2014 Article IV Consultation with Japan - Concluding Statement of the IMF Mission
IMF News, May 30, 2014
Source details
- Canonical URL
- 2014 Article IV Consultation with Japan - Concluding Statement of the IMF Mission
Other formats
Bibliographic details
- Published: May 30, 2014
Macro outlook and near-term assessment
- Date and location: Tokyo, May 30, 2014.
- Overall judgment:
- Abenomics has been successful in planting the seeds for a more dynamic Japan.
- The near-term outlook remains favorable and the economy is expected to weather well the consumption tax increase.
- Over the medium term, transitioning to self-sustaining growth requires greater structural and fiscal reform efforts to avoid slipping back into deflation, overburdening monetary policy, and undermining confidence in the sustainability of government debt.
- Growth and inflation projections and observations:
- Staff projects growth of 1.4 percent in 2014 and to remain above potential at 1 percent in 2015.
- Annual inflation—excluding the temporary impact of the consumption tax increase—is projected at 1.1 percent in 2014 (calendar year).
- Staff expects that 2-percent inflation will be achieved by 2017.
- Near-term dynamics:
- Preliminary GDP data for the first three months of 2014 suggest stronger-than-anticipated rush demand ahead of the consumption tax increase; a consumption payback in Q2 will cause a sharp growth contraction, with recovery expected in the second half of the year.
- Business investment is picking up, labor markets are tightening, capacity utilization is rising, and exports are forecast to rise on the back of last year’s yen depreciation and robust partner-country demand.
- Risks:
- Near-term risks are balanced (possible higher growth offset by external risks).
- External risks include a sharper-than-expected moderation of growth in China and geo-political risks (Ukraine, Thailand) that could raise energy prices, disrupt supply chains, trigger safe-haven appreciation, and weaken inflation momentum.
- Key medium-term tail risk: a sharp rise in bond yields if monetary policy becomes overburdened and markets lose faith in policies restoring fiscal sustainability.
Structural reforms: progress, gaps, and recommended measures
- Diagnosis:
- Structural factors are a brake on growth and perpetuate a deflationary mindset and passive firm behavior.
- Staff projects potential growth to remain below 1 percent over the medium term due to declines in the working-age population from aging.
- Rising share of non-regular workers is impeding wage and productivity growth; weaknesses in corporate governance are holding back investment; barriers to entry and exit in the SME sector undermine growth and job creation.
- Progress noted:
- Energy sector deregulation, creation of farmland banks, agricultural subsidy and Government Pension Investment Fund (GPIF) reforms.
- Launch of the JPX Nikkei 400 index.
- Potential gains from a Trans Pacific Partnership agreement and strategic economic zones (SEZs) if they remove investment barriers.
- Specific recommended measures:
- Increase labor supply and productivity:
- Raise employment of women and older workers and accept more foreign labor.
- Faster roll-out of child care facilities; gradually raise the retirement age; relax immigration restrictions in areas with labor shortages.
- Reform spousal deduction in the income tax and social security legislation to remove disincentives to work.
- Address labor market duality through contract reform to stimulate productivity growth and increase pass-through of labor market tightness into higher wages.
- Enhance risk capital provision and corporate dynamism:
- Reduce reliance on personal guarantees, increase sharing of credit information, and expand asset-based lending.
- Allow unprofitable firms to exit or restructure; scale back credit guarantees for SMEs; encourage out-of-court workouts.
- For households, introduce individual savings accounts and consider raising the 5-year term limit and the maximum contribution limit.
- Implement comprehensive corporate governance reform:
- Complement Stewardship Code with a corporate governance code for firms.
- Expand use of independent outside directors beyond current plans.
- Further deregulate agriculture and domestic services:
- Permit agricultural land ownership by corporations.
- Clarify specific regulatory measures governing SEZs to encourage investment.
Fiscal policy: current stance, risks, and recommendations
- Recent actions and near-term stance:
- Successive consumption tax increases are critical to establish a track record of fiscal discipline.
- The first increase in April was a major achievement; going ahead with the increase to 10 percent would strike the right balance between establishing fiscal policy credibility and preserving the recovery.
- Concern that the increase in October 2015 could harm low-income households; equity concerns are best addressed through targeted subsidies rather than reducing tax rates on essential items.
- Fiscal risks and consolidation needs:
- Despite consecutive consumption-tax increases, the gross debt-to-GDP ratio will remain above 240 percent.
- Staff estimates that fiscal consolidation of at least 10 percent of GDP is needed over the next decade to put the debt-to-GDP ratio on a downward trajectory.
- About half of the adjustment is expected to come from the second consumption tax rate increase, winding down of stimulus and reconstruction spending, and expenditure restraint; a sizeable gap of yet to be identified measures remains.
- Recommended fiscal framework and measures:
- A post-2015 fiscal consolidation plan is urgently needed; it should be growth friendly and equitable and allow near-term flexibility.
- Options include gradually increasing the consumption tax to at least 15 percent, broadening the personal income tax base, and taking measures to contain pension and health care spending.
- The consolidation should be grounded in a stronger fiscal framework through adoption of medium-term rules to curb expenditures in the context of multi-year budget planning and limits on the use of supplementary budgets.
- Corporate income tax (CIT) considerations:
- Reducing the CIT rate would likely raise investment and growth but would not be self-financing and would add to fiscal consolidation needs; offsetting revenue and expenditure measures are required.
- Limited scope exists for CIT base broadening; removal of some allowances (such as for accelerated depreciation) and incentives (R&D) could weaken investment effects of a rate cut.
- Options to limit fiscal risks: announce new tax schedule and identify offsetting revenue sources upfront, phase in rate reductions over time.
- Alternative: consider an Allowance for Corporate Equity (ACE) system to encourage investment in a more cost-effective way.
Monetary policy: evaluation and guidance
- Assessment of BoJ actions:
- Monetary easing by the BoJ is delivering anticipated effects: actual and expected inflation steadily progressing toward the 2-percent target, with notable rise in bank lending, including to SMEs.
- Increasing asset purchases now to raise the probability of meeting the target sooner is not needed; policy space should be preserved to address downside risks.
- Operational guidance:
- The current aggressive pace of monetary easing may need to be maintained for an extended period; providing more information about asset purchases beyond end-2014 could further enhance transparency.
- The BoJ should act quickly if actual or expected inflation stagnates or growth disappoints. Policy options include expanding purchases of private assets and government bonds, and further lengthening the maturities of assets being purchased.
- Expand the Loan Support Program by increasing the size, reducing the funding cost, and lengthening the term beyond the current 4 years.
- Risks of prolonged easing and exit considerations:
- Sustained easing without complementary reforms would raise risks to financial stability and complicate the exit.
- Each year that the Quantitative and Qualitative monetary Easing (QQE) program is maintained, the BoJ will add approximately 5 percent of the outstanding stock of JGBs to its existing holdings, estimated at 23 percent at end 2014.
- Continuing QQE in current form for too long could impair market liquidity or give rise to financial stability risks as asset prices could become disconnected from fundamentals.
- Structural and fiscal reforms are critical to strengthen policy transmission and facilitate an earlier exit from QQE.
- Communication:
- BoJ communication has been effective, but could better explain the indicators used to assess whether inflation is on track.
- When exit comes in sight, the criteria for determining whether inflation has been sustainably achieved should be spelled out.
External position and exchange rate assessment
- External balance judgment:
- The external position is broadly in line with fundamentals, provided Abenomics succeeds in raising inflation, growth, and restoring debt sustainability.
- The yen’s large depreciation last year has not led to an improvement in Japan’s trade balance, partly because of temporarily higher imports including due to rush demand ahead of the consumption tax increase.
- Expectation is that the external balance will strengthen as temporary effects fade and exports pick up.
- Compared to the prior year, Japan’s external balance will not improve beyond levels consistent with fundamentals and the implementation of growth and fiscal reforms because exports have become less responsive to exchange rate movements.
- The shift of manufacturing production abroad and lower competitiveness in certain industries—notably parts of the electrical machinery and appliances sector—contain export growth.
Financial sector stability: improvements and emerging risks
- Current strengths:
- Financial sector stability has further improved.
- Major financial institutions’ capital positions have benefited from securities trading income and valuation gains on equity holdings.
- QQE has reduced interest rate risk for major banks which have sold part of their JGB holdings.
- Emerging pressures:
- Declining net interest margins on domestic loans and rising excess reserves are exerting downward pressure on banks’ core profitability.
- Interest rate risk for regional banks remains high; profitability pressures are most evident in the regional banking sector.
- Risks from portfolio rebalancing:
- The search for higher yield by Japanese investors could generate new risks as portfolios are rebalanced.
- Specific concerns and recommended supervisory actions:
- Major banks expanding abroad will face challenges securing stable and long-term dollar funding.
- Supervisors should encourage banks to strengthen funding sources (reduce reliance on FX swaps, issue longer-term dollar-denominated bonds, build depositor base in overseas operations).
- Additional cross-border collateral arrangements could help reduce local-currency funding risks in overseas markets.
- For regional banks, authorities should strengthen capital standards of domestically-active banks, including reassessing treatment of unrealized losses in capital.
- Authorities should develop a strategy to establish a stronger regional banking sector, including through private sector-led consolidation, as recommended by the 2012 FSAP Update.
Global spillovers
- Completing Abenomics and launching all three arrows will create positive spillovers to the region and global economy.
- During its first year, spillovers via the trade channel have been mild, but are expected to increase as exports and imports adjust to the weaker yen, adversely affecting some competitors in the near term.
- Spillovers through capital markets are expected to rise as Japanese investors diversify overseas; these outflows will help cushion the effects of tightening global financial conditions, including in emerging economies.
- Positive spillovers will dominate so long as Japan proceeds with its reform agenda.
- Spillovers could turn negative if monetary easing is not supported by fiscal and structural reforms, leading to further yen depreciation, concerns about fiscal sustainability, and potentially higher interest rates.
We are grateful to the authorities for their generous hospitality and very constructive discussions.