IMF Completes 2009 Article IV Consultation Discussions With Japan

by Mike Godfrey, Tax-News.com, Washington

01 June 2009

An IMF team has held discussions with senior government officials, the Bank of Japan (BoJ), and private sector representatives.

The extent of fiscal stimulus given should support growth significantly this year and next, but growth momentum is expected to remain weak as the export collapse spills over to domestic demand and financial conditions remain tight. On the assumption of a pickup in global growth, a sustained recovery should take hold during the course of 2010. The outlook remains subject to high uncertainty, with 'risks tilted to the downside'.

From the monetary policy point of view, the measures taken by the Bank of Japan have gone a long way towards easing the tightness of credit and reinforcing confidence in the institutions. If necessary, there is scope for further easing; the IMF would like to see the Bank of Japan being even more open to the general public in explaining its objectives and guiding market expectations. An explicit commitment to low short term interest rates until prices recover would, in the opinion of the IMF, help fulfil the objective of capping longer term rates.

The fiscal stimulus has widened the deficit significantly and on current trends, net public debt could rise to about 135% by 2014. Japan’s cumulative stimulus spending is sizable at almost 5% of GDP, well above the G20 average. However the IMF considers that, if the recession persists longer than expected, there is scope for more stimulus measures in 2010 - measures which should be targeted and reversible. This depends on an adequate medium term consolidation strategy supported by greater public awareness of its necessity over time. The IMF posited a possible change in emphasis in the drive for public support from the size of the current fiscal deficit to the extent of public debt. The target would then be to cap the public debt ratio. In any case, the IMF regards spending cuts and tax reform as necessary for such consolidation, including a commitment to raise consumption tax after the recovery takes hold. The need to achieve medium-term fiscal sustainability is most apparent when it comes to raising funds through Japanese Government Bond (JGB) issuances, which may rise as high as 30% of GDP in 2009. In the short term, risks are contained, since little reliance is placed traditionally on capital inflows from abroad, but the capacity to absorb JGBs in the domestic market is likely to diminish.

On current policies, potential growth could fall from about 1.75% in 2007 to close to 1% per annum over the medium term, while structural rigidities prevent a reallocation of labour and capital from export-oriented sectors to domestic services. The IMF states: "Given the need to absorb excess labour and reallocate capital, the short-term emphasis should be on reforms which create new investment and job opportunities. Concerted efforts to deregulate the agricultural and services sectors—including medical, child, and elderly care are needed to create new drivers for growth and job creation. Further reforms in the areas of inward FDI and financial market development could also support rebalancing. In light of the sharp increase in unemployment, difficult labour market reforms could be put on hold for now, but pressures to reduce market flexibility should be resisted."

Preliminary conclusions will be expanded on in the Fund's forthcoming Article IV report after considering feedback from Japan and an Article IV Board meeting in July.

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