 4.0; 2009: 5.1; 2010: 5.1; 2011: 4.6; 2012: 4.5; 2013: 4.4 - General government revenue (percent of GDP): 2007: 31.2; 2008: 31.6; 2009: 29.6; 2010: 29.6; 2011: 30.6; 2012: 30.9; 2013: 31.4 - General government expenditure (percent of GDP): 2007: 33.3; 2008: 35.7; 2009: 40.0; 2010: 39.0; 2011: 40.7; 2012: 40.9; 2013: 39.9 - General government balance (percent of GDP): 2007: -2.1; 2008: -4.1; 2009: -10.4; 2010: -9.4; 2011: -10.1; 2012: -9.9; 2013: -8.6 - Public Debt, gross (percent of GDP): 2007: 183.0; 2008: 191.8; 2009: 210.2; 2010: 215.3; 2011: 229.9; 2012: 234.5; 2013: 240.0 ### Balance of payments and external position (highlights) - Current account balance (in billions of US$): 2006: 171.0; 2007: 212.2; 2008: 159.8; 2009: 146.6; 2010: 204.0; 2011: 119.2 - Current account (percent of GDP): 2006: 3.9; 2007: 4.9; 2008: 3.3; 2009: 2.9; 2010: 3.7; 2011: 2.0 - Trade balance (in billions of US$): 2006: 81.1; 2007: 105.1; 2008: 38.4; 2009: 43.4; 2010: 91.0; 2011: -20.5 - Exports of goods (in billions of US$): 2006: 615.7; 2007: 678.4; 2008: 746.5; 2009: 545.3; 2010: 730.1; 2011: 787.2 - Imports of goods (in billions of US$): 2006: 534.6; 2007: 573.3; 2008: 708.0; 2009: 501.9; 2010: 639.1; 2011: 807.7 - Total reserves minus gold (US$ billion): 2007: 952.8; 2008: 1009.4; 2009: 1022.2; 2010: 1096.2; 2011: 1258.2 ### External and financial indicators (summary) - Real exports (percent change): 2007: 8.7; 2008: 1.4; 2009: -24.2; 2010: 24.2; 2011: -0.1; 2012 (Q1 yoy): 1.0 - Real imports (percent change): 2007: 2.3; 2008: 0.3; 2009: -15.7; 2010: 11.1; 2011: 15.9; 2012 (Q1 yoy): 6.6 - Terms of trade (percent change): 2007: -2.1; 2008: -9.6; 2009: 19.5; 2010: -3.3; 2011: -7.9; 2012: -4.7 - Broad money (M2 + CDs) to reserves ratio: 2007: 0.6; 2008: 0.7; 2009: 0.8; 2010: 0.8; 2011: 0.9; 2012: 0.8 - Net international investment position (US$ billion): 2007: 2129.4; 2008: 2188.9; 2009: 2855.5; 2010: 2876.2; 2011: 3188.5 ### Medium-term projections (2010–17) — key projections - Real GDP (percent change): 2010: 4.5; 2011: -0.7; 2012: 2.4; 2013: 1.5; 2014: 1.5; 2015: 1.2; 2016: 1.1; 2017: 1.1 - Unemployment rate (percent): 2010: 5.1; 2011: 4.6; 2012: 4.5; 2013: 4.4; 2014: 4.3; 2015: 4.2; 2016: 4.1; 2017: 4.0 - CPI inflation (percent): 2010: -0.7; 2011: -0.3; 2012: 0.2; 2013: 0.0; 2014: 0.5; 2015: 0.7; 2016: 0.8; 2017: 1.0 - Overall fiscal balance (percent of GDP): 2010: -9.4; 2011: -10.1; 2012: -9.9; 2013: -8.6; 2014: -7.8; 2015: -7.5; 2016: -7.5; 2017: -7.4 - General Government Debt, gross (percent of GDP): 2010: 215.2; 2011: 229.8; 2012: 234.5; 2013: 240.0; 2014: 244.4; 2015: 248.6; 2016: 252.4; 2017: 255.7 - External Current Account Balance (percent of GDP): 2010: 3.7; 2011: 2.0; 2012: 2.2; 2013: 2.7; 2014: 2.6; 2015: 2.3; 2016: 2.1; 2017: 1.9 - National Savings (percent of GDP): 2010: 23.5; 2011: 21.9; 2012: 22.4; 2013: 23.2; 2014: 23.2; 2015: 22.9; 2016: 22.6; 2017: 22.4 ### General government operations (fiscal composition) - Total revenue (percent of GDP): 2006: 30.8; 2007: 31.2; 2008: 31.6; 2009: 29.6; 2010: 29.6; 2011: 30.6; 2012: 30.9; 2013: 31.4 - Total expenditure (percent of GDP): 2006: 34.5; 2007: 33.3; 2008: 35.7; 2009: 40.0; 2010: 39.0; 2011: 40.7; 2012: 40.9; 2013: 39.9 - Primary balance (percent of GDP): 2006: -3.7; 2007: -2.1; 2008: -3.8; 2009: -9.9; 2010: -8.7; 2011: -9.2; 2012: -8.8; 2013: -7.4 - Net lending/borrowing (overall balance, percent of GDP): 2006: -3.7; 2007: -2.1; 2008: -4.1; 2009: -10.4; 2010: -9.4; 2011: -10.1; 2012: -9.9; 2013: -8.6 - Nominal GDP (FY, trillion yen): 2006: 509.1; 2007: 513.0; 2008: 489.5; 2009: 473.9; 2010: 479.5; 2011: 469.9; 2012: 482.1; 2013: 488.4 ### Financial sector soundness (selected indicators) - Total capital ratio (all banks, percent, end-March): 2001–2011 series shows rise to 14.1 (2011, Mar) - Nonperforming loans to total loans ratio (percent, end-March): 2001–2011 series generally declining; 2011 (Mar/Sep): 2.9 - Total loans to assets (percent): 2007: 53.8; 2008: 53.2; 2009: 53.2; 2010: 51.3; 2011: 49.8 - Total loans to deposits (percent): 2007: 75.5; 2008: 77.5; 2009: 74.6; 2010: 72.1; 2011: 70.6 ### Risk Assessment Matrix — main risks, likelihood, impact, and policy responses - 1. Financial Turmoil in Europe - Overall Level of Concern: High/Medium - Likelihood (Over next one to three years): High - Impact: Exports would decline, appreciation pressures, equity prices fall, weaker confidence, higher market risk for banks and insurers, potential dollar funding pressure. - Policy response: Further easing of monetary policy advisable; fiscal policy could play a role through automatic stabilizers but constrained by limited fiscal space; it would not be advisable to delay legislation of the increase in the consumption tax. - 2. A Hard Landing in China - Overall Level of Concern: Low - Likelihood: High - Impact and response: Similar to Financial Turmoil in Europe. - 3. Increase in Energy Costs and Electricity Shortages - Overall Level of Concern: Medium - Likelihood: Medium - Impact: Higher energy imports and costs reduce production, weaken trade balance, hurt investor confidence, increase chance of a JGB shock; extended nuclear plant closures could reduce potential growth. - Policy response: Allow full pass-through of energy costs to electricity prices; encourage alternative energy sources to reduce medium-term vulnerabilities. - 4. Sharp rise in JGB Yields - Overall Level of Concern: Low - Likelihood: High - Impact: Threat to fiscal sustainability; modest rise in interest rate-growth differential from near historic lows (0 percent in 2012) could worsen debt dynamics, undermine confidence, reduce growth, worsen deflation; severe tail risks via fiscal-financial linkages could threaten financial stability. - Policy response: Reinforce fiscal consolidation to regain market confidence; BoJ could step in to address temporary market volatility. - 5. Protracted Growth Slowdown and Deflationary Pressures - Overall Level of Concern: Medium - Likelihood: Medium - Impact: Real GDP well below baseline and continued deflation worsen debt dynamics. - Policy response: Speedy implementation of structural reforms, supported by aggressive monetary policy easing and growth-friendly fiscal consolidation. - 6. Faster Recovery - Overall Level of Concern: Medium - Likelihood: Medium - Impact: Faster-than-expected recovery would lift domestic demand, close output gap earlier, raise inflation toward BoJ goal, improve public debt dynamics. - Policy response: Front loading fiscal consolidation to capture long-term benefits. ### Public debt scenarios (chart summary) - Net public debt (percent of GDP) scenarios described: - No adjustment scenario: No consumption tax increases are assumed. - Staff estimates of authorities' current plan: Consumption tax increases to 8 percent in 2014 and 10 percent in 2015 are assumed. - Policy adjustment scenario: Assumes a 10 percentage points of GDP improvement (authorities' current proposal +5.0 points) in the structural primary between end-2011 and 2020. *2012 ARTICLE IV STAFF REPORT JAPAN; INTERNATIONAL MONETARY FUND* ### Appendix II. Japan: Public Sector Debt Sustainability Analysis ### Appendix II. Japan: Public Sector Debt Sustainability Analysis ### Baseline Macroeconomic Assumptions - Real GDP growth and the inflation rate are assumed to converge to 1 percent over the long term. - Nominal GDP growth is around 2 percent per year over the next 10 years. - The nominal interest rate growth differential is assumed to converge to 1 percent (pre-crisis average since 2000) over the long run. - The average nominal interest rate is assumed to rise to 3 percent (compared to about 1 percent currently) over the long run. ### Scenarios and Debt Projections - Four scenarios are presented: - No adjustment scenario. - Authorities’ current plan (staff estimate). - Policy adjustment scenario to reduce net public debt to 125 percent of GDP (215 percent of GDP on a gross debt basis) by 2030. - Upside scenario that could see net public debt reduced to 115 pecent of GDP (205 percent of GDP on a gross debt basis) by 2030. - No Adjustment Scenario: - Assumptions: expiration of enacted stimulus (1 percent of GDP), modest expenditure adjustment (1½ percent of GDP), unchanged tax policy (no increase in the consumption tax) between end-2011 and 2020. - Combined effect: improves the structural primary balance by 2½ percent of GDP over the next decade. - Outcome: net debt would rise to about 245 percent of GDP (335 percent of GDP on a gross debt basis) by 2030. - Authorities’ Current Plan: - Plan: raise the consumption tax rate to 8 percent in 2014 and then 10 percent in 2015. - Combined with the expenditure adjustments outlined above, estimated improvement: structural primary balance improves by 5 percent of GDP over the next decade. - Outcome: net public-debt-to-GDP ratio would rise to around 200 percent of GDP (290 percent of GDP on a gross debt basis) by 2030 (would fail to stabilize). - Policy Adjustment Scenario: - Objective: stabilize and put public-debt-to-GDP ratio on a downward path. - Assumes a 10 percent of GDP improvement of the structural primary balance over the next decade (between end-2011 and 2020). - Composition of the 10 percent of GDP: - Withdrawal of crisis-era fiscal stimulus: 1 percent of GDP. - Additional policy measures: 9 percent of GDP, of which: - 5 percentage points from a gradual rise in the consumption tax starting in 2014. - 4 percentage points from other reforms (e.g., curbing growth rate of nominal nonsocial security spending, limiting growth in social security spending). - Outcome (baseline nominal interest rate growth differential = 1.0 percent): net-public-debt-to-GDP ratio declines to 124 percent of GDP by 2030 (214 percent of GDP on a gross debt basis). - Upside Scenario: - Assumes higher long-term growth rates of real GDP (2 percent) and GDP deflator (1½ percent). - Outcome: net-public-debt-to-GDP ratio declines to 115 percent of GDP (205 percent of GDP on a gross debt basis) by 2030—10 points lower than under the baseline macroeconomic assumptions. - Note: an increase in the inflation rate by 5 percentage points (relative to the baseline assumption) could reduce the debt ratio at most by around 15 percentage points over the long run; average nominal interest rate would catch up quickly (average debt maturity is about 6 years). An even higher inflation rate (e.g., 10 percentage points or higher) could be damaging to real economic activity. ### Sensitivity Analysis and Stochastic Simulations - Debt dynamics are sensitive to macroeconomic assumptions, particularly the nominal interest rate growth differential. - Examples from sensitivity table (Net debt, selected entries shown exactly as in source): - No adjustment scenario, Nominal Interest Rate Growth Differential over the Long Term = 1.0 (baseline): net debt by 2030 = 245. - No adjustment scenario, differential = 2.0: net debt by 2030 = 266. - No adjustment scenario, differential = 4.0: net debt by 2030 = 318. - Policy adjustment scenario, differential = 1.0 (baseline): net debt by 2030 = 124. - Policy adjustment scenario, differential = 2.0: net debt by 2030 = 137. - Policy adjustment scenario, differential = 4.0: net debt by 2030 = 172. - Returning net-public-debt-to-GDP to its pre-crisis level by 2030 would require an adjustment of between 13–15½ percent of GDP depending on the interest rate growth differential. - Stochastic simulations with shocks to growth, inflation, and interest rates show: - Debt dynamics are sensitive to macroeconomic shocks. - In case of severe macroeconomic shocks, the public-debt-to-GDP ratio would continue to rise even under the staff’s policy adjustment scenario. - Implementation of staff’s suggested policy adjustment would prevent debt from exploding in most cases (simulated percentiles shown in figures). ### Contingent Liabilities - Including government guaranteed bonds increases broader general government net debt by about 10 percentage points of GDP. - Including contingent liabilities associated with TEPCO and regional banks would have a modest additional impact (1-3 percentage points). - Specific contingent liability assumptions: - Contingent liabilities associated with TEPCO: maximum support of 1.9 percent of GDP (9 trillion yen) including a capital injection through the Nuclear Damage Liability Facilitation Fund is counted as contingent liabilities. - Contingent liabilities associated with regional banks: assumed at 0.75 percent of GDP (based on the maximum capital injection estimated in the 2012 FSAP update). - Compensation and related costs paid directly by the government for TEPCO are included in the scenario excluding contingent liabilities at ¼ percent of GDP. - Table excerpts (Net public debt excluding/including contingent liabilities, selected entries shown exactly as in source): - No adjustment scenario excluding contingent liabilities, 1.0 (baseline): net debt by 2030 = 245. - No adjustment scenario including government guaranteed bonds, 1.0 (baseline): net debt by 2030 = 335. - Policy adjustment scenario excluding contingent liabilities, 1.0 (baseline): net debt by 2030 = 124. - Policy adjustment scenario including government guaranteed bonds, 1.0 (baseline): net debt by 2030 = 214. ### Key Findings and Implications - Without additional adjustment, net public debt could rise to about 245 percent of GDP (335 percent gross) by 2030. - The authorities’ current plan (consumption tax to 10 percent by 2015) improves the structural primary balance by 5 percent of GDP but is insufficient to stabilize the debt ratio (net debt around 200 percent of GDP by 2030). - A comprehensive policy adjustment of 10 percent of GDP improvement in the structural primary balance over the next decade could place debt on a declining path (net debt to about 124 percent of GDP by 2030 under baseline assumptions). - Higher nominal GDP growth (upside scenario) materially aids debt dynamics, but inflation alone has limited long-run payoff because nominal interest rates adjust relatively quickly given an average debt maturity of about 6 years. - Contingent liabilities and guarantees materially worsen headline debt metrics and should be taken into account in fiscal risk management. *Source: Appendix II. Japan: Public Sector Debt Sustainability Analysis, 2012 Article IV Staff Report* ### ANNEX I. STATISTICAL ISSUES ### ANNEX I. STATISTICAL ISSUES ### Data adequacy and standards - 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 the coverage, periodicity, and timeliness of data. - A data module mission for a Report on the Observance of Standards and Codes (data ROSC) was hosted by the Japanese authorities on 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. ### Japan: Table of Common Indicators Required for Surveillance (as of June 20, 2012) - Exchange Rates - Date of Latest Observation: June 2012 - Date Received: June 2012 - Frequency of Data: DDD - Frequency of Reporting: Every 10 days - Frequency of Publication: Every 10 days - International Reserve Assets and Reserve Liabilities of the Monetary Authorities - Date of Latest Observation: 6/10/2012 - Date Received: 6/12/2012 - Frequency of Data: Every 10 days - Frequency of Reporting: Every 10 days - Frequency of Publication: Every 10 days - Reserve/Base Money - Date of Latest Observation: May 2012 - Date Received: June 2012 - Frequency of Data: M - Frequency of Reporting: M - Frequency of Publication: M - Data Quality – Methodological soundness: LO, LO, LO, LO - Data Quality – Accuracy and reliability: O, O, O, O, O - Broad Money - Date of Latest Observation: May 2012 - Date Received: June 2012 - Frequency of Data: M - Frequency of Reporting: M - Frequency of Publication: M - International Investment Position - Date of Latest Observation: 2012 Q1 - Date Received: June 2012 - Frequency of Data: Q - Frequency of Reporting: Q - Frequency of Publication: Q - Central Bank Balance Sheet - Date of Latest Observation: 6/10/2012 - Date Received: 6/12/2012 - 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 2012 - Date Received: June 2012 - Frequency of Data: M - Frequency of Reporting: M - Frequency of Publication: M - Interest Rates - Date of Latest Observation: June 2012 - Date Received: June 2012 - Frequency of Data: D - Frequency of Reporting: D - Frequency of Publication: D - Consumer Price Index - Date of Latest Observation: April 2012 - Date Received: May 2012 - Frequency of Data: M - Frequency of Reporting: M - Frequency of Publication: M - Data Quality – Methodological soundness: O, LO, O, O - Data Quality – Accuracy and reliability: O, O, LO, O, O - Revenue, Expenditure, Balance and Composition of Financing – General Government - Date of Latest Observation: 2010 - Date Received: Jan 2012 - Frequency of Data: A - Frequency of Reporting: A - Frequency of Publication: A - Data Quality – Methodological soundness: O, LNO, O, O - Data Quality – Accuracy and reliability: LO, O, O, O, LO - Revenue, Expenditure, Balance and Composition of Financing – Central Government - Date of Latest Observation: 2010 - Date Received: Jan 2012 - 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 2012 - Date Received: May 2012 - Frequency of Data: Q - Frequency of Reporting: Q - Frequency of Publication: Q - External Current Account Balance - Date of Latest Observation: Apr 2012 - Date Received: June 2012 - Frequency of Data: M - Frequency of Reporting: M - Frequency of Publication: M - Data Quality – Methodological soundness: O, O, LO, O - Data Quality – Accuracy and reliability: LO, O, O, O, O - Exports and Imports of Goods and Services - Date of Latest Observation: Apr 2012 - Date Received: June 2012 - Frequency of Data: M - Frequency of Reporting: M - Frequency of Publication: M - GDP/GNP - Date of Latest Observation: 2012 Q1 - Date Received: Jun 2012 - Frequency of Data: Q - Frequency of Reporting: Q - Frequency of Publication: Q - Data Quality – Methodological soundness: O, O, O, O, - Data Quality – Accuracy and reliability: LO, LO, O, O, LNO - Gross External Debt - Date of Latest Observation: Mar 2012 - Date Received: June 2012 - Frequency of Data: Q - Frequency of Reporting: Q - Frequency of Publication: Q (Note: footnotes in the table describe coverage details, frequency codes D/W/M/Q/A/I/NA, and DQAF-based assessments indicating O, LO, LNO, NO, NA.) ### Fund relations (As of May 31, 2012) - I. Membership Status: Joined 8/13/1952; Article VIII - II. General Resources Account - Quota: 15,628.50 SDR (100.00 percent) - Fund holdings of currency: 12,920.74 SDR (82.67 percent) - Reserve Tranche Position: 2,708.15 SDR (17.33 percent) - Lending to the Fund: 7,454.01 (SDR, listed) - III. SDR Department - Net cumulative allocation: 12,284.97 SDR (100.00 percent) - Holdings: 12,903.57 SDR (105.04 percent) - IV. Outstanding Purchases and Loans: None - V. Latest Financial Arrangements: None - VI. Projected Obligations to Fund (SDR Million; Based on Existing Use of Resources and Present Holdings of SDRs) - Charges/Interest: 0.14 (2012), 0.14 (2013), 0.14 (2014), 0.14 (2015) - Total: 0.14 0.14 0.14 0.14 - VII. Exchange Rate Arrangement - Japan maintains a free floating exchange rate regime. - Since the 2011 Article IV consultation, Japan intervened on two occasions: - August 4, 2011: purchased 4.5 trillion yen worth of U.S. dollars. - October 31–November 4, 2011: purchased 9.1 trillion yen worth of U.S. dollars. - The exchange system is free of restrictions on payments and transfers for current international transactions except for security-related restrictions notified pursuant to Executive Board Decision No. 144-(52/51). ### Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) - Japan underwent an assessment of its AML/CFT framework by the Financial Action Task Force (FATF) and the Asia/Pacific Group (APG) in 2008. - The 2008 mutual evaluation report highlighted significant deficiencies in: - customer due diligence requirements, - the criminalization of terrorist financing, - the freezing of terrorist assets. - Japan reported to the FATF in 2010, 2011 and 2012 that measures are being taken to address some of the deficiencies identified in 2008. ### Article IV Consultation — Key macroeconomic findings and forecasts - Background and recent performance - The March 2011 Great East Japan earthquake caused major disruptions including supply-chains and reductions in electricity supply; Thai floods in late 2011 also impacted exports. - Real GDP contracted by ¾ percent in 2011. - Real GDP grew at a seasonally adjusted annual rate of 4¾ percent in 2012 Q1, driven by reconstruction spending, pickup in private consumption, and inventory rebuilding. - Headline inflation was -0.2 percent (year-on-year) in June 2012. - Core inflation, excluding food and energy, was -0.6 percent (year-on-year) in June 2012. - External sector and financial market developments - The trade balance moved into deficit in 2011: 1/3 percent of GDP (first annual deficit since 1980). - Current account surplus remained about 1½–2 percent of GDP in 2011 and early 2012 due to sizable investment income earnings. - Since mid-2011: equity prices declined by about 15 percent; yields on 10-year JGBs fell to near 70–80 basis points; the yen appreciated by about 8 percent in nominal effective terms. - Forecasts - 2012: economy expected to expand by almost 2½ percent, helped by public reconstruction spending of around 1½ percent of GDP and recovering consumer demand. - 2013: recovery forecast to slow to 1½ percent as reconstruction winds down. - Medium-term growth expected to converge to around 1 percent as aging population slows potential growth. - Fiscal outlook - Fiscal deficit set to increase to about 10 percent of GDP in 2012. - Structural primary deficit expected to rise slightly to 7½ percent of GDP. - Lower House approved a tax bill to increase the consumption tax to 8 percent in April 2014 and 10 percent in October 2015; Upper House is considering the bill. - If implemented and combined with planned expenditure measures, overall reduction in the structural fiscal deficit would be about 5 percent of GDP over the next decade. - Monetary policy - Bank of Japan adopted a medium to long-term price stability goal of 1 percent in February 2012. - BoJ expanded its Asset Purchase Program by ¥15 trillion in 2012 in two steps and extended JGB purchase maturities from 1–2 years to 1–3 years. - The combined monetary expansion totals about 5 percent of GDP over the next year. - Financial sector stability - FSAP update finds important steps taken since 2003 to strengthen the financial system; regulation and supervision encouraged large banks and insurers to strengthen capital and resilience. - FSAP stress tests indicate near-term resilience of banks and insurers to severe economic distress and moderate market shocks. - Key challenges: raise profitability in low growth environment and manage risks from JGB and equity holdings. ### Executive Board assessment and policy recommendations - Macroeconomic risks and priorities - Directors noted recovery but saw risks tilted to the downside, mainly from escalation of the European crisis and sharper-than-expected slowing in China. - Main long-term challenge: reduce the public debt burden in a low growth environment, address deflation, and manage the impact of a rapidly aging population. - Fiscal policy - Reducing the public debt burden is a key policy priority requiring sustained fiscal consolidation over the next decade. - Directors welcomed the Lower House passage of legislation to double the consumption tax rate to 10 percent by 2015. - Targeted transfers to lower income groups could be considered to address regressive effects of the tax. - Additional fiscal consolidation measures beyond 2015 will be needed to put the public debt ratio on a downward path. - Pension reform is of particular importance to contain social security spending while balancing intergenerational equity. - Structural reforms - Speedy implementation of far-reaching structural reforms is critical to raise growth. - Policies to increase employment of women and older workers and to facilitate immigration could have large payoffs. - Productivity improvements can be achieved by easing regulation in agriculture and services, and participation in additional free trade agreements was encouraged. - Monetary policy - Directors commended the BoJ for adopting a 1 percent inflation goal and generally supported further monetary easing as part of a comprehensive anti-deflation package, while noting limited effectiveness at very low interest rates. - Improved communication of policy intentions was underscored. - Exchange rate policy - Japan’s external position seen as moderately weaker than consistent with fundamentals and desirable policies. - Directors considered Japan should continue to allow the exchange rate to be market determined; intervention could be used to counter volatile or disorderly market conditions. - Financial sector policy - Directors agreed with FSAP findings that the financial system is stable and resilient but highlighted concerns about low bank profitability and large JGB holdings. - Recommendations to safeguard stability included: - strengthen systemic risk monitoring; - improve prudential framework (tighten large exposure limits on bank lending; raise capital requirements for domestically oriented banks); - base assessment of insurers’ solvency on a more refined economic valuation; - strengthen crisis resolution framework for systemically important nonbank financial institutions; - promote more market-based credit intermediation and reduce the role of government to enhance the financial sector’s support for growth. ### Japan: Selected Economic Indicators, 2007–13 (key figures) - Nominal GDP: US$ 5,867 billion (2011) - Population: 127.8 million (2011) - GDP per capita: US$ 45,900 (2011) - Quota: SDR 15,628.5 million - Growth (percent change) — Real GDP: 2007: 2.2; 2008: -1.0; 2009: -5.5; 2010: 4.4; 2011: -0.7; 2012: 2.4 (Proj.); 2013: 1.5 (Proj.) - Domestic demand: 2007: 1.1; 2008: -1.3; 2009: -4.0; 2010: 2.7; 2011: 0.1; 2012: 3.0 (Proj.); 2013: 1.5 (Proj.) - Private consumption: 2007: 0.9; 2008: -0.9; 2009: -0.7; 2010: 2.6; 2011: 0.1; 2012: 2.7 (Proj.); 2013: 1.7 (Proj.) - Business investment: 2007: 4.9; 2008: -2.6; 2009: -14.3; 2010: 0.5; 2011: 1.1; 2012: 3.2 (Proj.); 2013: 4.8 (Proj.) - Government consumption: 2007: 1.1; 2008: -0.1; 2009: 2.3; 2010: 2.1; 2011: 1.9; 2012: 2.0 (Proj.); 2013: -0.5 (Proj.) - Public investment: 2007: -5.9; 2008: -7.4; 2009: 7.0; 2010: 0.4; 2011: -3.6; 2012: 6.3 (Proj.); 2013: -12.5 (Proj.) - Net exports (contribution to GDP growth) and trade: - Net exports: 2007: 1.1; 2008: 0.2; 2009: -1.5; 2010: 1.7; 2011: -0.8; 2012: -0.5 (Proj.); 2013: 0.0 (Proj.) - Exports of goods and services: 2007: 8.7; 2008: 1.4; 2009: -24.2; 2010: 24.2; 2011: -0.1; 2012: 3.1 (Proj.); 2013: 5.0 (Proj.) - Imports of goods and services: 2007: 2.3; 2008: 0.3; 2009: -15.7; 2010: 11.1; 2011: 5.9; 2012: 7.4 (Proj.); 2013: 5.7 (Proj.) - Inflation (annual average) - CPI: 2007: 0.1; 2008: 1.4; 2009: -1.3; 2010: -0.7; 2011: -0.3; 2012: 0.2 (Proj.); 2013: 0.0 (Proj.) - GDP deflator: 2007: -0.9; 2008: -1.3; 2009: -0.5; 2010: -2.1; 2011: -2.1; 2012: -0.1 (Proj.); 2013: -0.1 (Proj.) - Unemployment rate (annual average): 2007: 3.8; 2008: 4.0; 2009: 5.1; 2010: 5.1; 2011: 4.6; 2012: 4.5 (Proj.); 2013: 4.4 (Proj.) - Government (percent of GDP) - General government revenue: 2007: 31.2; 2008: 31.6; 2009: 29.6; 2010: 29.6; 2011: 30.6; 2012: 30.9 (Proj.); 2013: 31.4 (Proj.) - General government expenditure: 2007: 33.3; 2008: 35.7; 2009: 40.0; 2010: 39.0; 2011: 40.7; 2012: 40.9 (Proj.); 2013: 39.9 (Proj.) - General government balance: 2007: -2.1; 2008: -4.1; 2009: -10.4; 2010: -9.4; 2011: -10.1; 2012: -9.9 (Proj.); 2013: -8.6 (Proj.) - Primary Balance: 2007: -2.1; 2008: -3.8; 2009: -9.9; 2010: -8.7; 2011: -9.2; 2012: -8.8 (Proj.); 2013: -7.4 (Proj.) - Public Debt, gross: 2007: 183.0; 2008: 191.8; 2009: 210.2; 2010: 215.3; 2011: 229.9; 2012: 234.5 (Proj.); 2013: 240.0 (Proj.) - Money and credit (percent change, end-period) - Base money: 2007: 0.4; 2008: 1.8; 2009: 5.2; 2010: 7.0; 2011: 13.5 - M2 (period average): 2007: 2.1; 2008: 1.8; 2009: 3.1; 2010: 2.3; 2011: 3.2 - Domestic credit: 2007: -2.3; 2008: 1.6; 2009: 0.4; 2010: 1.3; 2011: 0.8 - Bank lending: 2007: 0.7; 2008: 4.6; 2009: -0.9; 2010: -1.8; 2011: 0.7 - Interest rates (end-period / annual average) - Overnight call rate, uncollateralized (end-period): 2007: 0.46; 2008: 0.10; 2009: 0.09; 2010: 0.1; 2011: 0.1 - Three-month CD rate (annual average): 2007: 0.5; 2008: 0.5; 2009: 0.3; 2010: 0.3; 2011: 0.3 - Official discount rate (end-period): 2007: 0.75; 2008: 0.30; 2009: 0.30; 2010: 0.3; 2011: 0.3 - Balance of payments (in billions of US$) - Current account balance: 2007: 212.2; 2008: 159.8; 2009: 146.6; 2010: 204.0; 2011: 119.2; 2012: 130.3 (Proj.); 2013: 167.0 (Proj.) - Percent of GDP: 2007: 4.9; 2008: 3.3; 2009: 2.9; 2010: 3.7; 2011: 2.0; 2012: 2.2 (Proj.); 2013: 2.7 (Proj.) - Trade balance: 2007: 105.1; 2008: 38.4; 2009: 43.4; 2010: 91.0; 2011: -20.5; 2012: -10.2 (Proj.); 2013: 35.1 (Proj.) - Percent of GDP (trade balance): 2007: 2.4; 2008: 0.8; 2009: 0.9; 2010: 1.7; 2011: -0.3; 2012: -0.2 (Proj.); 2013: 0.6 (Proj.) - Exports of goods, f.o.b.: 2007: 678.4; 2008: 746.5; 2009: 545.3; 2010: 730.1; 2011: 787.2; 2012: 807.4 (Proj.); 2013: 830.0 (Proj.) - Imports of goods, f.o.b.: 2007: 573.3; 2008: 708.0; 2009: 501.9; 2010: 639.1; 2011: 807.7; 2012: 817.6 (Proj.); 2013: 795.0 (Proj.) - Oil imports (trade basis): 2007: 130.1; 2008: 190.6; 2009: 99.9; 2010: 134.3; 2011: 185.0; 2012: 227.8 (Proj.); 2013: 233.7 (Proj.) - FDI, net (percent of GDP): 2007: -1.2; 2008: -2.2; 2009: -1.2; 2010: -1.1; 2011: -2.0; 2012: -1.3 (Proj.); 2013: -1.3 (Proj.) - Terms of trade (percent change): 2007: -2.1; 2008: -9.6; 2009: 19.5; 2010: -3.3; 2011: -7.9; 2012: 3.9 (Proj.); 2013: 7.0 (Proj.) - Change in reserves: 2007: 36.5; 2008: 30.8; 2009: 27.3; 2010: 44.3; 2011: 177.0 - Total reserves minus gold (in billions of US$): 2007: 95.2; 2008: 100.9; 2009: 102.2; 2010: 109.6; 2011: 1258.2 - Exchange rates (annual average) - Yen/dollar rate: 2007: 117.8; 2008: 103.4; 2009: 93.6; 2010: 87.8; 2011: 79.8 - Yen/euro rate: 2007: 161.4; 2008: 152.1; 2009: 130.3; 2010: 116.5; 2011: 111.0 - Real effective exchange rate (2000=100, based on normalized unit labor costs): 2007: 83.6; 2008: 93.7; 2009: 110.5; 2010: 118.2; 2011: 126.2 - Real effective exchange rate (CPI-based): 2007: 83.2; 2008: 90.1; 2009: 101.5; 2010: 102.7; 2011: 104.4 *Source: ANNEX I. STATISTICAL ISSUES, _cr12208 - ANNEX I. STATISTICAL ISSUES (IMF, 2012).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12208.pdf_