IMF Executive Board Concludes 2015 Article IV Consultation with Japan
A modest economic recovery is underway. GDP is expected to grow at an above-potential pace this year (0.8 percent) buoyed by gradually strengthening private consumption on higher real wages and a gradual recovery of external demand. Inflation remains well below the Bank of Japan’s 2 percent target partly due to commodity price developments, but will start to pick up toward the end of this year with the dissipation of the negative effects of falling oil prices and higher wage growth.
Long-term prospects have improved modestly by ongoing structural reforms. Growth is projected to stabilize at around 0.7 percent over the medium-term with improvements in productivity and capital formation and higher labor force participation offsetting headwinds from the diminishing labor force. On the back of the closing of the output gap, a tight labor market and renewed favorable wage-price dynamics, inflation is expected to increase gradually to about 1.5percent over the medium term under current policies. However, risks to this outlook are tilted to the downside with the most important risks stemming from weak domestic demand and incomplete policies, particularly with regard to the fiscal consolidation and structural reforms.
Abenomics needs to be reloaded so that policy shortcomings do not become a drag on growth and inflation. In addition to swift implementation of already announced reforms, further high-impact structural reforms are urgently needed to lift growth, facilitate fiscal consolidation, and unburden monetary policy. The next round of reforms should lift labor supply, reduce labor market duality, continue with agricultural and services sector deregulation and turn the financial sector into a driver of reforms.
A credible medium-term fiscal consolidation plan is needed to remove uncertainty about the direction of policies that may be holding back domestic demand. The medium-term fiscal reform plan should aim to put debt on a downward path, based on realistic economic assumptions, and specify structural revenue and expenditure measures upfront. The Bank of Japan needs to stand ready to ease further, provide stronger guidance to markets through enhanced communication, and put greater emphasis on achieving the 2 percent inflation target in a stable manner. However, further monetary easing without bolder structural reforms and a credible medium-term fiscal consolidation plan could lead to sluggish domestic demand and overreliance on yen depreciation to pursue domestic policy objectives, with possible adverse spillovers abroad.
Executive Board Assessment
Executive Directors welcomed the recovery and the improved medium-term outlook for growth and inflation. Directors concurred that a firming of the outlook was essential to address downside risks from weaker than-expected-domestic demand, low profitability of the financial system, and possible shocks to the sovereign risk premium. Directors agreed that it would be essential to strengthen all elements of the government’s economic strategy to lift growth and create benefits for the global economy.
Directors emphasized the need for bold structural reforms to face the challenge of a rapidly shrinking labor force and make progress toward achieving the welcome, but ambitious growth objectives of the authorities’ revitalization strategy. They commended the recent progress in a number of areas, including corporate governance reform and reforms to raise female labor force participation. Directors urged more vigorous efforts in other areas to raise labor supply, reduce labor market duality, deregulate agriculture and services sectors and turn the financial system into a catalyst for growth.
Directors agreed that the fiscal consolidation strategy needed to strike a balance between making progress in deficit reduction and supporting growth and inflation momentum. They welcomed the recent announcement of a medium-term fiscal consolidation plan with firm primary deficit targets. To impart further credibility to the fiscal strategy, Directors concurred that the adoption of prudent economic assumptions, upfront identification of concrete structural revenue and expenditure measures to put the public debt-to-GDP ratio on a clear downward trajectory and the strengthening of fiscal institutions would be helpful.
Directors noted that raising inflation to the 2 percent target remained challenging. They encouraged the authorities to continue to strengthen wage-price dynamics, through emphasis on wage growth in the tripartite dialogue, encouragement of risk-taking in the financial sector, and if needed, further monetary policy action. In particular, they felt that the Bank of Japan could provide stronger guidance to markets through enhanced communication and put greater emphasis on achieving the inflation target in a stable manner. Directors agreed that the financial system remained sound and that financial sector policies should continue to focus on bolstering the resilience of the financial system to market and credit risks, including higher volatility in the JGB market.
Directors noted that Japan’s external position in 2014 had been broadly in line with medium-term fundamentals and desirable policies. They observed that the further depreciation of the yen relative to its 2014 average and improvement in Japan’s terms of trade, while beneficial for the domestic economy, made it important for the authorities to continue with bold structural reforms and credible fiscal consolidation to avoid overreliance on depreciation of the yen [in the pursuit of domestic policy objectives].
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