This 1999 Article IV Consultation highlights that Japanese growth has been lackluster throughout most of the 1990s. Since the asset price bubble burst in 1991, the economy has grown at an average of 1 percent per year, in striking contrast to the rapid growth achieved in previous decades. A series of fiscal stimulus packages raised the structural general government deficit by more than 5 percentage points of GDP between FY1991 and FY1998, while monetary policy has progressively eased.
1. This statement provides an update of information that has become available since the release of the staff report (SM/99/165, 7/12/99). It covers: recent monthly data and the short-term outlook; exchange rate developments; fiscal policy plans; the package of measures to support corporate restructuring; proposals for reform of the public pension system; and information on the situation of regional banks and the deposit insurance system.
2. Monthly data for June seem broadly consistent with GDP remaining flat or declining moderately in the second quarter, somewhat stronger than anticipated earlier. Retail sales data suggest that private consumption has continued to rise, exports look to be picking up, and a strong increase in industrial production in June limited the decline of this variable in the second quarter to 1 percent. Nevertheless, a sharp quarterly drop in capital goods shipments suggests that business investment has renewed its decline. Moreover, a rise in the unemployment rate to a record 4.9 percent and a sharp drop in bonus payments in June may dampen consumer sentiment in the second half of 1999, when the recovery will already be under pressure from the expected contraction in public investment. Even so, there now looks to be some room to raise the staffs current 0.2 percent projection for GDP growth in calendar 1999, which at present is just above the consensus.
3. Views on the outlook for 2000 remain widely dispersed. Like the staff, a number of forecasters expect a pick-up in growth based on a turnaround in business investment together with a positive contribution from the external sector, provided that macroeconomic policies remain supportive. However, many observers are more pessimistic, concerned that corporate restructuring will continue to have a negative impact on private demand and that there may be a significant withdrawal of fiscal stimulus. The consensus forecast growth in 2000 is still below zero, compared to the staffs projection of 1 percent growth.
4. Since mid-July, the yen has risen to around 114 to the U.S. dollar, an appreciation of almost 6 percent (around 4 percent in nominal effective terms). Market reports suggest that exchange market intervention—largely sterilized—has continued over this period but in reduced amounts in the face of broader downward pressures on the dollar. Officials have emphasized that the overall policy towards the yen remains unchanged, and that a premature strengthening of the exchange rate would be undesirable.
5. Recently approved guidelines for drawing up the FY2000 budget have increased the need for a substantial second FY1999 supplementary budget. The first supplementary budget for FY1999—authorizing 500 billion of spending related to the June 11 jobs package—has now been passed by the Diet. On July 30, the Cabinet approved guidelines for the FY2000 initial budget which imply about a 2½ percent increase in general account appropriations compared to the initial budget for FY1999 (on an equivalent basis). Nevertheless, on this basis, actual outlays in FY2000 could fall significantly because FY1999 disbursements are being boosted by the large supplementary budget announced in late 1998. A decision on the scale of a possible second FY1999 supplementary budget is expected in September, after release of the second quarter GDP results.
6. In mid-July, the cabinet approved a package of tax and administrative measures to support industrial revitalization. The package is intended to support the scrapping of current production facilities, the streamlining of business organization, and the exploitation of new markets by firms engaged in a serious restructuring effort. Incentives include:
Tax benefits including an extension of the carry forward period for losses related to scrapping capital from five years to seven years, reduction of registration and licensing taxes applied to transfer of assets, and accelerated depreciation allowances for new investments in specific assets.
Exemptions from commercial law requirements to streamline approvals for divestiture of subsidiaries and affiliates.
Raising the upper limit on the issue of preferred stocks from one third to one half of all stocks to facilitate debt-equity swaps.
Increasing the upper limit on the use of stock option schemes from 10 percent of total stocks to 25 percent.
Providing financial support for management and employee buy-outs to facilitate stock purchases.
Low interest loans and loan guarantees to encourage new businesses, drawing on the pool of funds already established in October 1998.
Corporations wanting to benefit from the measures would be required to submit business restructuring plans to the Government, which should be approved before end-March 2001. Legislation has been sent to the Diet and is expected to be passed by mid-August.
7. It is too early to assess the overall impact of this package. Many of the details—such as criteria for eligibility—remain to be worked out in detail. Care will be needed to ensure that application is nondiscriminatory. Moreover, it will be important to follow through with broad-based and permanent reforms of the legal and tax framework.
8. In mid-July, the cabinet approved pension reform legislation for submission to the Diet. The bills include measures to raise gradually the minimum age for earnings-related pensions from the current 60 to 65, to adopt a new formula that will tend to limit increases in the salary-based portion of pension payments to new retirees from April 2000, and to reduce pension payments to those aged between 65 and 70 who continue to work. Based on these changes, official estimates suggest that the employee pension insurance contribution rate would need to rise from its current rate of 17.4 percent of base wages to 27.6 percent by 2025 to ensure the viability of the pension system; this compares to a 34.5 percent contribution rate needed by 2025 for viability under the current framework. The LDP and the Liberal Party also agreed to expand the government’s share of funding for the basic pension program from the current one-third to one-half, provided that specific funding for this increase (which would cost about 2 trillion or 0.4 percent of GDP) can be identified. The legislation is likely to be considered in the Diet this fall. Similar reforms for pensions to public sector employees were also recently recommended, while plans are also proceeding to introduce 401(k) style defined contribution schemes from next year, which will help to encourage labor mobility.
9. Recent data on the financial position of regional banks confirm the weak position of this sector. The results recently announced for the special examination of first tier regional banks conducted by the Financial Supervisory Agency showed that on average provisions were about one third less than those thought appropriate by FSA inspectors. Results for second tier regional banks—not yet announced—may well be considerably worse. Moreover, even before adjusting for higher needed provisioning, the capital adequacy ratio of about half of the regional banks is less than 8 percent, the Basle standard for international banks.
10. Continuing concern for the weak financial situation of the banking system is focussing attention on the reform of the deposit insurance system. The Financial System Council issued an interim report in early July setting out a broad set of issues to be addressed in returning to partial deposit insurance coverage scheduled for April 2001. The final report is expected by the end of the year, with a view to tabling legislation by early 2000. Difficult issues to be addressed include the possible need for flexibility to respond to any recurrence of systemic pressures and the design of effective methods for dealing with failed institutions (the current framework expires at end-March 2001). A separate problem is that the 7 trillion specifically set aside in the March 1998 legislation to compensate losses in failed institutions through March 2001 is quite likely to be exhausted by the resolution of the Long-Term Credit Bank (LTCB) and the Nippon Credit Bank (NCB), implying a need for additional public funding.