Japan: Staff Concluding Statement of the 2023 Article IV Mission
IMF News, January 26, 2023
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- Published: January 26, 2023
Recent economic developments, outlook, and risks
- Recovery drivers: pent-up demand, supply chain improvements, border reopening, and policy support.
- Inflation: accelerated in recent months; Japan core inflation (i.e., excluding fresh food) recorded levels not seen in four decades.
- Near-term outlook:
- Output gap projected to close in 2023.
- Core inflation projected to peak in the first quarter of 2023 and gradually decline to below 2 percent by end-2024.
- Current account surplus estimated at 1.8 percent of GDP in 2022.
- External position preliminarily assessed as broadly in line with medium-term fundamentals and desirable policies.
- Risks:
- Downside: deepening geo-economic fragmentation and geopolitical tensions; abrupt slowdown of the global economy; outbreaks of new lethal and highly contagious COVID-19 variants; lingering supply-side constraints; natural disasters; debt sustainability; cyberthreats; abrupt change of the current monetary policy framework.
- Upside: stronger recovery of consumption (especially services) and stronger-than-expected recovery of inbound tourism.
Near-term policy challenge and overall economic policy stance
- Main challenge: ensure that the 2 percent inflation target is reached durably, without overshooting significantly, while preserving financial stability; medium-term priority is to reduce fiscal vulnerabilities and transition to a more dynamic, resilient, and inclusive economy.
- Monetary policy: overall accommodative stance remains appropriate given risk of inflation falling back below the 2 percent target by end-2024 without substantial acceleration in wage growth.
- Flexibility recommendation: consider more flexibility in longer-term yields to better manage two-sided inflation risks and to facilitate a smoother transition to a neutral monetary stance if warranted.
- Communication: changes in monetary policy settings should be well communicated.
- Macroprudential: should seek to curb financial sector vulnerabilities.
- Fiscal: pandemic-related fiscal support should be withdrawn more quickly; new measures should be limited and targeted to vulnerable households.
- Labor income: steps needed to boost labor income and achieve a virtuous cycle of income and growth.
Fiscal policy — assessment and recommendations
- Recent fiscal stance:
- Primary fiscal deficit expected to stay elevated in 2023 following the October 2022 fiscal package.
- The large fiscal package narrowed already limited fiscal space and could add to inflation, possibly requiring stronger monetary tightening.
- Medium- and long-term outlook:
- Under current policies, public debt-to-GDP ratio will increase steadily in the medium and long term.
- Primary deficit in percent of GDP projected to decline in the near term as stimulus phases out, but to rise in the medium and long term to accommodate age-related spending pressures.
- With public debt-to-GDP ratio on an upward path, interest rates could increase suddenly, and sovereign stress could emerge.
- Fiscal consolidation: warranted to rebuild fiscal buffers and ensure debt sustainability; should be growth-friendly and credible.
- Measures to bolster fiscal framework:
- Adopting more realistic projections:
- Cabinet Office projections have historically been too optimistic; more realistic scenarios and sensitivity analysis are warranted.
- A fiscal council could be tasked to evaluate the realism of macro-projections.
- Strengthening the fiscal framework:
- Budget expenditure ceilings do not limit actual expenditures due to frequent supplementary budgets.
- Reform budget process to ensure binding expenditure ceilings and consistency between the annual budget and medium-term fiscal targets.
- Supplementary budgets should be infrequent and deployed only for exceptionally large macroeconomic shocks.
- Balancing debt sustainability and protecting growth:
- Continue to assess progress towards the FY2025 primary balance target, weighing consolidation against the need for support if adverse shocks materialize.
- Fiscal consolidation requires revenue and expenditure measures. Suggested areas:
- Contain health and long-term care costs:
- Improve spending efficiency and target measures such as increasing copayments for high-income seniors.
- Increase government revenues (options include):
- Unifying and raising the consumption tax standard rate.
- Increasing corporate taxation.
- Strengthening property taxation by removing the preferential treatment of residential land.
- Rationalizing allowances and deductions in personal income taxation.
- Raising the capital income tax rate.
- Increasing premiums of social insurance.
- Strengthen the safety net:
- Address gap for the working poor; consider an earned income tax credit (EITC) scheme to provide tax credits for low-income earners and rationalize untargeted transfers.
Monetary policy — assessment and options
- Current assessment:
- Accommodative monetary policy remains appropriate but must be supported by policies to improve productivity and real wages to achieve 2 percent sustainably.
- Exceptionally high uncertainty around baseline inflation projections with risks tilted to the upside.
- Upside inflation risks: delayed effects of exchange rate depreciation, border reopening, second-round effects of imported inflation, fiscal support, and higher-than-expected wage growth.
- Downside risks: global slowdown, rigidity in inflation expectations, and prolonged weak wage growth.
- BoJ holdings and market functioning:
- BoJ holds close to 70 percent of outstanding 5-year and 10-year JGBs.
- Purchases have reduced liquidity in the JGB market and distorted the yield curve; market surveys indicate sharp deterioration in bond market functioning.
- BoJ modified the yield curve control (YCC) framework at the December monetary policy meeting.
- Options to allow further flexibility and increases in long-term yields (BoJ could consider):
- Widening the 10-year target band and/or raising the 10-year target.
- Shortening the yield curve target.
- Shifting from a JGB yield target to a quantity target of JGB purchases.
- Considerations:
- Widening the 10-year band is a minor adjustment but must be wide enough for market forces to play a leading role.
- Quantity-based approach avoids defending a particular yield level but requires state-contingent adjustment of purchase quantities.
- Shorter-term yield target ensures short-term yields remain low (important for real activity) but may retain costly side-effects of targeting yield levels.
- Contingency: if significant upside inflation risks materialize, monetary stimulus withdrawal will have to be much stronger — short-term rates may have to rise much earlier and above the neutral rate.
- Foreign exchange intervention (FXI):
- Authorities intervened in 2022 amid significant yen volatility.
- Yen depreciation since March 2022 largely reflects interest rate differentials; analysis suggests depreciation exceeded underlying drivers after June.
- FXI can lower excessive volatility and keep yen movements aligned with fundamentals but effects are likely temporary; use should be limited to special circumstances (disorderly markets, risks to financial stability, concerns about de-anchoring inflation expectations).
Preserving financial stability
- Banking sector: remains resilient with capital adequacy and liquidity ratios above regulatory requirements.
- Pressures: valuation losses on overseas securities holdings and higher foreign currency funding/hedging costs have weighed on financial institutions.
- US dollar liquidity resilience: major internationally active banks increasingly rely on more stable foreign-currency funding sources since mid-2010s, but steady efforts to further improve resilience to US dollar liquidity stress are warranted, including assessing risks due to unused committed credit lines at elevated levels.
- Credit risks and vulnerabilities:
- Monitor developments in credit risks, especially exposures to leveraged overseas borrowers and large domestic borrowers in a global slowdown.
- Some regional banks more exposed to yen depreciation via credit to non-exporting firms, though overall system impact is limited.
- Liquidity conditions of firms unable to pass rising raw material costs to prices should be monitored.
- Housing/household risks:
- Credit imbalances are high by historical standards (partly due to the sharp drop in GDP at pandemic outset).
- Growth in housing prices moderate relative to peers, but increasing loan-to-income ratios, rising share of borrowers with high debt servicing ratios, and large fraction of floating-rate mortgages warrant vigilance.
- Consider macroprudential policies to curb vulnerabilities from growth in housing loans.
- Policy tapering implications:
- Continue vigilance as pandemic-related support measures taper and consider reducing public credit guarantee ratio for new loans.
Supporting the New Form of Capitalism — labor, innovation, and inclusion
- Three dimensions to boost income growth: labor supply, wage growth, and productivity.
- Labor supply:
- Promote female and senior labor supply.
- Advance work-style reforms including telework; remove social security and tax distortions related to dependent spouses; remove obstacles to employment of older persons.
- Wage growth:
- Encourage higher wage growth through structural reforms: reduce labor market duality, improve mobility, shift to job-based employment, and merit-based pay.
- Productivity:
- Strengthen workforce in STEM fields: training and reskilling for existing workers, encourage more students (especially women) to pursue STEM, raise returns to STEM education via merit-based promotions and flexible work arrangements.
- Startups and open innovation:
- Holistic approach addressing labor market constraints, financing, and entrepreneurial education.
- Support venture capital; address constraints of personal guarantees; strengthen entrepreneurial education and universities as startup hubs.
- Fiscal incentives can be used to increase return on investment, especially in ICT technology and R&D, to encourage firms to invest amid higher cash holdings and rising intangible capital.
- Digital transformation and public sector digitalization:
- Digital Agency should continue coordination and implementation; progress includes expanding “My Number” digital ID cards.
- Data sharing between government agencies remains limited, impairing targeted transfers to vulnerable households.
- Support standardization of local government IT systems and linking “My Number” to provision of public and private services.
- Private sector digital transformation should be supported with IT training, data privacy, digital literacy, consumer protection, and cybersecurity.
- Corporate governance and trade:
- Continue reforms to ensure effective corporate governance practices and disclosure.
- Continue working with international partners to strengthen the rules-based multilateral trading system, including ensuring effective WTO dispute settlement.
Transitioning to a low-carbon economy (Green Transformation, GX)
- Current GX strategy: centered on public investment in decarbonization and green technology financed by GX bonds; government to provide incentives for private funding.
- Carbon pricing:
- Government committed to expand carbon pricing from current low levels from FY2028; details not yet decided.
- Other actions:
- Sectoral plans under development; plans to restart nuclear power plants and consider new facilities.
- FSA published “Supervisory Guidance on Climate-related Risk Management and Client Engagement”.
- BoJ and FSA completed pilot scenario analysis on climate-related risks with major banks and insurers.
- BoJ disbursed about 0.6 percent of GDP to banks in its funds-supplying operations to support climate finance.
- Policy recommendations:
- Comprehensive policy package with green investments to decarbonize electricity and transport and gradually rising carbon pricing for a growth-friendly path to targets.
- Without strong carbon pricing, achieving targets would be difficult and more costly.
- Regulatory actions and elimination of untargeted subsidies for gas, electricity, and fuel would support transition.
- Climate policies should protect vulnerable people and enable orderly transition of high-emission sectors.
- Green finance should support funding of green and transition activities and management of climate-related financial risks.
Key selected economic indicators (high-level)
- Nominal GDP: US$ 5,006 Billion (2021)
- GDP per capita: US$ 39,883 (2021)
- Population: 126 Million (2021)
- Quota: SDR 30.8 billion (2021)
- Real GDP growth (in percent change)
- 2019: -0.4
- 2020: -4.3
- 2021: 2.1
- 2022: 1.4
- 2023 (Proj.): 1.8
- 2024 (Proj.): 0.9
- Selected components (in percent change, period average where indicated)
- Domestic demand 2019–2022: 0.0; -3.4; 1.1; 1.6
- Private consumption 2019–2022: -0.6; -4.7; 0.4; 2.2
- Gross Private Fixed Investment 2019–2022: 0.2; -5.4; 2.8; 1.9
- Business investment 2019–2022: -0.7; -4.9; 2.0; 3.6
- Residential investment 2019–2022: 4.1; -7.9; -1.1; (no 2022 entry)
- Government consumption 2019–2021: 2.4; 3.5; 0.1
- Public investment 2019–2022: 3.4; -1.9; -6.8; 1.7
- Stockbuilding 2019–2021: -0.1; -0.5; -0.2
- Exports of goods and services 2019–2022: -1.5; -11.6; 11.7; 4.7
- Imports of goods and services 2019–2022: 5.1; 7.0; (no 2021 entry)
- Output Gap (in percent)
- 2019: 0.7
- 2020: -2.9
- 2021: -1.6
- 2022: -0.9
- Inflation (in percent change, period average)
- Headline CPI 2019–2021: 0.5; 2.5; (no 2021 entry)
- GDP deflator: (no numbers provided in source)
- General government (in percent of GDP)
- Revenue 2019–2022: 34.2; 35.5; 36.6; 36.8; 35.6
- Expenditure 2019–2022: 37.3; 44.6; 42.8; 44.8; 42.2; 39.7
- Overall Balance 2019–2024: -3.0; -9.1; -6.2; -8.0; -6.6; -4.2
- Primary balance 2019–2024: -2.4; -8.4; -5.6; -7.7; -6.5; -4.1
- Structural primary balance 2019–2021: -2.6; -7.5; -7.6
- Public debt, gross 2019–2024: 236.4; 258.7; 255.4; 258.3; 255.7; 256.4
- Macro-financial and balance-sheet indicators
- Base money (end-of-period change, percent) 2019–2022: 19.2; 8.5; -5.0; 3.8
- Broad money 2019–2021: 7.4; 2.9; (no 2021 entry)
- Credit to the private sector 2019–2021: 3.2; 6.1; 4.0
- Non-financial corporate debt in percent of GDP 2019–2022: 139.3; 152.1; 155.7; 154.6; 153.6; 152.6
- Balance of payments (in billions of USD and percent of GDP where provided)
- Current account balance (in billions): 176.3; 147.9; 197.3; 76.7; 129.9; 159.5
- Percent of GDP (current account): 3.9; 3.1; 3.7; (other years no entries)
- Trade balance (in billions): 26.6; 15.6; -116.5; -71.1; -41.3; 0.3; -2.8; -1.7; -1.0 (table formatting preserved as in source)
- Exports of goods, f.o.b. (in billions): 695.0; 630.6; 748.6; 758.1; 779.4; 802.9
- Imports of goods, f.o.b. (in billions): 693.6; 604.0; 732.9; 874.6; 850.5; 844.3
- Energy imports (in billions): 131.9; 89.1; 127.8; 177.3; 147.4; 135.8
- Change in reserves (in billions): 25.5; 10.9; 62.8; 20.0; 11.5
- Total reserves minus gold (in billions of US$): 1286.3; 1348.2; 1356.2
- Exchange rates (period average where indicated)
- Yen/dollar rate: 109.0; 106.8; 109.8
- Yen/euro rate: 122.0; 121.9
- Real effective exchange rate (ULC-based, 2010=100): 75.1; 74.1; 70.7
- Real effective exchange rate (CPI-based, 2010=100): 76.6; 77.3
- Demographic indicators
- Population Growth: -0.3
- Old-age dependency 2019–2024: 47.6; 48.3; 48.7; 48.9; 49.3; 49.8
Japan: Staff Concluding Statement of the 2023 Article IV Mission