Public Information Notice: IMF Executive Board Concludes 2007 Article IV Consultation with Japan

August 6, 2007

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2007 Article IV Consultation with Japan is also available.

Public Information Notice (PIN) No. 07/96
August 6, 2007

On July 27, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Japan.1


The current economic expansion is well into its sixth year. In 2006, GDP grew at 2.2 percent, led mainly by business investment and net exports. After slowing in mid-year, private consumption rebounded and activity has regained pace. Labor markets continue to tighten, but wage growth is still sluggish. Inflation remains low, as core CPI inflation (excluding fresh food) averaged 0.1 percent (year-on-year) in 2006 and since February, has dipped below zero—mainly due to lower energy and communication prices. The GDP deflator continues to fall, but the pace of decline has moderated and other indices, such as service and land prices, are on a rising trend.

Japan's external position remains strong. Boosted by investment income, the current account surplus widened in 2006 to nearly 4 percent of GDP, despite a shrinking trade balance. Financial outflows also picked up, reflecting mainly the secular decline in investor home bias and to a lesser extent, yen-financed carry trades. Japan's exchange rate is market-determined, and there have been no official interventions in the foreign exchange market since March 2004. In 2006, the yen depreciated against the U.S. dollar and the euro by 5½ percent and 6¼ percent, respectively. After depreciating more this year, the yen in real effective terms is at its weakest in about 20 years.

The financial and corporate sectors continue to strengthen. Bank nonperforming loans fell further in 2006, while capital ratios improved. Progress at regional banks has been more uneven. Corporate profits reached record highs, and leverage is at a 50-year low. With lending rates favorable and stock prices rising, financial conditions remain easy.

Fiscal consolidation has proceeded faster than expected, but the public debt ratio is still high. Supported by buoyant corporate tax collection and sustained spending cuts, the primary deficit for the general government (excluding social security) is projected to decline further to about 1 percent of GDP in FY2007 from over 5 percent of GDP four years ago. However, at above 80 percent of GDP, net public debt is one of the highest among Organisation for Economic Co-operation and Development (OECD) countries and is still rising.

Monetary conditions remain supportive of the expansion. With no signs of inflation pressures or worrisome financial imbalances, the Bank of Japan (BoJ) has opted for a gradual pace of adjustment—two quarter point hikes since July 2006.

The near-term economic outlook is favorable. GDP growth is projected at 2.6 percent in 2007 and 2.0 percent in 2008, increasingly driven by domestic demand. With activity close to full capacity, CPI inflation is expected to pick up, but very slowly. The risks are balanced, with downside risks mostly external (an unanticipated slowdown in the United States, volatile energy prices, or global financial turbulence), while a tightening labor market could lead to faster consumption.

Over the medium term, growth is expected to slow to potential—estimated at around 1.7 percent—and for the current account to narrow modestly. This scenario assumes a continued strengthening of the financial and corporate sectors, a shrinking labor force, and fiscal consolidation in line with the authorities' plans. Deeper structural reforms could raise potential growth and narrow further the current account.

Executive Board Assessment

Executive Directors welcomed Japan's continued economic expansion and its solid underpinnings. Supported by appropriate macroeconomic and structural policies, growth has become more broad-based; the financial and corporate sectors have strengthened further, and the labor market continues to improve. Directors took note that inflation remains very low but expected it to pick up gradually as the economy operates close to full capacity.

Directors observed that Japan's recovery has been accompanied by greater financial and trade linkages with the global economy that are creating new challenges for policies. In this regard, Directors stressed that achieving fiscal sustainability, promoting sustained non-inflationary growth, strengthening further the financial system, and boosting productivity through additional structural reforms would help Japan reap more fully the benefits from globalization.

Directors commended the authorities for the progress in reducing the fiscal deficit. They noted, however, that the public debt-to-GDP ratio still remains uncomfortably high, and most Directors encouraged the authorities to accelerate the pace of consolidation. Directors agreed that putting the debt ratio firmly on a downward trajectory will make room for the fiscal costs of population aging, buy "policy insurance" against adverse shocks, support private confidence, and improve overall growth prospects with positive international spillovers.

Most Directors considered that given the size of the task at hand, additional revenue measures will be needed, including for base broadening. They indicated that revenue measures could be best identified in the context of a broad reform of the tax system that addresses the challenges posed by Japan's aging society and globalization. Among possible measures, increasing the consumption tax has the benefit of being less detrimental to growth and equitable across generations. Some Directors, however, viewed the authorities' focus on expenditure adjustments as broadly appropriate at this juncture.

Directors considered that monetary policy remains appropriately accommodative, given very muted inflation risks. Some Directors pointed out that low interest rates in Japan are contributing to capital outflows, including speculative carry trades, that complicate policy setting in some recipient countries. On balance, Directors agreed that monetary policy should remain focused on domestic price stability. With no signs of worrisome financial imbalances, a return to a neutral monetary stance should proceed in tandem with inflation prospects. Many Directors considered that to better guide expectations, communication of the monetary framework could rely more on forward-looking policy statements and a greater emphasis on the 1 percent median within the Policy Board members' range of understanding on price stability.

Directors felt that, with the health of the banking system improving, financial policies are rightly focused on the challenges ahead. They urged the authorities to maintain regulatory vigilance and ensure sound risk management by financial institutions in the face of a growing appetite for risky assets. Directors also highlighted the need to raise core profitability of banks, press ahead with reforms of government financial institutions, and further develop the capital markets.

Directors stressed that deeper structural reforms are needed to improve Japan's growth potential and competitiveness. The reform priorities are to improve labor utilization and promote competition through greater market opening and further deregulation. As highlighted by the recent Multilateral Consultation, such reforms would also facilitate an orderly resolution of global current account imbalances.

Directors agreed that the yen should continue to be market determined. They noted the staff's assessment that—notwithstanding the appropriate focus of macroeconomic and structural policies—the yen appears to be undervalued relative to its longer-term value in real effective terms, although this reflects, in part, a waning home bias of Japanese investors and their greater demand for foreign assets. Several Directors noted factors that the Consultative Group on Exchange Rate Issues (CGER) methodology does not fully take into account, including in cases where the exchange rate is market determined. Directors felt that the yen could be expected to appreciate over time, supported by policy reforms to boost domestic demand—although capital outflows related to Japanese portfolio rebalancing might slow the adjustment. In this regard, Directors supported the authorities' policy of limiting intervention to counter disruptive exchange rate movements. Continued careful monitoring of exchange rate developments and their impact on the regional and global economy will be needed in the period ahead.

Directors urged the Japanese authorities to do their utmost to help secure a balanced and ambitious Doha Round agreement and seek provisions in Economic Partnership Agreements that limit trade diversion and work effectively on a regional level.

Japan: Selected Economic Indicators
  2003 2004 2005 2006 2007  

Real GDP

1.4 2.7 1.9 2.2 2.6  

Private consumption

0.4 1.6 1.6 0.8 1.7  

Nonresidential investment

4.4 5.6 6.6 7.5 4.4  

Residential investment

-1.0 1.9 -1.3 1.0 0.8  

Public investment

-10.8 -9.0 -6.2 -7.4 -3.8  

Public consumption

2.3 1.9 1.7 0.4 0.8  

Stockbuilding (contribution to growth)

0.2 0.3 -0.1 0.1 0.0  

Foreign balance (contribution to growth)

0.7 0.8 0.3 0.8 0.8  

Exports of goods and services

9.2 13.9 7.0 9.6 7.5  

Imports of goods and services

3.9 8.1 5.8 4.5 2.8  



GDP deflator

-1.6 -1.1 -1.3 -0.9 -0.7  

CPI (SA) 1/

-0.2 0.0 -0.6 0.2 0.0  

CPI (NSA) 1/

-0.2 0.0 -0.3 0.2 0.0  

Unemployment rate (period average, percent)

5.3 4.7 4.4 4.1 3.9  

Current account balance


Billions of U.S. dollars

136.2 172.1 165.7 170.4 181.7  

Percent of GDP

3.2 3.7 3.6 3.9 4.2  

General government balances (percent of GDP, FY)


Balance including social security

-7.7 -5.5 -4.3 -4.0 -3.5  

Balance excluding social security

-7.9 -6.0 -4.5 -3.9 -3.5  

Structural balance 2/

-6.9 -4.9 -4.0 -3.9 -3.5  

Money and credit (12-month growth rate; end period)


Base money

13.2 4.2 1.0 -20.0 -4.1


M2 + CDs (period average) 4/

1.7 1.9 1.8 1.1 1.8


Bank lending 4/

-2.0 -1.2 1.1 2.8 1.6


Exchange and interest rates (period average)


Yen/dollar rate

115.9 108.2 110.2 116.3 119.3


Yen/euro rate

131.1 134.5 137.3 146.0 163.6


Real effective exchange rate 6/

80.6 79.7 76.0 70.5 64.1


3-month CD rate

0.09 0.06 0.06 0.22 0.55


10-year government bond yield

1.00 1.51 1.39 1.74 1.80



Sources: Global Insight, Nomura database and Fund staff estimates and projections.
1/ Annual growth rates are calculated from annual averages of monthly data.
2/ Including social security, excluding bank support.
3/ June 2007.
4/ From April 1998 onward, data reflect the inclusion of foreign banks, foreign trust banks and Shinkin banks in the monetary survey.
5/ July 31, 2007.
6/ Based on normalized unit labor costs; 2000 = 100. Figure for 2007 is as of June.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.


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