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MISSION CONCLUDING STATEMENT 


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 * 日本語


JAPAN: STAFF CONCLUDING STATEMENT OF THE 2024 ARTICLE IV MISSION

February 8, 2024

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.



Washington, DC: The Japanese economy continues to recover from the pandemic.
Initially driven by cost-push factors, inflation is becoming demand driven with
the output gap closed and labor shortages intensifying . In the near term, the
focus should shift to tighten fiscal policy and wind down unconventional
monetary policy, while maintaining financial stability. In the medium term, the
priority is to rebuild fiscal buffers, strengthen the fiscal framework, and
advance structural reforms, with labor market reforms at the forefront, to
support potential growth.

RECENT DEVELOPMENTS, OUTLOOK, AND RISKS



The economic recovery picked up in 2023 and the output gap is estimated to have
closed. Core inflation (excluding fresh food and energy) seems to have peaked at
a high level and is becoming demand driven. Measures of underlying inflation
show that the current above-target inflation is broad-based across products and
services for the first time in three decades. Wages are rising, albeit less than
inflation, amid labor shortages.

The economic recovery is expected to continue. Growth is projected to decelerate
in 2024, owing to fading of one-off factors that supported growth in 2023,
including a surge in inbound tourism. Japan’s preparedness will help mitigate
the economic impact of the Noto Peninsula Earthquake. Core inflation is expected
to decline gradually as the effect of higher import prices wanes. A closed
output gap and increasing nominal wages will keep core inflation above the
two-percent target until the second half of 2025. The primary fiscal deficit
will remain sizable in 2024, reflecting the impact of the latest fiscal stimulus
package. The current account surplus is expected to increase in 2024, supported
by higher exports and lower import prices. The external position is assessed as
broadly in line with the level implied by medium-term fundamentals and desirable
policies.

Risks to growth and inflation are broadly balanced. For growth, downside risks
are mainly driven by external factors, including a slowdown in the global
economy, deepening geoeconomic fragmentation, and more volatile food and energy
prices. On the domestic side, the main downside risks are continued low real
household income growth if inflation continues to outpace wage growth, more
acute labor shortages that could constrain activity, and a return to a
zero-inflation environment. On the upside, additional recovery of inbound
tourism and a stronger global economy could support growth. For inflation,
upside risks stem from backward-looking inflation expectations and significantly
stronger-than-expected wages following the spring wage negotiations. Downside
risks could come from a faster decline in global goods and import prices and
weaker-than-expected increases in wages in the spring negotiation.

ECONOMIC POLICIES



Fiscal Policy



Given a closed output gap and high debt-to-GDP ratio, the large,
not-well-targeted fiscal stimulus in the November package was not warranted.
Additional expenditure should have been offset by higher revenues or expenditure
savings elsewhere. Given its temporary nature and Japanese households’ low
propensity to consume, the untargeted income tax cut is expected to have a
limited impact on growth, while worsening the debt dynamics. In addition, energy
subsidies can distort energy consumption and hamper decarbonization initiatives
and should be replaced with targeted transfers to vulnerable households.

Under current policies, the public debt-to-GDP ratio will increase steadily in
the long term to accommodate age-related spending pressures. Additional planned
spending on defense, green transformation, digital transformation, and
children-related policies are expected to weigh on the fiscal balance and should
be offset by sustainable revenues. In the near and medium term, the real
interest rate-growth dynamics will remain favorable and support lower debt
levels, despite a gradual rise in interest rates. However, lower potential
growth reflecting an aging and declining working age population will push up
debt levels in the long term. The sovereign risk and debt sustainability
analysis found that gross financing needs are elevated but rollover risks are
mitigated by the large domestic investor base and by the debt profile, with the
overall risk of debt distress assessed as moderate.

Fiscal consolidation is needed to rebuild fiscal buffers and ensure debt
sustainability, underpinned by both revenue and expenditure measures. This can
be achieved by limiting untargeted transfers with a low fiscal multiplier or
phasing out energy subsidies, while mobilizing revenues to offset additional
expenditure policies. Detailed proposals are:

 * Revenue mobilization. The following options should be considered: i) unifying
   and increasing the consumption tax rate; ii) strengthening financial income
   taxation for high-income earners; iii) reinforcing property taxation by
   eliminating preferential treatment for residential land; iv) rationalizing
   allowances and deductions in personal income taxation; and v) increasing
   premiums for social insurance.

 * Health expenditure.Reforms to contain the cost of health care while
   preserving its quality should be considered. These include: i) an increase in
   copayments for high-income or wealthy seniors; ii) higher usage of generic or
   over-the-counter drugs; iii) increased adoption of prescription refilling;
   iv) enhanced preventative medical care; and v) more targeted covered services
   and drugs.

 * Children-related spending. There is limited evidence that untargeted cash
   transfers are effective in supporting fertility, based on international
   experience. The efficiency of children-related spending could be enhanced
   through a further expansion of childcare facilities and workstyle and labor
   market reforms, which could also close gender gaps.

 * SME support. Some pandemic-related measures and subsidies initiated before
   the pandemic are still in effect. A comprehensive assessment of the necessity
   and effectiveness of these measures is necessary to rationalize expenditure
   and to improve productivity.

· The authorities should continue to strengthen the medium-term fiscal
framework, as part of the review planned in FY2024:

 * More realistic assumptions. Fiscal policy planning should be grounded in more
   realistic assumptions on growth, revenue, and expenditure measures. An
   independent fiscal council could be tasked with evaluating the realism of
   macro projections.

 * Governance of state funds. State funds are typically formed outside the
   annual budgetary control system by the national government, and approximately
   one-third of them do not have a specified termination point. This weak
   governance structure leads to inefficiencies in spending and undermines
   budgetary discipline. The authorities should set a clear exit plan for each
   state fund to enhance better fiscal management.

 * Discipline the formulation of supplementary budgets. Budget expenditure
   ceilings set in the initial budgets do not work well in controlling final
   government expenditures given the established practice of adopting
   supplementary budgets. The budget process should be reformed to ensure that
   expansionary supplementary budgets are limited to unexpected large economic
   shocks. Policy priorities with less urgency or those that could be identified
   earlier should be taken up in the context of the annual budget discussions.

Monetary Policy

Inflation is expected to converge in the medium term to Bank of Japan (BoJ)’s
two-percent target. The return of sustained inflation follows a persistently
above-target inflation outturn for some time now and reflects: (i) higher
inflation expectations for a prolonged period for the first time in decades;
(ii) the highest base wage growth since 1995 amid intensifying labor shortages;
and (iii) a historical high degree of monetary policy accommodation—with a real
interest rate much lower than the estimated neutral rate along with balance
sheet accommodation.

The BoJ has been appropriately cautious, given Japan’s history of deflation and
mixed signals from recent data. That said, upside risks to inflation have
materialized in the past year, with strengthening nominal wages and a closed
output gap. The BoJ’s recent policy adjustments are in line with our past policy
recommendations. These allowed the 10-year yield to be more flexible and driven
by market forces, which: (i) helped curb excessive expansion of the BoJ’s
Japanese Government Bond (JGB) purchases and its unintended side-effects on bond
market functioning; (ii) will support financial institutions’ profitability as
well as stability by potentially reducing the incentives for exposure to riskier
asset portfolios in search of higher yields; and (iii) will allow for a smoother
exit from unconventional monetary policy in the near future.

The BoJ should consider exiting Yield Curve Control (YCC) and ending
Quantitative and Qualitative Easing (QQE) now while gradually raising short-term
policy rates thereafter:

 * Exit the YCC and QQE framework: This framework has already successfully met
   its intended objective of lowering interest rates below the neutral rate and
   raising inflation expectations. Officially exiting the framework would
   simplify communication. The BoJ could continue to reinvest maturing JGBs on
   its balance sheet to avoid abrupt shifts in bond market conditions and sharp
   increases in term premiums.

 * Shift to the short-term policy rate as the main policy instrument: If staff’s
   baseline inflation forecast bears out, the BoJ should gradually raise the
   policy rate over its policy horizon (i.e., three years) thereafter.

 * These policy shifts should take a gradual and well-communicated approach to
   anchor market expectations.This approach will continue to keep monetary
   policy and financial conditions accommodative, while giving the BoJ time to
   confirm the strength of the incoming data. To mitigate risks:

 * The BoJ may also need to make state-contingent purchases of JGBs and
   implement other targeted and temporary measures to ensure sufficient
   liquidity support for relevant financial markets.

 * A clear and effective communication strategy by the BoJ that underscores
   factors that support a gradual and cautious pace/timing of policy rate
   increases (e.g., confirming that wage growth is sufficiently robust to
   support private consumption and sustain inflation at target) will be key for
   a smooth transition. This strategy would also minimize disruption from
   outward spillovers to other sovereign debt markets, where Japanese investors
   hold large positions.

 * Japan’s longstanding commitment to a flexible exchange rate regime will help
   absorb economic shocks and support monetary policy’s focus on price
   stability.At the same time, it will also help maintain an external position
   in line with fundamentals.

Safeguarding Financial Stability

The Japanese financial system has withstood a series of recent shocks including
the COVID-19 pandemic, aided by strong capital and liquidity buffers and
extensive policy support. Credit provision to the private sector has remained
robust since the pandemic, supporting a steady economic recovery. Key risks to
macro-financial stability stem from an abrupt slowdown in global growth and a
surge in inflationary pressures that could lead to an increase in foreign and
domestic interest rates and financial market volatility. A materialization of
these risks could potentially interact with three key sources of vulnerabilities
in the financial system: the sizable holdings by financial institutions of
securities under mark-to-market accounting, some banks’ notable foreign currency
exposures, and signs of overheating in part of the real estate markets.

The systemic risk analysis, conducted as part of the ongoing IMF’s Financial
Stability Assessment Program (FSAP), suggests the financial system is broadly
resilient, but some areas merit attention and close monitoring.Japanese banks
and insurers are, in the aggregate, well able to withstand an adverse scenario
with low global growth and high inflation but some institutions may be
vulnerable. Liquidity risks for banks appear contained at the system level,
though there could be pressure on some banks under a stress scenario due, in
particular, to their sizable foreign currency exposures. Climate risk analysis,
while uncertain, suggests that banks have notable exposures to emission
intensive sectors but at a system level may be resilient to a transition to net
zero emissions by 2050.

 * The financial oversight and crisis preparedness frameworks need to be
   strengthened further to manage the challenging and evolving risk environment.
   The risk-based approach to the supervision of banks should be developed
   further. Appropriate minimum liquidity requirements should be set for all
   banks, while capital requirements need to be tailored to individual bank risk
   profiles. A framework of comprehensive risk-based and proactive supervision
   should be established for insurers. The macroprudential framework could be
   further strengthened by clarifying the mandate of the Council for Cooperation
   on Financial Stability and expanding the macroprudential toolkit. Against the
   backdrop of growing global cybersecurity risks, the regulatory and
   supervisory frameworks of cybersecurity need to be enhanced. More banks
   should be subjected to recovery and resolution planning requirements. The
   authorities should continue to ensure an effective recovery and resolution
   (planning) regime for insurers and central clearing counterparties (CCPs)
   that is consistent with pertinent international standards and guidance. As a
   priority, staffing resources need to be increased significantly to enhance
   the supervision and resolution of financial institutions.

Structural Policies

 * Further structural reforms are needed to support fertility, promote female
   leaders, advance a more equal society, accelerate startups and innovation,
   and transition to a green economy, with labor market reforms at the forefront
   of the reform agenda.

Supporting Japan’s Fertility and Promoting Female Leaders

Amidst a declining labor force due to an ageing population, supporting
fertility, increased female economic participation, and effective use of women’s
skills can help boost Japan’s growth potential. Advancing reforms in the
following areas are key to improve career prospects for women, which in turn
would also support Japan’s fertility rate.

 * Expanding childcare facilities and resources and facilitating fathers’
   contribution to home/child-care. A further expansion of childcare facilities,
   particularly for children below the age of two, is crucial to support
   fertility. Attracting foreign workers to address labor shortages (e.g.,
   nursery teachers) could complement the support provided by childcare
   facilities. At the same time, offering stronger incentives for the use of
   paternity leave– which while growing, remains low–can alleviate the burden of
   childcare on mothers.

 * Reforming current employment practices. Facilitating a cultural shift at the
   workplace by expanding the use of telework and flexible working schedules
   could support women’s ability to participate in the labor force (particularly
   for those with young children) while also allowing men to share more
   home-care burden.

 * Labor market reforms. While the government has been successful in increasing
   female labor force participation over the last decade, a substantial gender
   gap remains. A large share of female workers are non-regular and non-career
   track workers with lower wages and limited skill development and career
   advancement opportunities. Reducing labor-market dualism, encouraging
   merit-based promotions, and facilitating more job mobility can expand career
   prospects for women.

 * Advancing a More Equal Society

 * Market income inequality in Japan has increased and is now close to the OECD
   average. The redistributive effects of social transfers have helped lower
   income inequality. However, with high public debt limiting the scope for
   greater broad-based social spending, social transfers should be better
   targeted to protect the most vulnerable population. Moreover, reforms to
   reduce labor market dualism and removing the disincentives in the social
   security system that limit working hours are more sustainable ways to achieve
   a more equal society.

 * Accelerating Startups and Innovation

 * Japan’s startup ecosystem has grown in recent years, but with scope for
   further expansion. Startups in Japan tend to be smaller than those in other
   countries, with relatively low venture capital equity funding as a share of
   GDP. Better access to equity funding is crucial for startups to grow,
   innovate, and exit successfully. Dynamic firm entry and exit can help
   encourage entrepreneurship, innovation, and more efficient allocation of
   resources. A more flexible labor market and a shift away from the lifelong
   employment system could encourage talented individuals to consider setting up
   startups and to have a second chance in case they fail.

 * Transitioning to a Green Economy

Additional policies would be needed to reach Japan’s climate targets. While
expanding carbon pricing and introducing carbon credits trading are broadly in
line with previous staff advice, further clarifications on the planned measures
are needed. Given the potentially adverse distributional effects of carbon
pricing, it is crucial to protect the vulnerable population in the transition to
a green economy. The phasing out of untargeted subsidies for gas, electricity,
and fuel would support the transition.


CONTINUING OTHER REFORMS

Reform efforts in digitalization and corporate governance should continue. The
Digital Agency should continue to coordinate and implement policies to
digitalize the public sector. Better data sharing between central and local
governments and standardizing local government IT system can help improve the
targeting of transfers to the most vulnerable households. Ensuring effective
corporate governance practices and improved disclosure standards are needed.

Japan should continue to work actively with international partners to strengthen
the rules-based multilateral trading system. It is important that trade
agreements are used for further integration among members.

Industrial policies (IP) should be pursued cautiously and remain narrowly
targeted to specific objectives where externalities or market failures prevent
effective market solutions and aim to minimize trade and investment distortions.
Pursuit of and competition among advanced economies over IP could lead to
further strains in the global supply chain, technological fragmentation, rising
input costs, increased trade tensions, and reduced international
cooperation—outcomes that could undermine Japan’s broad support of the strong
multilateral trading system. Furthermore, IP should avoid favoring domestic
producers over imports or creating incentives that lead to a fragmentation of
the global system for trade and investment.

The IMF team would like to thank the authorities and other interlocutors in
Japan for the frank and open discussions. On behalf of the IMF, we would also
like to convey our heartfelt condolences to those affected by the Noto Peninsula
Earthquake.





Table 1. Japan: Selected Economic Indicators, 2020-25

Nominal GDP: US$ 4,256 Billion (2022)

GDP per capita: US$ 34,005 (2022)

Population: 125 Million (2022)

Quota: SDR 30.8 billion (2022)

2020

2021

2022

2023

2024

2025

Proj.

(In percent change)

Growth

Real GDP

-4.1

2.6

1.0

1.9

1.0

0.8

Domestic demand

-3.3

1.5

1.5

1.0

1.0

0.9

Private consumption

-4.4

0.8

2.2

0.9

0.8

0.7

Gross Private Fixed Investment

-5.4

0.3

0.9

1.5

1.6

1.8

Business investment

-4.9

0.5

1.9

1.5

1.9

2.1

Residential investment

-7.7

-0.3

-3.5

1.4

0.4

0.1

Government consumption

2.4

3.4

1.7

0.9

1.1

0.2

Public investment

3.5

-1.8

-9.6

1.9

-0.7

-0.8

Stockbuilding

-0.5

0.2

0.4

0.0

0.0

0.1

Net exports

-0.8

1.0

-0.5

0.7

0.1

-0.1

Exports of goods and services

-11.6

11.9

5.3

2.3

3.2

2.5

Imports of goods and services

-6.8

5.1

7.9

-1.2

2.8

3.2

Output Gap

-2.9

-1.6

-0.9

0.2

0.3

0.2

(In percent change, period average)

Inflation

Headline CPI

0.0

-0.2

2.5

3.3

2.2

2.1

GDP deflator

0.9

-0.2

0.3

4.0

3.0

2.3

(In percent of GDP)

Government

Revenue

35.5

36.4

37.6

36.5

35.8

36.5

Expenditure

44.5

42.5

41.9

42.1

42.2

39.5

Overall Balance

-9.1

-6.1

-4.4

-5.6

-6.4

-3.0

Primary balance

-8.4

-5.5

-3.9

-5.5

-6.3

-2.8

Structural primary balance

-7.5

-4.8

-3.9

-5.6

-6.4

-2.8

Public debt, gross

258.3

253.9

248.7

251.7

251.6

250.2

(In percent change, end-of-period)

Macro-financial

Base money

19.2

8.5

-5.6

6.4

2.9

2.2

Broad money

7.3

2.9

2.2

2.9

1.8

1.7

Credit to the private sector

6.1

1.9

4.2

4.1

2.7

2.1

Non-financial corporate debt in percent of GDP

151.8

155.0

159.4

154.3

153.5

153.8









(In percent)

Interest rate

Overnight call rate, uncollateralized (end-of-period)

0.0

0.0

0.0

…

…

…

10-year JGB yield (end-of-period)

0.0

0.1

0.4

…

…

…















(In billions of USD)

Balance of payments

Current account balance

149.9

196.4

84.5

148.4

159.4

160.1

Percent of GDP

3.0

3.9

2.0

3.5

3.7

3.6

Trade balance

26.6

16.4

-117.5

-50.7

-24.4

-30.4

Percent of GDP

0.5

0.3

-2.8

-1.2

-0.6

-0.7

Exports of goods, f.o.b.

630.6

749.2

751.8

708.0

733.9

768.7

Imports of goods, f.o.b.

604.0

732.7

869.4

758.7

758.3

799.1

Energy imports

89.1

127.8

195.5

162.2

155.1

146.1

(In percent of GDP)

FDI, net

1.7

3.5

2.9

2.8

3.0

2.9

Portfolio Investment

0.8

-3.9

-3.4

-1.3

-1.3

-2.0

(In billions of USD)

Change in reserves

10.9

62.8

-47.4

11.5

11.5

11.5

Total reserves minus gold (in billions of US$)

1348.2

1356.2

1178.3

…

…

…

(In units, period average)

Exchange rates

Yen/dollar rate

106.8

109.8

131.5

…

…

…

Yen/euro rate

121.9

129.9

138.6

…

…

…

Real effective exchange rate (ULC-based, 2010=100)

75.3

73.5

62.0

…

…

…

Real effective exchange rate (CPI-based, 2010=100)

77.3

70.7

61.0

…

…

…



(In percent)

Demographic Indicators

Population Growth

-0.3

-0.3

-0.3

-0.4

-0.5

-0.5

Old-age dependency

48.3

48.7

48.9

49.3

49.8

50.3

Sources: Haver Analytics; OECD; Japanese authorities; and IMF staff estimates
and projections




--------------------------------------------------------------------------------

[1] An IMF mission, led by Ranil Salgado and including Kohei Asao, Yan
Carriere-Swallow, Salih Fendoglu, Purva Khera, Chris Redl, Haruki Seitani, and
TengTeng Xu, conducted meetings in Japan during January 25-February 7, 2024. The
mission met with senior officials at the Ministry of Finance, Bank of Japan, and
other ministries and government agencies, along with representatives of labor
unions, the business community, financial sector, and academics.

IMF COMMUNICATIONS DEPARTMENT

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