NEWS Release - Japan: Staff Concluding Statement of the 2016 Article IV Mission
A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
Abenomics has made progress in revitalizing the Japanese economy but sustained higher growth and inflation remain elusive. Under current policies, the high nominal growth goal, the inflation target, and the primary budget surplus objective all remain out of reach within the timeframe set by the authorities. Recognizing the risk of falling short, the authorities have responded through easing of monetary and fiscal policies, but the outlook remains weak. Achieving Abenomics’ ambitious targets will therefore require a more substantial, coordinated policy upgrade. Income policies in combination with reforms to tackle labor market duality should move to the forefront, supported by additional monetary and fiscal stimulus in the near term and more credible policy frameworks. The fiscal strategy needs to commit to fiscal consolidation over the medium term and replace large discretionary consumption tax increases with a path of smaller, but sustained increases over a prolonged period. Such a package would make serious headway in achieving the authorities’ objectives, but if it is not forthcoming soon, the timeframe for achieving all targets should be pushed out and policies should be reset for steady but more gradual progress while building risk resilience. This would require embarking on prolonged and cumulatively larger fiscal adjustment and moving explicitly towards a more flexible time frame for achieving the inflation target, while reserving further monetary easing and fiscal stimulus for addressing large shocks.
After initial success, Japan is facing headwinds and policy challenges…
Abenomics has met with initial success. Strong coordination between the Bank of Japan’s (BoJ) unprecedented quantitative and qualitative easing program and fiscal stimulus combined with ambitious structural reforms helped narrow the large output gap, reversed the undue appreciation of the yen, eased financial conditions, boosted corporate profits, and lifted actual and expected inflation into positive territory. The first consumption tax hike locked in considerable fiscal savings. The economy reached full employment and modest, but historically significant, increases in base wages took hold.
But the recovery and progress with reflation stalled.Headline inflation fell back into deflationary territory, dampening base wage growth. Growth dropped towards potential, with consumption and investment remaining sluggish, amid declining sentiment. The yen appreciated in recent months, equity prices declined, and inflation expectations fell anew. Several factors explain the difficulties in achieving sustained lift off:
Structural impediments: Low confidence in economic prospects, related to an aging and shrinking population, is holding back investment and credit demand, constraining portfolio rebalancing. Labor market duality and inflexibility are clogging the pass-through from a tightening labor market and high profits of large firms to wage increases. Weak demand and a lingering deflationary mindset are reducing the ability of firms to raise output prices. The financial sector does not sufficiently support risk taking, limiting access to risk-based capital, as suggested by high reliance of banks on fixed asset collateral and slow restructuring of non-viable SMEs.
Policy shortcomings: The fiscal stance turned out to be too contractionary in 2014, over and above the anticipated consolidation due to the consumption tax hike. The stop-go nature of fiscal policy, with yearly supplementary budgets, discretionary changes in consumption tax hikes, and optimistic growth assumptions underlying medium-term budget projections have left fiscal policy without a credible medium-term anchor and are contributing to policy uncertainty. Weak monetary transmission, sluggish wage-price dynamics, and a falling natural rate of interest are preventing the needed rise in inflation expectations, creating a communication and credibility challenge for the BoJ. Structural reform efforts did not sufficiently address the above-mentioned structural impediments, notably in the labor market.
Global weakness and volatility: Sluggish global growth and overcapacity in the traded goods sector, prevented the weaker yen from materially boosting exports. Concerns in emerging markets and revisions to the expected path of monetary policy in advanced economies led to heightened volatility in financial markets and safe haven appreciation pressures. Declining commodity prices did not boost activity as expected, but instead put downward pressure on headline inflation and forced the BoJ to repeatedly push out its timeline for hitting the inflation target.
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