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Japan: Staff Report for the 2016 Article IV Consultation—Supplementary Information

Author(s):
International Monetary Fund. Asia and Pacific Dept
Published Date:
August 2016
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Recent Developments and Revised Outlook

Recent economic developments together with the increased uncertainty in the aftermath of the Brexit referendum warrant a downgrading of the outlook. Short-term economic indicators released since the staff report was issued point to softness in economic activity. Recent PMI indicators suggest sustained weakness in manufacturing activity, reflecting sluggish export demand, while the inventory-to-sales ratio in the manufacturing sector has increased and machinery orders data have disappointed. In line with downward revisions to growth in major trading partners, and without taking into account any potential policy response, higher uncertainty following the Brexit vote is expected to contribute to a further drag on growth, especially investment, but also consumption and exports including from the recent volatility in the exchange rate. Although direct trade and financial exposures to the United Kingdom are limited, those to the rest of Europe are relatively large and would, together with domestic confidence effects, constitute the main channel of impact.1 All combined, compared to the staff report Japan’s growth projections for 2016 and 2017 have been revised down by 0.2 percentage points to 0.3 and 0.1 percent, respectively. The outlook for inflation has been reduced by 0.1–0.2 percentage points, reflecting a stronger yen, weaker commodity prices, and softer domestic demand. These projections assume a gradual waning of uncertainty surrounding Brexit but do not factor in any policy response.

Source: Bloomberg, L.P.

Source: Bloomberg, L.P.

Repercussions from the Brexit referendum and expectations of a large policy response caused market gyrations. Financial conditions tightened considerably on impact of the Leave vote: the yen appreciated strongly amid safe-haven effects and expectations of further delays in rate hikes by the U.S. Federal Reserve, and equity prices slumped, led by financial sector stocks.2 Short selling in the Tokyo Stock Exchange (as a share of total selling) increased to historical highs in June. Yields on Japanese government bonds (JGBs) declined further, reflecting higher risk aversion and expectations of further monetary policy easing. In particular, the JGB yield curve shifted down and flattened, with the 10-year benchmark rate falling by over 14 bps to -0.29 percent within two weeks after the referendum.3 Moreover, USD funding costs increased sharply, with the 3-month JPY/USD basis swap widening from -55 to -68 bps on the day of the Brexit. The BoJ’s provided USD$1.475 billion on June 28—the largest amount since December 2014, but assurances about availability of USD funding through a joint statement by Finance Minister Aso and BoJ Governor Kuroda helped stabilize markets. Since the initial response, both the yen and the equity markets have more than retraced their steps, helped by the broad victory of the leading coalition in the Diet Upper House elections and the anticipation of a sizeable package of fiscal support measures. Market volatility has fallen back to pre-referendum levels and equity valuations, including of financial institutions, are significantly above these levels. JGB yields have reversed some of their decline, especially at the long end.

Policy Implications

The staff advice remains broadly in line with the “reload package” of the staff report and the need for near-term support for the economy to deal with downside risks. The reload scenario should be accelerated as it remains the most effective response to recent developments and uncertainty (¶18 of the staff report). The realization of downside risk justifies a fiscal response, to target a modest positive fiscal stance in 2017, and some further monetary easing to underscore the BoJ’s resolve to achieve its inflation target (¶16):

  • Fiscal policy: In the near term, fiscal policy should aim for a modest fiscal impulse, using measures with high multipliers. A large stimulus would have merit only as part of the staff’s comprehensive and coordinated “reload” package and support for labor market reforms. To create the necessary near-term space and reduce policy uncertainty, the commitment to fiscal consolidation over the medium-term should be enhanced and fiscal policy frameworks strengthened.

  • Monetary policy: To create balanced support for the economy and exploit synergies, the fiscal policy response should be complemented with additional easing by the BoJ to loosen financial conditions and underscore its commitment to achieve the inflation target in a sustained and stable manner. All easing options should remain on the table, including lowering of the negative interest rate on marginal excess reserves and increasing annual targets for ETF and corporate bond purchases.

Authorities Views4

The authorities consider that the impact of Brexit on growth is likely to be modest given Japan’s relatively small export exposure to the United Kingdom and the rest of Europe. They felt that the impact of Brexit was highly uncertain, and noted that the initial steep correction in the Nikkei has reversed and that strong appreciation of the yen has moderated. The authorities expected to revise their outlook shortly as the basis for new budget projections and preparation. In terms of policies, they noted that details on the size and composition of the planned stimulus package would be formulated soon and that the BoJ would not hesitate to take additional easing measures, if necessary to achieve the 2 percent price stability target at the earliest possible time, in terms of the three dimensions, that is the quantitative, qualitative, and interest rate dimensions.

Table 1.Japan: Selected Economic Indicators, 2011–17Nominal GDP: US$ 4,124 Billion (2015)Population: 127 Million (2015)GDP per capita: US$ 32,480 (2015)Quota: SDR 15.6 Billion (2015)
2011201220132014201520162017
Proj.
Growth (percent change) 1/
Real GDP−0.51.71.40.00.50.30.1
Domestic demand0.42.61.70.00.10.40.3
Private consumption0.32.31.7−0.9−1.20.61.1
Gross Private Fixed Investment4.33.61.11.50.81.52.1
Business investment4.13.7−0.53.11.51.11.8
Residential investment5.13.28.4−5.3−2.52.53.6
Government consumption1.21.71.90.11.21.1−1.6
Public investment−8.22.78.00.4−2.5−5.3−7.5
Stockbuilding 2/−0.20.2−0.20.20.5−0.20.0
Net exports 2/−0.8−0.8−0.20.30.4−0.1−0.3
Exports of goods and services 3/−0.4−0.21.28.32.8−0.21.1
Imports of goods and services 3/5.95.33.17.20.30.23.0
Output Gap−3.3−2.0−1.1−1.6−1.5−1.7−2.0
Inflation (annual average)
CPI 4/−0.30.00.42.70.80.20.4
CPI excluding VAT−0.30.00.41.20.30.20.4
Core Core CPI excluding VAT 5/−0.8−0.4−0.20.70.9
GDP deflator−1.9−0.9−0.61.72.00.60.3
Unemployment rate (annual average)4.64.34.03.63.43.23.3
Government (percent of GDP)
General government
Revenue30.831.132.133.634.133.834.0
Expenditure40.639.840.639.839.338.938.3
Overall Balance−9.8−8.8−8.6−6.2−5.2−5.1−4.3
Primary balance−9.0−7.9−7.8−5.6−4.9−5.1−4.5
Structural primary balance−7.7−7.0−7.5−5.2−4.5−4.7−4.0
Public debt, gross231.6238.0244.5249.1248.0250.7254.0
Macro-financial (percent change, end-period, unless otherwise specified)
Base money22.219.360.336.729.122.618.3
Broad money3.62.84.03.03.12.72.7
Credit to the private sector−0.63.15.51.52.62.32.4
Non-financial corporate debt in percent of GDP191.3196.3225.6238.2234.4234.0236.1
Household debt in percent of disposable income128.3127.1128.5129.3129.3130.3131.8
Interest rate
Overnight call rate, uncollateralized (end-period)0.10.10.10.10.0
Three-month CD rate (annual average)0.30.30.20.20.2
Official discount rate (end-period)0.30.30.30.30.30.30.3
10-year JGB yield (e.o.p.)1.10.90.70.60.4−0.1−0.1
Balance of payments (in billions of US$)
Current account balance129.859.745.936.4135.6159.4143.2
Percent of GDP2.21.00.90.83.33.42.9
Trade balance−4.5−53.9−90.0−99.9−5.319.30.7
Percent of GDP−0.1−0.9−1.8−2.2−0.10.40.0
Exports of goods, f.o.b.790.8776.0695.0699.4621.9620.5643.0
Imports of goods, f.o.b.795.3829.9784.9799.3627.2601.2642.3
Energy imports242.8272.2257.4241.7133.7112.6130.3
FDI, net (percent of GDP)2.02.02.92.63.22.52.4
Portfolio Investment, net (percent of GDP)−2.80.5−5.7−0.93.23.33.4
Terms of trade (percent change)−9.0−1.8−2.5−1.014.01.3−1.2
Change in reserves177.3−37.938.78.55.19.510.0
Total reserves minus gold (in billions of US$)1258.21227.21237.31231.01207.1
Exchange rates (annual average)
Yen/dollar rate79.879.897.6105.9121.0106.9101.1
Yen/euro rate111.0102.6129.6140.8134.3118.9112.5
Real effective exchange rate (ULC-based) 6/118.5119.796.788.885.0
Real effective exchange rate (CPI-based) 7/101.7100.680.475.170.2
Demographic Indicators
Population Growth0.2−0.2−0.2−0.2−0.1−0.2−0.3
Old-age dependency36.437.839.841.843.645.146.3
Sources: IMF, Competitiveness Indicators System; OECD, and IMF staff estimates and projections as of July 7, 2016.

Annual growth rates and contributions are calculated from seasonally adjusted data.

Contribution to GDP growth.

For 2014 export and import growth rates are inflated because of changes in the compilation of BoP statistics (BPM6) implying a break in the series relative to previous years.

Including the effects of consumption tax increases in 2014 and 2015.

Bank of Japan Measures of Underlying Inflation; excluding fresh food & energy.

Based on normalized unit labor costs; 2005=100.

2010=100.

Sources: IMF, Competitiveness Indicators System; OECD, and IMF staff estimates and projections as of July 7, 2016.

Annual growth rates and contributions are calculated from seasonally adjusted data.

Contribution to GDP growth.

For 2014 export and import growth rates are inflated because of changes in the compilation of BoP statistics (BPM6) implying a break in the series relative to previous years.

Including the effects of consumption tax increases in 2014 and 2015.

Bank of Japan Measures of Underlying Inflation; excluding fresh food & energy.

Based on normalized unit labor costs; 2005=100.

2010=100.

Japan’s exports to the United Kingdom respectively the rest of Europe made up about 2 and 9 percent of its total exports in 2015. Japan’s FDI respectively portfolio claims on the United Kingdom are about 7 and 5 percent of Japan’s total foreign claims, compared to 17 and 25 percent for the rest of Europe.

Stocks of banks and insurance companies had fallen by 14 and 13 percent within two weeks after the Brexit referendum, respectively.

This is less than the reaction in the U.S., where the 10-year Treasury yield fell about 30 bps.

Based on an exchange of views between staff and authorities during July 14–15, 2016.

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