Japan
Recent Economic Developments
Author: International Monetary Fund
Publication Date:
10 Sep 1996
eISBN:
9781451820423
ISBN:
9781451820423
Language:
English
Keywords:
ISCR; CR; capital ratio; private sector; first quarter; government bond; current account; debt ratio; economic activity; potential GDP; public funds; U.S. dollar
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This paper reviews economic developments in Japan during 1994. It focuses on the weak recovery that began in 1994, and the subsequent strengthening of growth since mid-1995. The paper examines developments in output and prices, and reviews the role that fiscal policy has played in providing support to demand, and the resulting sharp deterioration in the fiscal position. Monetary developments, including the reduction in interest rates to record lows in 1995, are discussed. The paper analyzes developments in the external sector and exchange markets. Developments in trade and structural policies are also reviewed.

Abstract

This paper reviews economic developments in Japan during 1994. It focuses on the weak recovery that began in 1994, and the subsequent strengthening of growth since mid-1995. The paper examines developments in output and prices, and reviews the role that fiscal policy has played in providing support to demand, and the resulting sharp deterioration in the fiscal position. Monetary developments, including the reduction in interest rates to record lows in 1995, are discussed. The paper analyzes developments in the external sector and exchange markets. Developments in trade and structural policies are also reviewed.

Japan--Basic Data

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Contribution to real GDP growth.

Disposable income deflated by the private final consumption deflator.

Staff estimate.

Based on average employee compensation and monthly hours index (Labor Force Survey).

Fiscal year beginning April 1.

I. Introduction

This review of recent economic developments focuses on the weak recovery that began in 1994, and the subsequent strengthening of growth since mid-1995. Chapter II examines developments in output and prices, while Chapter III reviews the role fiscal policy has played in providing support to demand, and the resulting sharp deterioration in the fiscal position. Monetary developments, including the reduction in interest rates to record lows in 1995, are discussed in Chapter IV. Chapter V analyzes developments in the external sector and exchange markets. Developments in trade and structural policies are reviewed in Chapter VI, followed by an analysis of the situation in the financial sector, including the policy initiatives taken over the past year to address these problems.

The annexes to the chapters study specific issues pertaining to the main text. Annex I examines the implication of the rebasing of the national accounts data to 1990. Alternative indicators of government debt stock are discussed in Annex II, including developments in gross and net debt over time and in comparison with other G-7 countries.

II. Output and Price Developments

1. Aggregate demand and output

The pace of economic recovery remained slow through the first half of 1995 (Table 1 and Chart 1). 1/ This was in part due to factors that led to the previous downturn, including significant drops in asset prices and wealth. In addition, the yen appreciated sharply in the second quarter of the year, and consumer confidence was further battered by the Kobe earthquake, terrorist attacks and worsening labor market prospects. As a result, the economy grew at an annual rate of 3/4 percent in the six quarters since the trough in the fourth quarter of 1993, compared to an average rate of 5 percent in three previous upturns (Chart 2).

Table 1.

Japan: Growth Rates of Real GDP and Demand Components, 1990-96 1/

(Percentage change from previous year or quarter)

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Sources: Economic Planning Agency, Annual Report on National Accounts; and data provided by the Japanese authorities.

At 1990 prices.

Contribution to real GDP growth.

Government consumption and investment.

CHART 1
CHART 1

JAPAN GROSS DOMESTIC PRODUCT AT 1990 CONSTANT PRICES, 1970–96

(Percentage change from previous year)

Citation: IMF Staff Country Reports 1996, 090; 10.5089/9781451820423.002.A001

Source: EPA, National Income Accounts.
CHART 2
CHART 2

JAPAN COMPARISON OF FOUR CYCLICAL DOWNTURNS 1/

Index (trough of cycle=100)

Citation: IMF Staff Country Reports 1996, 090; 10.5089/9781451820423.002.A001

Source: Nikkei Telecom.1/ Troughs defined as: 1993Q4 for current downturn; 1987Q2 for 1986–87 downturn; 1983Q2 for 1982–83 downturn; 1975Q1 for 1974–75 downturn.

Economic activity accelerated in the second half of the year, despite sharp negative contributions to growth from net exports, as private sector demand picked up and public sector spending, which had contracted in the first half of the year, began growing. This upturn was influenced by expansionary financial policies, including historically low interest rates and the introduction of a sizable public spending package in September. The economy grew by a further 3 percent (quarterly rate) in the first quarter of 1996, with positive contributions from all components of domestic demand. However, this strong pace was in part the result of the leap year (which accounted for an estimated 0.5 percentage points of growth), and recent monthly indicators suggest that part of these gains would be offset in the second quarter.

Private real consumption grew by 1.7 percent in 1995. The slow growth reflected, in part, weak income growth. Employee compensation rose by only 1.6 percent, as the spring wage round (shunto) resulted in an historically low 2.8 percent increase, while hours worked rose by only 0.1 percent, and bonus payments declined for the fourth consecutive year. The gain in employee compensation was almost fully offset by reductions in property income, as interest rates declined to historically low levels. As a result, nominal disposable income grew by only 0.4 percent. Nevertheless, falling consumer prices helped boost real disposable incomes and consumption. Durable goods consumption picked up, especially in the latter half of the year, reflecting a replacement cycle for goods purchased during the bubble period, low interest rates, and--following the yen’s decline--improved consumer confidence. As a result, the household saving rate fell slightly, to about 12 percent of disposable income.

Consumption grew strongly in the first quarter of 1996. The increase was consistent with strong growth in monthly indicators, including retail sales and the family expenditure survey. Although the reasons behind the increases are not fully understood, the extra day provided by the leap year may have had some effect. However, recent indicators of private consumption have fallen back, suggesting a drop in expenditures in the second quarter.

While part of the surge in consumption in the first quarter was temporary, improving labor market conditions suggest there is a basis for steady growth in the second half of the year. The spring shunto agreement was again 2.8 percent, marking the first time in five years the wage increase had not fallen. Total hours worked recorded increases of about 1/2 percent in both the fourth quarter of 1995 and first quarter of 1996, and strong growth in corporate profits led to expectations that bonuses would increase. The ratio of job offers to job seekers has also increased in recent quarters. However, the unemployment rate remains at an historic high.

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Growth over the first quarter of 1995.

These figures may differ slightly from those shown in Table 1, as the latter include consumption expenditures by non-profit institutions serving households.

Staff estimate.

Private business investment grew by 3.1 percent in 1995, following three years of contraction. The growth rate remained subdued in comparison to previous recoveries, however, reflecting a sizable, albeit diminishing, capital stock overhang, low capacity utilization rates, and uncertainties resulting from large fluctuations in the yen’s value. 1/ Nevertheless, a number of economic fundamentals suggest that positive investment growth will continue, although at a moderate pace (Chart 3). Corporate profits rebounded sharply in 1995, especially among large manufacturing firms, as they restructured activities, increased their reliance on lower-cost imported parts, and as labor costs moderated. Moreover, the cost of capital fell sharply, as interest rates were lowered and equity prices rebounded following the yen’s depreciation. Overall business conditions, as reported in the Bank of Japan’s Tankan survey, have also improved markedly in recent quarters. In addition, the survey reported that principal enterprises intend to increase their investment in the current year, while the rate of decline among small enterprises has been revised downward sharply. Factors suggesting that the pace of growth in business investment will remain moderate, however, include: continued balance sheet pressures in the real estate sector; caution in the construction sector due to real estate weakness, and among wholesalers amid reorganization in the distribution system; and continued weak demand among part manufacturers as import penetration in manufacturing steadily increases.

CHART 3
CHART 3

JAPAN INDICATORS OF BUSINESS INVESTMENT, 1980–96

Citation: IMF Staff Country Reports 1996, 090; 10.5089/9781451820423.002.A001

Source: Nikkei Telecom.1/ Percentage of respondents reporting improving business conditions versus deteriorating.

After strong growth in 1994, residential investment declined by over 6 percent in 1995. The contraction was centered in the middle of the year, as confidence was hit by the yen’s appreciation and worsening labor market situation, and as households delayed activity in anticipation of lower interest rates. In the event, a lowering of rates and a continued decline in land and housing prices boosted housing affordability, and housing starts increased sharply beginning in September. Homeowners shifted to banks for increasing shares of housing finance to take advantage of relatively cheaper fixed-rate mortgages. While residential investment grew by a further 8.4 percent in the first quarter of 1996, its growth is anticipated to slow substantially in the remainder of the year, as the recent surge in housing starts may partly reflect expectations of an increase in interest rates.

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Growth over the first quarter of 1995.

On a national accounts basis, stockbuilding contributed positively to growth in 1995, after three years of negative contributions. This pattern continued in the first quarter of 1996. Industrial inventories rose by 3 percent in 1995. Industrial production increased by 3.6 percent in 1995, while shipments rose by 2.9 percent, resulting in a 1.6 percent increase in the inventory-shipment ratio. Production in the first quarter of 1996 stood some 3/4 percent higher than at the same period in 1995, while shipments were almost 1 1/2 percent higher. Nevertheless, inventories rose further, with the inventory-shipment index near its cyclical peak. Excess inventories are acute in the electrical machinery and chemical sectors, and their runoff is anticipated to dampen the growth of industrial production over the near term.

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Contribution to real GDP growth over the first quarter of 1995.

Inventories of public enterprises.

Real government consumption rose by 2 percent in 1995, equaling its average growth rate over the 1990–94 period. Public investment, in contrast, rose by only 1.3 percent, the smallest increase since 1989. However, this annual change masks a strong increase in investment through the year, with growth of 12.8 percent on a four-quarter basis. Investment rose initially in the second quarter as reconstruction efforts began relating to the Kobe earthquake, and as the government intentionally front-loaded public works spending in an effort to boost the economic recovery. Investment growth quickened in the fall with the adoption of the September package of stimulus measures, and further accelerated in the first quarter of this year. As a result, public investment now accounts for 10 percent of real GDP, its highest share since 1978. It is anticipated, however, that investment will begin to decline in the latter half of this year, as the effect of past packages unwinds.

In contrast to an acceleration of domestic demand in 1995, the negative contribution to growth from real net exports widened to -0.8 percent of GDP. This was largely the result of a sharp increase in imports of goods and nonfactor services, which grew by 13.5 percent, compared to a 5 percent increase in exports. The surge in imports reflect rising domestic demand and the change in relative prices following the yen’s sharp appreciation, as well as structural shifts associated with outsourcing of production and changes in the distribution system.

2. Saving-investment balances

There has been a marked shift in the domestic public and private sector’s net saving patterns over the 1990s. While the private sector net saving position has improved by almost 8 percentage points of GDP to 5 1/4 percent in 1995, the public sector’s net saving position has worsened by about 7 percentage points (Table 2). Enterprise net saving has accounted for all of the improvement within the private sector, while household net saving has declined as a share of GDP since 1992. A worsening in general government net saving has accounted for more than three-fourths of the public sector net saving performance.

Table 2.

Japan: Saving and Investment Balances, 1990-95

(In percent of GDP)

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Source: Economicy Planning Agency, Annual Report on National Accounts; and staff estimates.

Current account balance.

Staff estimate.

Residential investment.

The improved private sector net saving position is largely the result of a lower share of enterprise investment in GDP, although the latter rose slightly in 1995. The decline in recent years has reflected the effects of overaccumulation of capital during the bubble period, of low capacity utilization rates during the protracted recession, and, until recently, declining profits and relatively high costs of capital. Household net saving has declined as a share of GDP since 1992 in light of a sharp slowdown in the growth of disposable incomes, despite a significant tax cut introduced in 1994 and extended into 1995, which outpaced a slowdown in consumption expenditures. The worsened public sector position reflects both the endogenous effects of the business cycle on general government revenues and public enterprise profitability, as well as expansionary policy decisions taken with a view to boost economic activity. The latter includes the reduction in household taxes mentioned earlier, as well as the impact of five stimulus packages since 1992, which have raised general government investment shares significantly.

3. Price developments

Inflation has been on a declining trend since the recession began in 1991. The effect on prices of weak demand and a slowdown of wage increases has been reinforced by the sharp appreciation of the yen through mid-1995, although this has been slightly reversed subsequently. The year-on-year rate of consumer price inflation has declined from about 3 1/2 percent in early 1991 to deflation of 1/2 percent in the last quarter of 1995, although underlying consumer prices have remained roughly stable since last November (see Ch26 art 4 and following tabulation). “Core” inflation, excluding perishable food and energy prices, has also declined since 1991, with core prices stabilizing in early 1995. In terms of composition, core goods prices have fallen at a 1 1/2 percent annual rate since late 1994, which has been offset by a similar rate of increase in the prices of services.

CHART 4
CHART 4

JAPAN PRICE DEVELOPMENTS, 1985–96

Citation: IMF Staff Country Reports 1996, 090; 10.5089/9781451820423.002.A001

Source: Nikkei Telecom.1/ CPI excluding perishable food and energy.
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Growth over the first quarter of 1995.

Domestic wholesale prices have fallen steadily at about a 1 1/4 percent annual rate since the fourth quarter of 1991. Overall wholesale price deflation, which includes the influence of imported wholesale goods, began in early 1991 and declined more rapidly than the decline in domestic wholesale prices until the second half of 1995, when the effects of the yen’s recent depreciation were felt. Several factors account for the larger and more persistent drop in wholesale prices relative to consumer prices: the exclusion of services from the WPI, whose prices continued to rise until mid-1993 (although these have also recently declined, due largely to falling rental prices); the larger weight of imports in the WPI; and the inclusion of export prices in the WPI. The foreign trade component price indices have been falling mainly due to the appreciation of the yen, although the recent reversal of the yen has boosted these prices moderately since mid-1995.

III. Fiscal Policy

This chapter discusses fiscal policy developments since the bursting of the asset-price bubble in 1990–1991. Section 1 briefly reviews fiscal developments during the FY 1992–94 period and then discusses policies and developments in FY 1995 and FY 1996. Section 2 deals with medium-term policy issues. 1/

1. Recent fiscal developments and budgetary performance

a. Developments during FY 1992–94

Since the onset of the economic slowdown in the latter half of FY 1991, fiscal policy has played an important role in providing countercyclical support to domestic demand (Chart 5). Four major fiscal stimulus packages were adopted between August 1992 and February 1994. In total, the four packages amounted to over ¥45 trillion, equivalent to 9 1/2 percent of GDP. The core of the packages consisted of substantial increases in public investment. Direct spending on public investment was boosted by about ¥20 trillion (4 percent of GDP) over the level that would otherwise have occurred, and, as a result, real public investment rose by over 40 percent from 1991 to 1994 (Chart 6). In addition, the fourth package (announced in February 1994) included a major cut in income taxes amounting to ¥6 trillion (1 1/4 percent of GDP). Virtually all of the cut was due to a 20 percent across-the-board reduction in national and local personal income taxes. 2/

CHART 5
CHART 5

JAPAN GENERAL GOVERNMENT BALANCE, FY 1975–2001 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 1996, 090; 10.5089/9781451820423.002.A001

Sources: Ministry of Finance; Economic Planning Agency estimates and projections.1/ The fiscal year is from April to March.
CHART 6
CHART 6

JAPAN PUBLIC INVESTMENT PROFILE, 1991–2000

(Billions of Yen)

Citation: IMF Staff Country Reports 1996, 090; 10.5089/9781451820423.002.A001

Sources: Ministry of Finance Economic Planning Agency; and estimates and projections.

During FY 1994, while the tax cuts provided stimulus from the revenue side, public investment declined as the effects of previous packages unwound, and no major fiscal stimulus packages were introduced in FY 1994. Toward the end of the fiscal year (early in calendar year 1995), two supplementary budgets were adopted: the first included agricultural support in the wake of the Uruguay Round agreement; and the second included urgent reconstruction and relief measures from the earthquake that hit the Kobe region in mid-January. Even with these supplementary spending measures, capital spending for FY 1994 at the level of the general government declined by about 4 percent from the previous year. As revenues declined by over 1 1/2 percent of GDP, reflecting a major income tax cut, the structural deficit of the general government (excluding social security) for FY 1994 widened by about 1/2 percent of GDP from the previous year, implying a positive overall fiscal stimulus. 1/ 2/

b. FY 1995 budgetary operations

Almost immediately after Diet approval of the initial budget, a large supplementary budget (amounting to ¥2.7 trillion yen, or over 1/2 percent of GDP) was adopted in May 1995 to appropriate additional expenditures for earthquake reconstruction. 3/ With the supplementary budget offsetting the decline in the deficit that would otherwise have occurred, the initial stance of fiscal policy for FY 1995 was cyclically neutral--implying a continuing high level of demand support.

Amid growing concerns that the economic recovery was faltering in mid-1995, the Government announced a major economic stimulus package, the fifth since the onset of the recession, in September 1995. The package consisted wholly of expenditure increases, totalling ¥14.2 trillion (3 percent of GDP). The central government portion of the expenditure measures was submitted to the Diet in the form of a second supplementary budget for FY 1995, which was approved in mid-October. Local governments boosted budgetary appropriations through their supplementary budgets, most of which were approved in December.

The cornerstone of the package was a large increase in direct spending on public investment (over ¥8 trillion, or 1 1/2 percent of GDP). Table 3 provides the main elements of the September 1995 package and compares them with the previous four packages. The additional public investment included: general public works (¥4 trillion); public works solely financed by local governments (¥1 trillion); education, telecommunication networks, science and technology projects (¥l trillion); disaster relief (¥0.7 trillion); and other investments including earthquake reconstruction and agricultural support projects (¥1.6 trillion). The package also emphasized measures to stimulate activity in the real estate market, providing for land purchases totalling ¥3.2 trillion.1/ Furthermore, the lending authority of the Housing Loan Public Corporation was increased by ¥0.5 trillion, and that of other public financial institutions was raised by ¥2.4 trillion for the provision of loans, mainly to small businesses, and for investment in new business activities. 2/3/

Table 3.

Japan: Summary of Economic Stimulus Packages, 1992-95

(In trillions of yen, unless otherwise indicated)

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Sources: Data provided by the Japanese authorities; and staff estimates.

Includes disaster relief, unidentified land component of public investment, and FILP lending to public corporations for public works.

Including ¥0.5 trillion of land purchases to be conducted over a five-year period.

Including ¥0.5 trillion of land purchases by a government-affiliated urban development organization.

Taking into account the impact of the September package, expenditures at the general government level are estimated to have risen in FY 1995 by about 5 percent, with 10 1/2 percent growth in capital expenditures. Overall expenditures in relation to GDP rose further to 35 1/2 percent in FY 1995, compared with 34 1/2 percent in FY 1994.

Revenue developments in FY 1995 reflected the impact of the tax reform package, as well as the weaker-than-expected economy. The tax reform package replaced the FY 1994 temporary income tax cut with a permanent cut in personal income taxes (¥3.5 trillion) and a temporary income tax cut (¥2 trillion). A rise in the consumption tax rate from 3 to 5 percent was scheduled for April 1997. The lag between tax reductions and the consumption tax increase was a device to provide fiscal stimulus in the intervening period. 4/ During FY 1995, as the economy proved to be weaker than initially expected, the revenue estimates were revised downward. A third supplementary budget was adopted in end-December to finance the ¥3 trillion in revenue shortfalls. 5/

These expenditure and revenue developments have increased the general government deficit (excluding social security) sharply to 6 1/2 percent of GDP from 5 1/2 percent of GDP in FY 1994 (Table 4). The structural balance of the general government (excluding social security) deteriorated by about 3/4 percent of GDP to 5 percent of GDP. The social security surplus slightly declined from the previous year to 2 3/4 percent of GDP.

Table 4.

Japan: General Government Balances, FY 1988-96

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Sources: Economic Planning Agency, Annual Report on National Accounts, 1996; and staff estimates and projections.

The fiscal year begins on April 1.

In percent of potential GDP.

c. FY 1996 budgetary operations

Fiscal policy for FY 1996 is characterized by a cyclically neutral budget with large carryover effects from the September 1995 package. As the FY 1996 budget proposal included a controversial disbursement of the funds to the Deposit Insurance Corporation as a part of the arrangement to resolve the jusen problem, Diet deliberation was prolonged. After the introduction of a provisional budget for the first 50 days of the fiscal year, the budget was approved by the Diet without revisions in mid-May.

The FY 1996 initial general account budget envisages a deficit of 3 1/2 percent of GDP (Table 5). This is about 1 percent of GDP lower than the revised general account deficit in FY 1995, which had widened to 4 1/2 percent of GDP from an initial estimate of 2 3/4 percent due to the adoption of three supplementary budgets. Compared with the initial FY 1995 budget, expenditures follow a slightly contractionary medium-term path, while the revenue projection is noticeably weaker.

Table 5.

Japan: central Government General Account Budget, FY 1991-96 1/

(In billions of yen)

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Source: Data provided by the Japanese authorities.

This presentation differs from that of the authorities; certain revenue and expenditure items in the official presentation are reclassified as financing items.

Includes administrative costs.

Comprises cash expenditures related to commitments entered into in previous years as well as noncash expenditures, including equity contributions to international organizations. The figures for FY 1993–95 include central government debt cancellation of local governments’ outstanding liabilities under the no-interest lending program.

Bonds issued for noncash expenditures. The figures for FY 1993–95 include transfers to finance central government debt cancellation.

Figures for FY 1995 and FY 1996 are based on staff projections of GDP.

Includes public works spending under the no-interest lending program.

Budgeted revenues for FY 1996 are more conservative, after four years of major revenue shortfalls (Table 6). The revenue estimates are predicated on the official economic outlook, which envisages 2.7 percent growth in nominal GDP for FY 1996, and reflect the impact of extending the temporary income tax cut (¥2 trillion) into FY 1996. The estimates also incorporate the effects of the tax measures introduced for FY 1996, including cuts in the rates of the land holding tax and the securities transactions tax, although their revenue implication is very small (less than ¥250 trillion). Among major tax items, while corporate tax revenue is projected to be buoyant with growth of 6 percent, individual income tax revenues are projected to decline by 1.5 percent, owing mainly to the decline in interest income reflecting lower interest rates. As a result, tax and stamp duty revenues are budgeted to rise by only 1.3 percent over the revised estimate for FY 1995. As other revenues are expected to decline, total revenues are projected to be flat, implying a small decline as a ratio to GDP.

Table 6.

Japan: Tax Receipts of the Central Government General Account, FY 1991-96

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Source: Data provided by the Japanese authorities.

Percentage changes calculated relative to most recent data of previous year.

Compared with the initial budget for FY 1995, total general account expenditures are budgeted to rise by only 1.7 percent, and general expenditures to grow by 2.4 percent, in line with the nominal growth rate of potential GDP. Looking at the components of general expenditures, current expenditures grow by only 1.5 percent, while capital expenditures grow by relatively high rate of 5.2 percent. The differentiation in growth rates between the two types of expenditures reflects the authorities’ view that the multiplier is higher for the capital expenditures than for current expenditures--thus the spending mix is designed to provide further support to activity. Compared with the revised budget for FY 1995, expenditures are significantly smaller, owing to a reduction in public investment (about 1 percent of GDP) that was boosted substantially during FY 1995 by supplementary measures, including the September package.

As with the initial general account budget, the initial FILP budget for FY 1996 is also cyclically neutral, returning toward the underlying trend level (Table 7). FILP spending is budgeted at ¥40.5 trillion (excluding portfolio investment), unchanged from the initial FY 1995 level. It represents a decline by 8 1/4 percent compared with the revised FY 1995 FILP of ¥44.2 trillion, which incorporates a supplementary rise during FY 1995. 1/ Still, at 8 1/4 percent of GDP, the size of the FY 1996 FILP remains significantly above its level before the downturn. In formulating the FY 1996 FILP, the selective allocation of funds was emphasized, with the goal of contributing to stable economic growth and improving standards of living. Specifically, funds for public financial institutions declined considerably, reflecting lower demand for FILP funds from those financial institutions as a result of low market interest rates. On the other hand, sufficient funds are provided to ensure implementation of public works projects, to the central and local governments and other public works executing corporations.

Table 7.

Japan: Fiscal Investment and Loan Program (FILP), FY 1991-96

(In billions of yen)

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Source: Ministry of Finance, Zaisei Kinyu Tokei Geppo (Financial and Monetary Statistics Monthly).

Difference between “sources of funds” and “uses of funds” reflects short-term off-program investments of the Trust Fund Bureau.

Reflects the funding of the “lend-back” system under which the postal savings system, public pension funds, and the postal life insurance fund receive funds for portfolio management on their own account.

Excluding portfolio investment.

Compared with preliminary outturn of the previous year.

Compared with revised plan of the previous year.

As a percentage of projected GDP.

The Local Finance Plan for FY 1996 envisages growth in total local government expenditures of 3.4 percent. Local tax revenues are projected to grow very little (by only 0.1 percent). Transfers from the central government are budgeted to grow by 4.3 percent, reflecting an upgraded boost over the statutorily defined level. 2/ Remaining financing requirements will be met by local government borrowing, which is projected to rise by 15 percent over FY 1995.

While all the initial budgetary plans for FY 1996 indicate a cyclically neutral stance, the other important component is the carryover effects of the September 1995 package. As discussed earlier, the expenditure increases of the September package were all budgeted in FY 1995--in October at the central and in December at the local government level. Given the timing of the budgetary approvals of the package and the normal implementation period of public works projects, the stimulative effects of the package occurring in FY 1995 is estimated to be about one third, and two thirds of the total effect are “carried over” and actually felt in FY 1996. 3/

At the level of the general government, taking into account the carryover effects and cyclically neutral budgetary plans, the staff estimates that the deficit (excluding social security) will expand by a small margin in FY 1996 to around 6 1/2 percent of GDP. Total revenues are estimated to grow by 3 3/4 percent over FY 1995, reflecting slightly higher growth in nominal output (2.8 percent) than the official economic outlook (2.7 percent) and a scheduled increase in the pension premium rate. Total expenditures are estimated to grow by 4 1/4 percent in FY 1996, rising to 36 percent of GDP from 35 1/2 percent of GDP in FY 1995. The structural deficit of the general government (excluding social security) is projected to widen to 5 1/4 percent of GDP from 5 percent of GDP in FY 1995. The social security surplus is expected to remain unchanged at 2 3/4 percent of GDP (Charts 7 and 8).

CHART 7
CHART 7

JAPAN GENERAL GOVERMENT EXPENDITURES AND RECEIPTS FY1984-FY 1996 1/

(Percent of GDP)

Citation: IMF Staff Country Reports 1996, 090; 10.5089/9781451820423.002.A001

Sources Economic Planning Agency, Annual Report on National Accounts; and staff estimates.1/ Figures for FY 1994 and FY 1995 are staff estimates.
CHART 8
CHART 8

JAPAN GENERAL GOVERNMENT FISCAL INDICATORS FY1984–96 1/

(Percent of GDP)

Citation: IMF Staff Country Reports 1996, 090; 10.5089/9781451820423.002.A001

Sources: Economic Planning Agency, Annual Report on National Account% and staff estimates.1/ Figures for FY 1995 and FY 1996 are staff estimates.

2. Medium-term issues

a. Medium-term fiscal position and strategy

Reflecting weak activity and countercyclical fiscal actions, including five packages and tax cuts, the general government deficit (excluding social security) has deteriorated from 1/4 percent of GDP in FY 1991 to 6 1/2 percent of GDP in FY 1996 (Chart 5). The consolidation effort of the 1980s has thus been entirely reversed.

As well as in flow terms, the deterioration in the fiscal position has been reflected in a sharp increase in debt stocks. The gross debt ratio to GDP of the general government has risen from 67 percent to over 90 percent during 1991–96. The net debt ratio to GDP has also risen by over 10 percentage points during the same period. Although at 15 percent of GDP the net debt remains relatively low in 1996 compared with other G-7 countries, it is misleading to look simply at Japan’s net debt; sizable assets currently held by the social security fund are intended to finance part of the much larger future liability, and therefore, should not be counted on to offset non-social security sector debts. Excluding social security assets, the net debt ratio to GDP is projected to stand at 60 percent in 1996, implying rise of over 20 percentage points during 1991–96. 1/

Reflecting the authorities’ emphasis on the need for consolidation in setting future fiscal policy, announced policies envisage significant consolidation measures in FY 1997. Public investment will decline as the carryover effects of the September package unwind. The consumption tax rate is scheduled to rise from 3 to 5 percent in April 1997, and the ¥2 trillion temporary income tax cut is to be reversed in FY 1997. The effects of these consolidation measures will, however, be partially offset by higher social security payments. Consequently, the structural deficit of the general government is projected to narrow by 1 1/2 percent of GDP in FY 1997.

Without further policy initiatives, the structural deficit is projected to widen beyond 1997. This is driven by three principal factors: population aging raises social welfare expenditure, including medical care spending and central government contributions to public pension funds; public investment spending rises in line with the 10-year public investment plan; and debt-servicing payments grow. By FY 2001, the structural deficit (excluding social security) rises from 3 1/2 percent of GDP in FY 1997 to 5 percent of GDP. Combined with the gradual decline in the social security surplus, which is projected with the assumed full implementation of the 1994 pension reform plan, the overall structural balance is projected to worsen by 1 3/4 percent of GDP during FY 1997–2000 to 2 1/2 percent of GDP.

Until recently, the authorities’ fiscal consolidation had been guided by the announced medium-term objective of reducing the “bond-financing” ratio of the general account budget to 5 percent by FY 2000. 1/ As this objective had appeared unrealistically ambitious given the recent deterioration in the fiscal position, the authorities are now in the process of formulating a new consolidation target. In line with past staff advice, the authorities recently presented medium-term fiscal scenarios, with and without new consolidation measures, to illustrate the seriousness of the fiscal sustainability problem. 2/ A special committee has also been established under the Fiscal System Council--an advisory body to the Finance Minister--to study consolidation options. Reflecting the wide recognition of the need for fiscal consolidation, Prime Minister Hashimoto recently convened a joint forum of the four related advisory councils to produce a coherent and coordinated consolidation policy. The authorities’ consolidation strategy will become clearer in the fall of this year when the advisory committee presents its recommendation. 3/

b. Allocation of public investment budget

Allocating the public investment budget to efficient projects is important, not only to provide higher multiplier effects on activity, but also to ensure cost-effective management of fiscal policy. In practice, however, as shown in Table 8, the shares of public investment allocated to various sectors of the economy have been very rigid. Large shares held by established sectors, such as agriculture, tend to be maintained over time, while newly emerging sectors tend to get little investment.

Table 8.

Japan: Allocation of Public Works Expenditure of Central Government General Account, FY 1985-96

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Source: Data provided by the authorities.