Japan: Staff Concluding Statement of the 2017 Article IV Mission
IMF News, June 19, 2017
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- Published: June 19, 2017
Mission summary and key findings
- The current momentum in the Japanese economy provides an opportunity to push forward with reforms that will enhance growth and inflation prospects and mitigate medium-term risks.
- Recent gains are vulnerable: a significant share of recent growth is tied to a favorable external environment and temporary fiscal stimulus.
- Five years into Abenomics, gaps remain between outturns and targets for inflation and the fiscal position.
- Demographic headwinds and an unprecedented level of public debt generate significant medium-term policy challenges.
- A comprehensive, macro-critical package—built around structural reforms and income policies—is needed to make the most of monetary accommodation and available fiscal space.
Context: recent economic developments and policies
- Abenomics outcomes since 2012:
- Eased financial conditions, increased corporate profits, boosted employment and female labor force participation.
- Structural reforms advanced in energy and agricultural liberalization, trade and investment promotion, and corporate governance.
- Revised national accounts indicate more robust GDP growth during 2013-15.
- Recent performance:
- Economy expanded above potential for five consecutive quarters.
- Private consumption turned positive in 2016; private investment strengthened.
- Unemployment at record lows; job offer-to-applicants ratio at an all-time high.
- 2016 current account surplus: income account accounts for about 90 percent of the surplus.
- Real exchange rate appreciated substantially between 2015 and 2016 to a level consistent with medium-term fundamentals.
- Policy backdrop:
- Monetary: September 2016 introduction of “yield curve control” (YCC) including a commitment to overshoot the inflation target.
- Fiscal: Postponement of the planned 2 percentage point consumption tax hike (to October 2019) and a 1.5 percent of GDP supplementary fiscal package raising spending mainly in 2017.
Core vulnerabilities and macro-financial challenges
- Inflation and labor
- Inflation remains stubbornly low; widespread labor shortages have yet to translate into sustained wage growth.
- Low labor mobility, preference for job security, and wage setting linked to past inflation hinder wage-price dynamics.
- Financial sector pressures
- Low interest rates have reduced profitability and induced search-for-yield behavior, increasing less-understood risks for banks and insurers.
- Credit growth picked up in the last quarter of 2016; overseas investment and real estate lending increased.
- Sovereign-financial linkages remain high.
- Large corporate cash holdings increased as corporate saving-investment balance strengthened.
- Structural reform gaps
- Work Style Reform has potential (equal pay for equal work; overtime cap; childcare expansion) but implementation timelines are long and some design gaps exist.
- Deregulation and corporate governance reforms have not yet spurred private investment as intended.
- Efforts to eliminate tax and social security disincentives to regular work have been limited (only a minor revision to the threshold for the spousal tax deduction allowance).
Outlook and numeric projections
- Growth
- Growth momentum is expected to continue in 2017 but would weaken in 2018 if fiscal stimulus fades as currently planned.
- Without additional spending, fiscal stance could become contractionary in 2018–20 due to expiration of stimulus and the scheduled consumption tax hike in October 2019.
- Inflation projections
- 2017 average inflation is expected to rise to 0.7 percent, supported by higher energy prices and a narrowing output gap.
- 2018 average inflation is projected to fall to 0.6 percent as growth slows.
- Inflation is likely to remain below the 2 percent target over the medium term absent reforms affecting wage dynamics.
- Fiscal consolidation benchmark
- The medium-term fiscal consolidation plan should embed a gradual approach, with an annual consolidation in the structural primary balance of 0.5 percent of GDP on average in accordance with the evolution of the economy.
- Consumption tax recommendation
- A gradual, pre-announced schedule of consumption tax rate hikes (of 0.5 to 1.0 percentage points in regular intervals, starting as soon as possible and continuing until the rate reaches at least 15 percent) while preserving the unitary structure of the tax.
Risks to the outlook
- Downside risks are tilted and include:
- Retreat from cross-border integration.
- Deflation from a sharp yen appreciation driven by geopolitical instability.
- Loss of confidence in domestic policies.
- Market risks from a decline in equity prices or a sharp increase in JGB yields.
- FX funding liquidity risk in some internationally active regional banks.
- Disorderly rebalancing in China.
- In the medium term, doubts about fiscal sustainability could trigger a jump in the sovereign risk premium forcing abrupt fiscal adjustment.
- Chronic low bank profitability and demographic headwinds could cause solvency problems for regional and Shinkin banks; life insurers could face solvency pressures if low interest rates continue.
Policy priorities and recommendations
- Overarching approach
- Implement a comprehensive and mutually reinforcing package of accelerated structural reform, coordinated monetary and fiscal support, and enhanced financial sector policies.
- Exploit synergies between monetary, fiscal, income, and structural policies.
- Clear communication and consistent policy implementation to reduce uncertainty and improve outcomes.
- Structural reforms (prioritized)
- First priority: Labor market reforms to increase productivity and boost wages.
- Promote “intermediate” job contracts to reduce gaps between regular and non-regular workers.
- Enhance worker mobility across firms.
- Accelerate “equal pay for equal work” and introduce job descriptions.
- Second priority: Reforms to increase private investment and long-term growth.
- Remove barriers to entry (i.e., in the telecoms and gas sectors); deregulate professional services.
- More ambitious corporate governance reforms (e.g., stronger requirements for outside directors; explicit limits on cross-shareholdings).
- Boost trade and FDI and advance SEZ deregulation.
- Financial sector policies to reduce SMEs’ financing constraints: facilitate banks’ move to risk-based lending and lower coverage of public credit guarantees.
- Third priority: Measures to diversify and enhance labor supply.
- Further support female and older worker labor force participation; increase use of foreign labor.
- Eliminate tax and social-security disincentives to full-time work.
- Increase availability of childcare and nursing facilities; reduce excessive overtime; support managerial practices that reward performance.
- Discourage firms from setting a mandatory retirement age.
- Coordinated monetary and fiscal support
- Monetary policy:
- Maintain a sustained accommodative stance.
- Carefully calibrate yield curve policy; further strengthen communication, including publishing staff forecasts of inflation and phasing out references to annual JGB purchase targets.
- Fiscal policy:
- Near-term fiscal stance should be at least broadly neutral in 2018, avoiding scheduled withdrawal of fiscal stimulus.
- Expansionary fiscal stance could be considered depending on reform ambition, macro conditions, and credibility of medium-term fiscal framework.
- Use the interim fiscal review planned for 2018 to strengthen the framework (limit reliance on supplementary budgets; use more independent and realistic growth assumptions).
- Curb social security spending through fundamental reforms to protect fiscal sustainability.
- Income policies:
- Raise administratively controlled wages annually in line with the inflation target.
- Further incentivize profitable companies to raise wages by at least three percent each year.
- Prioritize fiscal incentives for intermediate contracts, active labor market policies, and expanded childcare provision.
- Financial sector policies and resilience
- Enhance financial oversight to contain risks:
- Develop internal processes for full risk-based prudential supervision.
- Strengthen corporate governance across banking and insurance sectors.
- Tailor capital requirements to individual bank risk profiles.
- Implement an economic-value-based solvency regime for insurance with clarity on the future regime.
- Clarify the mandate of the Council for Cooperation on Financial Stability (CCFS) and proactively expand the macroprudential toolkit.
- Engagement and resolution:
- Further engage with bank boards and senior management to address viability risks and facilitate exit of unviable firms.
- Facilitate regional banks’ transition to higher fee-based income; consolidation may provide economies of scale but is not sufficient alone.
- Strengthen the crisis management and resolution framework: reduce complexity and ambiguity, embed early-intervention supervisory powers, expand the resolution toolkit, clarify legal framework (including extension to central counterparties (CCPs)), and improve operational readiness.
- Spillovers
- Accelerated structural reform and a credible medium-term fiscal consolidation plan would support growth, domestic demand, imports, and prices—mitigating inward spillovers from external developments.
- No significant spillovers from YCC to financial conditions in other economies were identified.
Implementation and sequencing
- Prioritize reforms that facilitate reflation (labor market and income policies), followed closely by reforms to lift potential growth.
- Coordinate monetary easing, near-term fiscal support, and income policies to strengthen wage-price dynamics and ensure reforms do not create deflationary pressures.
- Use the 2018 interim fiscal review to strengthen fiscal framework credibility and limit reliance on supplementary budgets.
Source: Japan: Staff Concluding Statement of the 2017 Article IV Mission — June 19, 2017