Economic growth in Japan has slowed due to weak private consumption and sluggish investment, and inflation has lost its forward momentum, according to the Executive Board of the International Monetary Fund (IMF), which concluded an Article IV consultation* with Japan in late July. While financial conditions remain accommodative, falling stock prices and the appreciation of the yen have resulted in a modest tightening, the board said.
The authorities have responded to the weaker domestic and external economic environment through additional monetary and fiscal support, including the adoption of the negative interest rate policy, plans for additional fiscal stimulus, and the postponement of the scheduled 2017 consumption tax hike by two and a half years.
Nevertheless, the outlook for growth and inflation remains subdued, the IMF said. Private consumption is projected to grow modestly and weakness in the global recovery and trade, higher uncertainty, especially in the wake of the Brexit referendum, and the recent appreciation of the yen will likely pose a drag on net exports and investment. Consequently, the economy is expected to expand at a moderate pace of about 0.3% in 2016, before slowing to 0.1% in 2017, excluding the possible effect of the yet to be adopted economic stimulus package. Over the medium term growth is projected to be in line with potential (which is on a declining trend), while inflation is expected to rise to about 1%.
Low confidence in economic growth prospects is holding back investment and credit demand, while labour market duality and inflexibility are hampering wage growth, the IMF said. The financial sector’s support of risk-taking is limited, and the stop-go nature of fiscal policy 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 Bank of Japan (BoJ).
Global weakness and volatility are complicating matters. Sluggish global growth and overcapacity in the traded goods sector prevented the weaker yen from materially boosting exports. Declining commodity prices failed to boost activity as expected, but instead put pressure on headline inflation and forced the BoJ to repeatedly extend its timeline for hitting the inflation target. Moreover, 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.
Executive Directors** welcomed the initial success of Abenomics and the authorities’ forceful implementation of policies to lift growth and inflation. Nevertheless, growth remains subdued and deflation persists, on the back of weak consumption, lacklustre private investment, and sluggish exports. Directors noted strong headwinds from a weak global recovery, the appreciation and volatility of the exchange rate, and adverse demographics. They generally agreed that a comprehensive and coordinated policy upgrade is now needed to achieve the ambitious targets on growth, reflation, and fiscal consolidation.
Directors consider structural reforms an essential component of the reloaded Abenomics, aimed at raising productivity, labour supply, and potential growth. They support labour market reforms to reduce duality and increase labour force participation by female, older, and foreign workers. As part of the overall policy mix, Directors generally saw a role for policies that could help generate wage-price dynamics without excessive interference in market mechanisms. In this regard, they welcomed the decision to lift minimum wage growth, and recommended consideration of options to strengthen incentives for companies to raise wages and promote flexible labour contracts.
Directors also commended the authorities for maintaining a sound and stable financial sector. They noted that financial stability risks could nonetheless arise from prolonged unconventional monetary policies and the delay in achieving reflation and fiscal sustainability. Directors therefore encouraged the authorities to continue to strengthen the macroprudential policy toolkit; and enhance the monitoring of liquidity in the government bond market, financial institutions’ profitability, and foreign exchange risks. Efforts should also continue to improve the resilience of regional banks and inter-agency coordination.
*Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
**At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarises the views of Executive Directors, and this summary is transmitted to the country's authorities. Explore any qualifiers used in summings up