Japan: Staff Concluding Statement of the 2019 Article IV Mission
IMF News, November 25, 2019
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- Published: November 25, 2019
Summary findings
- Japanese economy continues to grow above potential but moderated by a weaker external environment and rising downside risks.
- Reinvigorated policies are needed to: (i) boost potential growth; (ii) reflate the economy; and (iii) make public debt sustainable.
- A comprehensive, coordinated strategy should entail: (i) continued accommodative monetary policy coordinated with financial sector policies to mitigate growing financial stability risks; (ii) a well-specified medium-term fiscal framework with identified revenue and expenditure measures; and (iii) ambitious labor, product market, and corporate reforms.
Recent economic developments and policies
- Real GDP growth is projected to be above potential at 0.8 percent in 2019.
- Unemployment is at its lowest rate since 1993, but total hours worked are declining and the output gap remains negative.
- Headline inflation momentum has eased; core-core inflation (excluding food and energy) remains stable at around 0.5 percent.
- Consumption tax rate increased by two percentage points on October 1, 2019; accompanying countermeasures include: point-reward program for cashless payments in SMEs; tax allowance for automobile and house purchases; infrastructure investment; additional spending for childcare and tertiary education.
- Bank of Japan (BoJ) policy since 2016: negative short-term interest rate (at -10 bps) and a zero-percent yield target for 10-year Japanese Government Bonds (JGBs); under Yield Curve Control (YCC) framework, BoJ has reduced JGB purchases.
- Relative to one year earlier, the JGB yield curve has flattened with yields up to the 10-year maturity falling into negative territory—reducing net lending margins of banks and investment income of insurers and pension funds and inducing riskier asset allocations.
- Structural reforms: planned "equal pay for equal work" regulations (from April 2020); regulated cap on overtime effective for large firms since April 2019; new residency status for foreign workers enacted April 2019 with relatively strict qualification requirements; revisions to the 2015 Corporate Governance Code have not substantially reduced cross-shareholdings.
- Trade developments: Japan-European Union Economic Partnership and Comprehensive and Progressive Agreement for Trans-Pacific Partnership took effect in February 2019 and December 2018, respectively; Japan-U.S. agreements in October 2019 on market access and digital trade; negotiations advanced on Regional Comprehensive Economic Partnership.
- External price effect: higher energy prices important driver of the 2018 current account (CA) surplus decrease.
Outlook and risks
- Growth outlook: Private consumption expected to recover to pre-tax increase levels by end-2021. Growth in 2020-21 driven by domestic demand partly offsetting an expected fall in net exports. Inflation expected to edge up slowly but remain below BoJ’s two-percent target over the medium term.
- Near-term risks:
- A sharp and more-protracted fall in consumption following the consumption tax increase could pose a risk; a supplementary budget in 2019 would boost domestic demand and growth.
- External risks dominated by weaker-than-expected global growth and further de-globalization.
- Abrupt deterioration in market sentiment could lead to heightened risk aversion, yen appreciation, equity market volatility, and macro-financial risks.
- Disruptions in U.S. dollar funding markets could increase funding costs for some Japanese banks.
- Medium-term risks:
- Riskier asset allocations by banks, insurers, and pension funds may lead to balance-sheet deterioration and tighter capital constraints with negative spillovers.
- Market risks from large adverse variations in equity prices and JGB yields could generate large losses for major banks and life insurers.
- Demographic trends will increase age-related government spending, heightening fiscal sustainability concerns and potentially triggering bond market stress.
- External spillovers:
- IMF estimates: a 1 percent decline in Japan’s GDP generates output losses in other Asian countries of about 0.2 percent on average after one year.
- Through September 2019, the yen appreciated by 5 percent (in real effective terms) relative to end-2018.
- Key numeric indicators:
- Real GDP growth projection for 2019: 0.8 percent.
- Core-core inflation: around 0.5 percent.
- BoJ short-term interest rate: -10 bps.
- BoJ YCC zero-percent target for 10-year JGBs.
- 2018 CA surplus: decreased by 0.6 percentage points to 3.5 percent of GDP.
- Population projected to shrink by over 25 percent in the next 40 years under official projections.
Monetary and financial policy recommendations
- Maintain BoJ’s accommodative monetary stance while enhancing policy credibility and sustainability. Specific recommendations:
- Review the price stability target: consider an updated assessment of the inflation level consistent with the price stability objective and the introduction of an inflation range target to increase policy flexibility.
- Consider adopting Inflation Forecast Targeting (IFT) to make policy respond systematically to deviations of BoJ’s inflation forecast from the price stability target.
- Improve communication: simplify policy guidance by abandoning quantity guidance on JGB purchases and delinking the overshooting commitment from the monetary base; replace Board members’ forecasts with a BoJ staff forecast consistent with agreed policy instrument paths.
- Macro-financial measures to mitigate systemic risks:
- Adjust the YCC framework: shift zero-percent YCC target from the 10-year JGB yield to a shorter maturity and reduce purchases of longer-term JGBs to steepen the yield curve.
- Activate the countercyclical capital buffer (CCyB): consider raising the CCyB above its current zero percent level and expand its coverage to domestic credit exposures of all domestic banks, not just internationally active ones.
- Strengthen prudential supervision and regulation: intensify risk assessment, complete macroprudential toolkit, tailor capital requirements, and promote forward-looking loan-loss provisioning.
- Support regional banks’ business-model adjustment through revenue diversification, better IT/Fintech utilization, and consolidation.
- Strengthen crisis management and resolution framework, for example by extending Total Loss-Absorbing Capacity requirements to all D-SIBs, and progress toward economic-value-based solvency regime for insurance.
Fiscal policy recommendations
- Maintain a neutral fiscal stance in 2020 and, if warranted by data, in 2021—coordinated with continued monetary accommodation. The 2019 consumption tax revenue increase will be largely offset by expenditure increases and revenue losses from mitigating measures, making the 2019 fiscal stance broadly neutral.
- Near-term fiscal measures to support growth and social needs:
- Extend consumption tax countermeasures in 2020.
- Further increase wages of workers in childcare, health and long-term care sectors to match rising demand while containing social security spending.
- Reinforce income policies and protect the most vulnerable: commit to corporate tax incentives for wage increases, higher minimum wages, increases in administratively-controlled wages and social transfers; set administered prices by a mechanism reflecting costs with safeguards for low-income households.
- Support structural reforms: fiscal measures to raise childcare availability, strengthen firms’ incentives to provide childcare and nursing-care, enhance non-regular workers’ productivity, and boost R&D investment.
- Medium-term fiscal sustainability framework:
- Adopt realistic growth and fiscal projections, including realistic assumptions for TFP growth and public spending growth.
- Factor aging costs into macro-fiscal projections. IMF staff scenarios suggest financing aging costs would require the consumption tax rate to increase gradually to 15 percent by 2030 and to 20 percent by 2050.
- Strengthen redistribution: gradually increase the rate of taxation on capital gains (part of the Financial Income Tax) from the current flat rate of 20 percent to 30 percent, starting in 2022; alternatively consider re-introduction of a wealth tax with zero or very few exemptions, a high threshold, and a low flat rate.
- Consider raising the carbon tax together with measures to support vulnerable households.
- Improve budgetary transparency by limiting frequency and size of supplementary budgets to reduce policy uncertainty.
- Reform public social security programs:
- Pension: address projected funding gap under conservative scenarios if the committed replacement ratio of 50 percent is maintained; options include increasing flexibility for pension drawdowns and expanding the contributions base.
- Healthcare and long-term care: improve efficiency (wider use of generic drugs, rationalization of in- and out-patient care); increase out-of-pocket spending for those over 75 years old and wealthy elderly with safeguards for vulnerable households; reduce scope of covered services and drugs; explore measures to contain long-term care costs including rationalizing services for lower-care needs.
Structural reform priorities
- Structural reforms are essential to offset demographic headwinds. IMF analysis indicates:
- Under current policies, worsening demographics could reduce real GDP by 25 percent in four decades (relative to a scenario where recent performance is maintained).
- Credible implementation of structural reforms, with continued accommodative monetary stance and public debt stabilization, could boost real GDP by as much as 15 percent over the same horizon.
- Key reform areas:
- Labor market reforms: improve the 2018 Work Style Reform to boost productivity and wages; introduce measures to further increase labor supply.
- Regulatory and corporate reforms: advance product and service sector deregulation, SME reforms and corporate governance reforms to lift productivity and investment; promote broader adoption of automation and AI while considering distributional concerns.
- Trade liberalization and FDI promotion: further remove tariff and non-tariff barriers in high-standard multilateral trade agreements to boost investment and growth.
- Coordination: high degree of government commitment to reforms is critical to support reflation via confidence effects on consumption and investment.
External position and spillovers
- 2018 current account surplus decreased by 0.6 percentage points to 3.5 percent of GDP; Japan’s income surplus—stemming from a large NFA position and high net returns—accounted for bulk of CA surplus.
- Higher energy prices contributed to the 2018 CA surplus decline; goods trade balance fell to 0.2 percent of GDP.
- Through September 2019, the yen appreciated by 5 percent (real effective terms) relative to end-2018.
- Projected 2019 CA balance preliminarily assessed as broadly consistent with medium-term fundamentals and desirable policies; 2019 real exchange rate preliminarily assessed as in line with fundamentals and desirable policies.
- Slower growth or tighter financial conditions in Japan could have adverse outward spillovers—estimated IMF effect: a 1 percent decline in Japan’s GDP generates output losses in other Asian countries of about 0.2 percent on average after one year.
- Further advancement of multilateralism would help mitigate adverse inward spillovers from global trade disputes and yen appreciation.
Mission Concluding Statement, Japan: Staff Concluding Statement of the 2019 Article IV Mission