Japan: 2018 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for Japan

International Monetary Fund. Asia and Pacific Dept

doi:10.5089/9781484386729.002.A001

Jump to Content Jump to Main Navigation

Japan: 2018 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for Japan

Author: International Monetary Fund. Asia and Pacific Dept

Publication Date:: 27 Nov 2018

eISBN:: 9781484386729

Language:: English

Keywords:: ISCR; CR; headline CPI inflation; Japan's Cabinet Office; money market rate; government bond bond yield; guide inflation expectation; rate of interest; carry trade; real GDP; labor market; exchange rate; Consumption taxes; Income; Global

Download PDF (1.7 MB)

2018 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Japan

Abstract

2018 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Japan

Recent Developments

1. In September, Prime Minister Abe was reelected as the President of the ruling Liberal Democratic Party. This clears the way for PM Abe to remain in office into 2021, which would make him Japan’s longest-serving prime minister. Abe’s reelection also allows the policies of Abenomics to continue. However, the internal LDP leadership debate highlighted several economic concerns resonating with Japanese public opinion—including high public debt, stagnation of household incomes, and the unevenness of economic gains. Constitutional reform to formally recognize Japan’s Self-Defense Force as a legitimate entity will also likely be a central administration objective in Abe’s remaining term.

2. Economic growth is above potential, but inflation remains low. After a temporary soft patch early in the year, domestic demand recovered in the second quarter. With external demand expected to remain supportive, and despite recent natural disasters, real GDP growth is projected to stay above potential in 2018 at 1.1 percent. This will help narrow the output gap (staff estimate the output gap as small and negative, whereas the authorities estimate it as positive—the difference stems largely from diverging views on the impact of the Global Financial Crisis on potential growth, see Annex I). Headline and core inflation have gained momentum in recent months on the back of higher energy prices, but remain well below Bank of Japan’s (BoJ’s) two-percent target (Box 1). Wage growth remains weak despite tight labor market conditions.

3. Financial conditions have tightened slightly, but remain accommodative (Annex II). Domestic credit growth weakened over the past year, super-long yields drifted up, and dollar funding costs rose significantly. Heightened global uncertainty contributed to a slight appreciation in the yen and weaker equity prices. However, lending by regional banks to small enterprises continued to grow rapidly and indirect overseas investments via investment trusts remained strong (Box 2). Also, insurance companies and pension funds shifted from U.S. Treasuries to more risky U.S. securities with higher yields.

4. Fiscal consolidation was delayed and progress on structural reforms remained slow.

Fiscal policy. The authorities announced the “New Plan to Advance Economic and Fiscal Revitalization” in June, based on the interim fiscal review. The plan postponed the primary surplus target from FY2020 to a more realistic FY2025, but made limited progress in strengthening the fiscal framework by continuing to rely on relatively optimistic growth assumptions. While the plan set up a review of the social security system by FY2020, the current framework lacks a long-term plan to address the increases in social security expenditures and ensure debt sustainability. The government has reaffirmed its commitment to the October 2019 two-percentage point consumption tax rate increase, but associated mitigating measures are yet to be fully specified.¹
Structural policies. Labor market legislation (staff’s top reform priority) was passed by the Diet in June. Its effectiveness in boosting productivity and wages will depend on implementation, including the equal-pay for equal-work guidelines on acceptable reasons for worker wage differentials. Progress was made on enhancing labor supply—women and older workers’ participation rates are on a rising trend, and foreign labor is increasing. However, efforts to further eliminate disincentives to regular work stemming from the tax and social security system have been left out of the policy debate over the past year, and progress remains slow regarding deregulation. In contrast, revisions and guidelines for the corporate governance code (staff’s second-tier priority) were completed recently. Trade reforms (staff’s third-tier priority) have also accelerated, with the Japan-EU trade agreement and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP).

5. The monetary framework was made more sustainable and the supervisory framework more forward-looking.

Monetary policy. Facing rising concerns about side-effects from prolonged monetary easing, the BoJ decided in July to widen the range for the 10-year yield, in effect allowing yields to drift upward. BoJ also announced that future Exchange-Traded-Funds (ETF) purchases would depend on market conditions. To address recurrent speculation of a premature policy normalization, the BoJ explicitly committed to keep short and long-term policy rates low for an extended period of time.
Financial policies. The Japanese Financial Services Agency (JFSA) is moving towards a new forward-looking and dynamic supervisory framework. JFSA is also assessing the sustainability of regional banks’ business models, given demographic and low profitability challenges. Implementation of other main FSAP recommendations—particularly on macroprudential policies, and crisis management and resolution—is incomplete.

Authorities’ Views

6. The authorities noted that the economy is expanding moderately in a well-balanced manner, but that inflation developments remain weak. The authorities highlighted that growth is supported by both domestic demand and external demand where corporate profits and fixed business investment remain favorable, even after accounting for recent natural disasters. However, the authorities also noted that inflation has been sluggish despite a steadily improving labor market and a positive output gap. They argued that this partly reflects firms’ preference to invest in labor-saving technology rather than raise prices and wages. The authorities explained that the new fiscal plan is a step toward making the fiscal consolidation path more realistic, and noted that structural reforms are progressing, including the preparation of the Work Style Reform implementation guidelines. They clarified that the adjustments to the monetary policy framework do not constitute a change in policy stance, but instead improve the sustainability of the framework. The JFSA highlighted that the organizational changes to the JFSA included in the revisions to the supervisory framework should help bring a macro perspective into supervision.

Outlook and Risks

7. Underlying growth is expected to remain solid, notwithstanding the scheduled increase in the consumption tax rate. Real GDP growth is projected to stay above potential in 2018 at 1.1 percent, assuming that external demand remains supportive and the economy bounces back from recent natural disasters. Without effective mitigating measures, the implementation of the consumption tax increase is likely to lead to volatility in private consumption and investment. The effect of the tax increase is expected to carry past 2019 and adversely affect domestic demand and overall growth in 2020. Over the medium term, growth is expected to moderate and the output gap to close. Following a consumption tax-induced spike in 2020, inflation will rise over the medium term, but likely remain below target (see Annex III).

8. Downside risks have increased. In line with the global outlook, the balance of risks has shifted to the downside. Japan’s macro-financial vulnerabilities, fiscal consolidation needs, and limited monetary policy space make the economy vulnerable to adverse shocks (see Annex IV).

Near-term risks. Sharper-than-expected volatility in private consumption and investment due to the planned consumption tax increase in 2019 could undermine near-term growth momentum. Weaker global growth and heightened uncertainty—from trade or geopolitical tensions—could undermine growth, trigger yen appreciation and equity market shocks, and renew deflationary risks. Moreover, a disorderly tightening of global financial conditions could increase macro-financial risks, with financial institutions particularly sensitive to a sharp fall in equity prices or a spike in JGB yields. Rising FX funding cost may increase the FX funding liquidity risk in some internationally active banks, and, together with a flattening trend in the U.S. yield curve, further squeeze bank profitability and lead to excessive risk taking.
Medium-term risks. Continued monetary accommodation amidst tightening by other advanced economies could encourage financial institutions, particularly regional ones, to engage in excessive risk taking. If regional banks and life insurance companies do not adapt business models to the low interest rate environment and adverse demographics, their viability could be threatened in the medium term. Fiscal sustainability concerns and associated bond market stress could have adverse feedback effects on the financial system and the real economy.

Authorities’ Views

9. The authorities partly agreed with staff’s risk assessment but were more upbeat on the macro-financial situation and policy space. While agreeing that global uncertainty could weigh on near- term growth prospects, the authorities were confident that the economy will continue its moderate expansion as a main scenario. However, they also highlighted that the pace of expansion will likely moderate over the medium-term due to a modest slowdown in business fixed investment reflecting cyclical adjustments as well as Olympic Games-related demand winding down. While acknowledging that the reflation process will take time as both firms and households remain cautious about wage and price increases, the authorities emphasized that inflationary pressures are slowly building up. The authorities understand that the 2019 consumption tax increase could cause an economic fluctuation, and they consider it important to control its impact on the economy by mitigating measures planned by the government. The authorities broadly agreed with staff on financial risks. They did not view risks associated with higher FX funding cost or liquidity as significant at this time while recognizing that such risks warrant close monitoring.

Policies: Navigating Demographic Headwinds

10. Japan’s macroeconomic challenges will grow as demographic headwinds intensify. Japan’s population fell by about one million between 2012 and 2017—roughly the population of Stockholm. Official projections anticipate the population will rapidly age and shrink by over 25 percent in the next 40 years.² This will depress growth and productivity due to a shrinking and aging labor force and a shift toward consumption, while fiscal challenges will magnify with rising age-related government spending and a shrinking tax base. Additionally, labor market rigidities limit productivity growth and hamper the pass-through of demand stimulus to real wages and prices—effectively undercutting monetary transmission and blunting the impact of fiscal support.

11. Abenomics—now in year six—has eased financial conditions, reduced the fiscal deficit, and raised employment and female labor force participation.³ However, inflation remains well below BoJ’s two-percent target and fiscal policies have yet to put public debt on a sustainable path. The ‘third arrow’ of Abenomics (structural reforms) has made some headway but has fallen short overall. Bottlenecks remain in labor and product markets, and in the corporate sector.

12. The strategy of Abenomics remains appropriate, but reinvigorated and credible policies are needed. Bringing Abenomics to full strength requires that the three arrows are reinforced and are mutually supportive.⁴ Specifically:

Fiscal policy: Near-term fiscal and income policies should support BoJ’s reflation efforts and implementation of structural reforms. A well-specified and gradual medium-term consolidation plan, based on realistic growth assumptions, would help enhance near-term fiscal space, help ensure debt sustainability, and bolster public confidence in the government’s capacity to manage the financial costs of the demographic transition.
Structural reforms: Credible macro-structural reforms are imperative to lift long-run growth and stabilize government debt. Confidence and anticipation effects—associated with a credible reform program—will be key to avoid any deflationary impact. Structural reforms would help boost inflation through more effective monetary policy transmission, resulting from a higher natural interest rate and reinvigorated wage-price dynamics.⁵
Monetary and financial policies: The accommodative monetary policy stance should be maintained, but clear forward guidance and further strengthening of the monetary policy framework could help lift inflation expectations. Moreover, strengthened financial sector policies could mitigate the financial risks from demographic headwinds and prolonged low interest rates. This would improve BoJ’s ability to maintain its accommodative stance for longer.

A. Fiscal Policy—Near-Term Support and Long-Term Sustainability

13. The credibility of the FY2025 primary surplus target would be enhanced by the adoption of more realistic macroeconomic projections and specification of consolidation measures. Despite a small downward revision in this year’s update, the authorities’ macroeconomic projections still rely on relatively optimistic assumptions on TFP growth, which are based on Japan’s experience of the 1980s. At the same time, the optimistic growth projections for FY2019 and FY2020 do not provide guidance on the size of the mitigating measures needed to offset the adverse impact of the October 2019 consumption tax increase. The absence of concrete revenue and expenditure measures does not build confidence in the authorities’ new fiscal plan. In the near-term, Japan continues to have some fiscal space, helped by limited funding risks and low borrowing costs. However, this is conditional on the adoption of a credible medium-term fiscal consolidation plan to anchor the debt trajectory. Japan’s demographics, combined with a generous social security system, will further increase age-related costs. This will constrain fiscal space over the medium and long-term and call for a credible strategy that reaches well beyond FY2025.

14. Near-term fiscal tightening should be avoided—maintaining instead a neutral fiscal stance in 2019 and 2020 to make the planned consumption tax hike successful. The government has reaffirmed its commitment to the consumption tax hike in October 2019, which will bring in much needed revenue. But without mitigating measures to attenuate the adverse impacts, staff estimates that the 2019 and 2020 fiscal stance would be contractionary by 0.7 and 0.6 percent of GDP, respectively, as the effects of the 2018 supplementary budget fade and the October 2019 consumption tax increase comes into play. Therefore, measures should be implemented to support near-term reflation and growth momentum while helping advance accelerated structural reforms.

Mitigating the impact of the 2019 consumption tax rate increase. Temporary mitigating measures should be carefully designed to alleviate the adverse impacts from the October 2019 tax increase. In particular, mitigating measures should address concerns over durable consumption including automobiles and housing. For example, abolishing the automobile acquisition tax could help partly offset the impact of consumption tax rate increase. The authorities could also consider a time-bound and well-targeted tax rebate or transfer program to reduce the tax burden on households at the lower end of the income distribution. Importantly, clear communication to the public on the timing and content of the measures will help alleviate adverse effects due to uncertainty.⁶
Strengthening income policies and raising administered prices. Corporate tax incentives for wage increases should be strengthened, minimum wages raised further, and administratively-controlled wages and social transfers increased—including to reflect the impact of the consumption tax increase on prices. In addition, to support reflation efforts, reforming the price setting mechanism of administered prices should be considered to better reflect costs, with safeguards introduced for low-income households.

15. A well-specified fiscal framework for the medium and long-term is needed to reduce policy uncertainty, address demographic challenges, and mitigate debt sustainability risks. The fiscal framework needs to rely on more independent and realistic assessments of the economic outlook and budget projections, specify fiscal consolidation measures, and limit the use of supplementary budgets. An independent fiscal institution (IFI) could play an important role in this regard. To protect growth while putting debt on a stable path, medium-term fiscal consolidation should embed a gradual approach with annual consolidation of about 0.5 percent of GDP in the structural primary balance, starting from 2021 (see text chart and Annex V). Essential steps include:

Gradual and steady increases in the consumption tax rate, beyond 10 percent. To finance growing social security costs and reduce debt sustainability risks, consolidation should center on gradual increases in the consumption tax rate—the preferred financing option due to its relatively small negative effect on GDP and welfare including of future generations—until the rate reaches at least 15 percent. As far as possible, the unitary rate structure should be maintained as the tax rate moves beyond 10 percent, to enhance efficiency, reduce compliance and administrative costs, and support the revenue-raising capacity of the consumption tax. The cost of postponing adjustment is substantial as it benefits current elderly population to the detriment of future generations.⁷
Reforming healthcare. Measures to contain total healthcare spending should balance the objectives of delivering meaningful fiscal savings and preserving public welfare, focusing primarily on improving efficiency. Increasing the share of out-of-pocket spending can help contain the fiscal burden of future generations, but safeguards for low-income households should be included. Staff analysis suggests that a combination of reforms could generate fiscal savings of up to 2 percent of GDP by 2030.⁸
Addressing income inequality. Reforms to curb social security outlays should protect the most disadvantaged groups among the elderly, while addressing intergenerational and regional inequality. In addition, to reduce gender inequality, fiscal policy should support opportunities for women in the labor force, including by increasing the availability of childcare and nursing-care facilities, and eliminating disincentives to full-time and regular work embedded in the tax and social security systems.⁹

Options for Fiscal Policy Adjustment by 2030 (in percentage point of GDP) ^1/

^{^1/}These estimates build on findings in McGrattan and others (2018), Nozaki and others (2017), Kashiwase and others (2012), and 2018 Japan Selected Issues Paper “Japan – Options for Healthcare Reform”.

^{^2/}Credits will reduce personal income tax revenue gains.

Authorities’ Views

16. The authorities noted that the impact from the 2019 planned consumption tax rate increase will be smaller than the one from 2014. In addition to a smaller rate increase (2 percentage points in 2019 versus 3 percentage points in 2014), a reduced tax rate for food and non-alcoholic beverages and additional spending for the Human Resource Development Revolution¹⁰—mainly funded by part of the revenue raised by the consumption tax rate increase—will ease households’ net tax burden. The authorities also stressed that they will formulate additional mitigating measures by December, such as addressing demand fluctuations. They agreed with the importance of clear communication regarding the consumption tax increase and related mitigating measures.

17. The authorities broadly agreed with the need for a stronger fiscal framework, but stressed that this can be accomplished through strengthening the existing framework and institutions. The authorities recognized the importance of realistic macro-fiscal projections and expenditure reforms, through not only initial budgets but also supplementary budgets. While the authorities recognized the objectives of an independent fiscal institution (IFI), they stressed that the current framework can deliver on them via two councils providing advice on fiscal policy: the Council on Economic and Fiscal Policy (CEFP) (an advisory board to the Prime Minister) and the Fiscal System Council (FSC) (an advisory board to the Finance Minister). In this respect, the authorities noted that the CEFP has four outside members from academia and the private sector, and that the revision in medium and long-term growth projections in January 2018 was done in response to CEFP input. They noted that they will start to implement specific consolidation measures in social security, including a method for appropriately balancing benefits and burdens, within FY2019–FY2021 while conducting a comprehensive review of the social security system by FY2020. The authorities argued that the 2017 revision of the spousal tax deduction is expected to contribute to resolving the tax disincentive to full-time and regular work.

B. Macro-Structural Agenda—Reinvigorated Reforms

18. Structural reforms are essential to navigate Japan’s demographic headwinds. Aging and depopulation will depress productivity and growth—shrinking real GDP. Weak growth and inflation prospects, together with rising age-related spending, pose serious fiscal challenges. Further, structural rigidities in the labor market dampen productivity growth and hamper the pass-through of demand stimulus to real wages and prices. A credible and well-coordinated reform package is paramount to achieving faster short- and long-term growth, higher inflation, and stabilization of government debt.

19. A reinvigorated structural reform agenda should boost productivity, labor supply, and investment, while strengthening the credibility of the reforms would support reflation.¹¹ The government has properly identified areas for reform, but gaps remain and implementation has been slow. Staff analysis finds that under current policies real GDP will decline by over 25 percent in 40 years due to demographics (Box 3). Credible implementation of all structural reforms (as outlined below), accompanied by a continued accommodative monetary stance and public debt stabilization, could significantly boost real GDP. Additionally, a credible reform program would help reflation as the demand boost due to anticipation effects (as firms and households increase investment and consumption due to higher expected capital returns and permanent income) exceeds the contemporaneous supply boost from the reform plan. While there is a range of uncertainties around such long-run model simulations, the simulations suggest that real GDP could be higher by as much as 15 percent in 40 years due to credible reforms, relative to the current-policies scenario. By contrast, a not-fully-believed path of reforms would deliver significantly lower effects on near-term real GDP (8 percent boost in 10 years), would not help inflation reach BoJ’s two-percent target, and would lead to a smaller decline in the government long-run debt-to-GDP ratio.

20. The proposed reinvigorated reform agenda ranks reforms in terms of their output and inflation impact (see text chart including indicative reform estimates and ranges for the output and inflation impact).

Top-tier reform: Labor market reforms that increase productivity and labor supply.
The Diet passed Work Style Reform legislation in June, but the effects may be limited without supporting measures. Providing training and career opportunities to non-regular workers, including via contract reform, will help increase their productivity and real wages. Complementing “equal-pay for equal-work” legislation with job descriptions and a stronger reporting framework will increase its effectiveness.
Increasing labor supply. Greater labor participation by women, older workers, and foreign workers could partly offset Japan’s demographics. Eliminating disincentives in the tax and social security system to full-time and regular work, increasing availability of childcare and nursing facilities, and reducing the gender wage gap could increase female labor supply. Reducing excessive overtime and encouraging managerial practices rewarding productivity could further boost productivity and labor force participation, as could abolishing firms’ right to set a mandatory retirement age.
Second-tier reform: Product market and corporate reforms to lift productivity and investment.
Facilitating exit of non-viable small- and medium-sized enterprises (SMEs) and entry of firms with stronger potential would increase productivity, along with reduced coverage of the credit guarantee system, incentivizing alternative sources of SME financing, supporting SME R&D investment, and supporting business succession of firms with high growth potential.¹² Continued deregulation will help increase productivity and investment, including by lowering barriers to entry, removing incumbents’ protections in some industries (telecom and gas), deregulating professional services,¹³ and expediting deregulation in Special Economic Zones. Deeper corporate governance reform could help deploy cash reserves, and boost investment and productivity, including via more ambitious requirements for outside directors, explicit limits on cross-shareholdings, and enhanced transparency of beneficial ownership. Broader adoption of automation and AI could also boost productivity, but distributional concerns should be considered to ensure gains are spread evenly across occupations and regions.¹⁴
Third-tier reform: Trade liberalization and FDI promotion to strengthen investment and growth.
Japan remains a global leader in supporting a multilateral free and open trading system. The Japanese government has recently made good progress by advancing the Japan-EU Trade Agreement and the CPTPP. It has also announced the intention to enter into negotiations with the United States. Further removal of tariff and non-tariff barriers in the context of high-standard multilateral trade agreements would boost Japanese investment and growth.

Authorities’ Views

21. The authorities remain committed to an ambitious structural reform agenda and noted their continued progress. While acknowledging the challenges posed by the dual labor market, seniority system, and long-working-hours culture, the authorities assess that new regulations on wage gaps, working hours and overtime (coming into effect in April 2020) will boost productivity. They noted their continued efforts toward further boosting labor supply in order to compensate for demographic headwinds, including from female, older and foreign workers. The authorities noted that overall SME lending had decreased since the coverage reduction in the SME credit guarantee system in April (from 100 to 80 percent) but emphasized that banks’ SME risk assessments had improved. They highlighted continued deregulation efforts in gas and electricity markets. The authorities pointed to the new guidelines and revisions to the corporate governance code, and noted that they expect to see an increase in board diversity and a reduction in firms’ cross-shareholdings going forward. The authorities acknowledged their global leadership role in advancing multilateral trade agreements. Overall, they agreed with the importance of a credible and reinvigorated reform program to maximize its economic impact including by supporting reflation efforts.

C. Monetary Policy—In for the Long Haul

22. Monetary policy should remain accommodative while putting a premium on policy sustainability. Backward-looking inflation expectations (Box 1), structural rigidities, and adverse demographic trends are clogging the monetary transmission mechanism and reducing the effectiveness of monetary stimulus. These factors have manifested themselves in a narrow gap between the short-term actual and natural real interest rates (Box 4). Given the limited progress of monetary policy to generate inflationary pressures since the introduction of Abenomics, the BoJ must maintain the accommodative stance for a prolonged period. Continued efforts to make the accommodative stance more sustainable— including by mitigating side-effects from prolonged monetary easing—are crucial and consistent with a more patient approach to reaching the inflation target.

23. More can be done to improve market communication and further strengthen the monetary policy framework. Policy normalization by other major central banks and concerns about financial sector side-effects have complicated BoJ’s reflation efforts and market communication. While the recent commitment to keep interest rates low for an extended period should help stem market speculation over an earlier-than-expected normalization, further improvements to the communication framework are imperative to enhance policy predictability and generate public support for achieving the inflation target. Specifically, the relationship between forward guidance on the long-term interest rate target and the inflation target could be clarified and the quantitative guidance on JGB purchases could be removed.¹⁵ To strengthen the policy framework and help lift inflation expectations, the BoJ should consider moving closer to full-fledged inflation targeting by publishing BoJ’s staff baseline forecast together with underlying policy assumptions. This should help reduce the discrepancy between market and the BoJ Board’s inflation forecasts by enhancing the public’s understanding of monetary policy as well as reducing the likelihood of overly optimistic inflation forecasts by BoJ Board members (see text figure).

24. Financial sector side-effects, including JGB market functioning and potential distortions from ETF purchases warrant close monitoring.

JGB market. Some liquidity indicators have improved amid reduced JGB purchases under Yield Curve Control (YCC). However, the number of market transactions has declined sharply since the beginning of 2018, raising concerns about market functioning. The July increase in the range for 10-year JGB yields could help improve market conditions. Moreover, better coordination between BoJ, Ministry of Finance (MoF) and market participants could make MoF’s Liquidity Enhancement Auctions and re-opening issuances more flexible in reacting to changes in market conditions and investors’ need for particular JGB issues. This could help prevent liquidity stress in the JGB market.
ETF purchases. BoJ’s ETF purchases have increased substantially over the past few years, making BoJ one of the largest shareholders of listed companies. Concerns have been raised that ETF purchases are distorting equity prices, particularly of small-cap firms, and adversely affecting corporate governance (due to the ETF’s passive voting power). Recent actions by the BoJ to further shift ETF purchases to the broader, market cap weighted Topix index, as well as conditioning future ETF purchase on market condtions could help allieviate some side-effects.

Authorities’ Views

25. The BoJ acknowledged that reaching the inflation target will likely take more time than previously expected. The BoJ noted that because inflation expectations mostly respond to increases in actual inflation, efforts to maintain the output gap within positive territory will lead to achieving the price stability target of 2 percent at the earliest possible time. The authorities also argued that the current forward guidance on policy rates is appropriate as it strikes the right balance between the effectiveness of the commitment and the need to maintain future policy flexibility. Furthermore, the BoJ maintained that its quantitative guidance on JGB purchases indicates continuing the accommodative stance of monetary policy, and that publishing staff’s forecasts would be confusing for market participants given that current forecasts by board members are already published to a sufficient extent.

26. The BoJ emphasized that it is carefully monitoring financial sector side-effects. The authorities agreed that interest rate formation in the JGB market has been somewhat rigid, and that there has been a notable decline in transactions, but that measures taken in July are expected to contribute to maintaining and improving market functioning. The BoJ also emphasized that while ETF purchases may vary depending on market conditions, the guideline for the annual pace of increase of about ¥6 trillion will be maintained. Overall, the BoJ agreed that examining side-effects from prolonged monetary easing will be important to maintain the sustainability of the accommodative stance of monetary policy.

D. Financial Sector Policies—Containing Risks

27. Japan’s financial sector remains stable, but low interest rates and demographic headwinds are undercutting profitability and encouraging risk taking. The overall banking sector remains well capitalized and liquid. Nonetheless, the amount of risks taken by some financial institutions have exceeded their capital levels. Market risks from a large decline in equity prices or a sharp rise in JGB yields could lead to substantial losses for major banks and life insurers, while solvency concerns and higher risk taking due to demographic challenges and low interest rates are more severe for regional banks. In particular, the riskiness of credit allocation has increased significantly in recent years on the back of strong growth in lending to small enterprises, and exceeded the levels seen during the global financial crisis.¹⁶ Meanwhile, the ratio of real estate loans-to-GDP has reached an historic high. Moreover, banks have increased substantially their holdings of investment trusts while long-term investors have stepped up their risk taking in foreign securities.¹⁷ Risks associated with these activities should be carefully monitored and assessed against financial institutions’ risk management capacity. Recent stress testing conducted by the BoJ highlighted authorities’ concerns over the impact of low profitability on capital levels, and increased lending to financially vulnerable firms.

28. Financial sector policies should be enhanced to contain the build-up of systemic risks in line with the 2017 FSAP recommendations (see Annex VI).¹⁸

Enhance risk management and strengthen financial oversight. Financial institutions (particularly regional), should improve the effectiveness of credit risk management by, for example, making loan-loss provisioning more forward-looking. The JFSA’s new supervisory framework is a step in the right direction to help keep pace with more sophisticated activities among financial institutions. However, a more rigorous risk assessment process and a risk tolerance framework should be introduced to support the transition to a full risk-based approach. Capital requirements should be better tailored to individual bank’s risk profiles, corporate governance could be further strengthened across the banking and insurance sectors, and an economic-value-based solvency regulation for the insurance sector should be introduced. The JFSA’s recent move to include four more banks in its stress testing framework is welcome, while the macroprudential framework should be further strengthened in line with FSAP recommendations.
Adjust business models and strengthen crisis management and resolution. The JFSA should encourage regional financial institutions to adapt their business models to prevailing demographic trends, including through revenue diversification, utilization of IT and Fintech, and consolidation. The JFSA recently expanded the total loss absorbing capacity (TLAC) requirement to one domestic systemically-important bank (D-SIB), and should further strengthen the crisis management and resolution framework to avoid expectations of public support.

29. The JFSA could further facilitate Fintech adoption and should continue to strengthen crypto-asset oversight. Japan remains a heavily cash-based society with relatively low Fintech penetration—particularly in regional economies, despite the government’s efforts to increase cashless payments.¹⁹ The adoption of Fintech by regional banks has been largely discouraged by an aged customer base, limited resources, the lack of experience in managing cyber risk, and the lack of clear Fintech regulations. Measures could be taken to increase cyber resilience in regional financial institutions and Fintech firms. The JFSA should continue to promote RegTech to reduce regulatory costs and incentivize Fintech firms to participate in the regulatory sandbox (by, for example, reducing the regulatory reporting costs inside the sandbox for small start-ups). On crypto-asset oversight, more emphasis should be put on cybersecurity in crypto-asset exchanges, which requires adequate human and IT resources at the JFSA (Box 5). The JFSA should also clarify with the public its role in the exchange registration process to reduce reputational risk. Enhanced cross-border supervisory collaboration could help prevent regulatory arbitrage and avoidance.

Authorities’ Views

30. The JFSA stressed its close monitoring of financial risks and argued that significant progress was made in implementing the 2017 FSAP recommendations. The JFSA is examining whether regional banks have adequate risk management capacity for emerging risks, but does not see excessive risk taking at this moment. On insurance oversight, the JFSA plans to incorporate the idea of economic-value-based solvency assessments in its supervision and inspection, while working towards the introduction of economic-value-based solvency regulation in line with the development of the Insurance Capital Standard by the IAIS. The JFSA reiterated its preference to implement measures to contain potential systemic risks through microprudential approach, while introducing some macroprudential policies such as countercyclical buffer. The JFSA also emphasized efforts made to limit the need for temporary public funding, such as various works to improve financial institutions’ resolvability and the expansion of the scope of the requirements on Total Loss Absorbing Capacity.

31. The JFSA agreed that more could be done to facilitate the use of Fintech. The JFSA has emphasized that it is important for regional banks to build a sustainable business model, and stressed the need for regional banks to further streamline management, increase the use of IT, develop areas of expertise, and improve corporate governance. The JFSA highlighted cyber risk as a key (although not systemic) risk, and agreed that measures could be taken to increase cyber resilience in regional financial institutions and crypto-asset exchanges. The JFSA does not see significant reputational risks from registered exchanges, but echoed the need for enhanced cross-border collaboration in crypto-asset oversight.

E. External Position and Spillovers

32. The external current account (CA) surplus increased by 0.1 percent to 4.0 percent of GDP in 2017, due to a stronger income balance. Japan’s positive CA is due mostly to corporate saving in excess of domestic investment. The sizable income surplus, arising from Japan’s large NFA position and high net returns, accounts for most of the CA surplus (about 90 percent in 2017). The CA surplus is expected to shrink in 2018 to 3.6 percent of GDP, reflecting smaller goods trade and income balances. The yen has appreciated slightly in the first nine months of 2018 (in real effective terms) relative to end-2017.

33. The 2018 external position is projected to be broadly consistent with fundamentals and desirable policies, while bold structural reforms are required to maintain external balance going forward. As with the 2017 external sector assessment, the projected 2018 CA balance is preliminarily assessed as in line with the CA level consistent with fundamentals and desirable policies. Based on this CA assessment, the 2018 real exchange rate is also preliminarily assessed as in line with the real exchange rate level consistent with fundamentals and desirable policies (see Annex VII). Looking ahead, a well-specified medium-term fiscal consolidation plan and bolder and credible structural reforms that support growth and domestic demand are needed to maintain external balance. Staff estimate that the credible implementation of all structural reforms outlined will reduce the external current account surplus by over 1 percent of GDP in the medium term (see Box 3).

34. Rising global interest rates amid Japan’s continued accommodative monetary policy could amplify outward spillovers. Monetary easing in Japan and ‘search-for-yield’ by Japanese investors continue to support FDI outflows and overseas diversification by institutional investors. This should help offset tighter global financial conditions and potentially mitigate disruptive capital flows, particularly for emerging market and developing countries in the region. On the other hand, speculation over earlier-than-expected policy normalization in Japan could cause a significant shift in global market perceptions and accelerate global financial tightening. Moreover, growing differentials between global and domestic interest rates could encourage investors to take unhedged yen carry trade positions. A sharp reversal of these positions, due to heightened global uncertainty from trade or geopolitical tensions, could lead to a large and sudden appreciation of the yen. While a yen appreciation could help boost foreign investors’ asset returns, it could also adversely affect BoJ’s efforts to reflate the economy (see Box 6).²⁰

35. Continued advancement of multilateralism can help mitigate inward spillovers, including from potential trade-war escalation. Japan’s trade and FDI regimes show relative openness, with agricultural support being the only area ranking as relatively restrictive vis-à-vis other G20 countries. A global retreat from cross-border integration would likely reduce Japan’s net exports, investment and growth, including from direct and indirect effects via global value chains and adverse spillovers to the financial sector. For example, the October 2018 World Economic Outlook estimates that if the U.S. imposes the threatened 25 percent tariff on imported cars and car parts in 2019 (with trading partners responding with tariffs on an equivalent amount of U.S. goods exports), Japan will have a notable decline in output (i.e. long-run decline of almost 0.2 percent). Japan’s recent leadership in advancing multilateralism can help mitigate inward spillovers from a rise in protectionism.

Authorities’ Views

36. The authorities agreed with the preliminary 2018 external assessment and related policy recommendations but expressed concerns regarding the methodology. The authorities agree that bolder and credible structural reforms and medium-term fiscal consolidation plans are needed to maintain external balance by supporting growth and domestic demand. However, the authorities continue to have concerns over the REER assessment and the EBA methodology. On the REER assessment, the authorities emphasized the weak relationship for Japan between the exchange rate and the trade balance, and they stressed that the exchange rate has little relationship with the income balance. Due to the prominent role of the income balance in Japan’s CA, the authorities disagreed with the assumed link between the CA and the REER used for the REER assessment. Moreover, the authorities questioned potential policy recommendations that may advocate for exchange rate adjustment to reduce excess imbalances, particularly for cases where the CA is dominated by the income balance. On the EBA methodology, the authorities were appreciative of the recent refinements of the EBA CA model, but asked that the IMF should pursue providing further policy recommendations on structural reforms to address the imbalances identified by the EBA CA model, rather than focusing on the REER assessment.

37. The authorities highlighted the benefits of multilateralism and did not see, at the moment, significant spillovers from divergent advanced economy monetary policies. The authorities saw potentially large dampening effects from a rise in protectionism and plan to continue moving ahead with multilateral efforts to advance a free, fair and rules-based trading system. While recognizing the potentially large impact of carry trade on the exchange rate, the authorities did not observe, at the time of the meeting, a significant build-up of carry trade positions due to the widening differential between global and domestic interest rates.

F. Efforts in Tackling the Supply-Side of Corruption

38. While Japan has a low level of corruption in IMF staff’s view, recent efforts in implementing the OECD Anti-Bribery Convention have the potential to facilitate a more pro-active detection, investigation and prosecution of foreign bribery cases. The report by the OECD Working Group on Bribery in International Business Transactions, which for Japan is the basis of IMF staff’s assessment, noted positive aspects of Japan’s implementation of the Convention. ²¹^, ²² These include raising awareness of Japan’s foreign bribery offence among the legal profession and businesses. It was also noted that the police and prosecutors, and other agencies such as the National Tax Agency, Financial Service Agency’s Securities and Exchange Surveillance Commission, had started to coordinate and share information more closely.

39. The report of the OECD Working Group on Bribery raised serious concerns over Japan’s enforcement of foreign bribery laws. Efforts should focus on: (i) stepping up efforts to detect, investigate and prosecute foreign bribery cases; (ii) urgently establishing a legal basis for confiscating the proceeds of bribing foreign public officials and criminalizing the laundering of the proceeds of foreign bribery; (iii) ensuring that the Ministry of Economy, Trade and Industry—which is the main government body with responsibility for Japan’s implementation of the Anti-Bribery Convention—takes a stronger role in ensuring the effective implementation of the Convention; and (iv) reviewing its whistleblower protection legislation. Due to concerns about the low level of enforcement of Japan’s offence of bribing foreign public officials—just four prosecutions since 1999—a June 2016 high-level OECD mission urged the authority to implement the Phase 3 recommendations, in particular to establish the legal basis for confiscating the proceeds of foreign bribery and to criminalize the laundering of such proceeds. Japan is urged to continue to move forward to implement these recommendations.

40. The authorities have also provided Fund staff with an update on recent developments in response to the Phase 3 recommendations. Those are mostly related to organizing police and prosecution resources to detect and enforce against cases of foreign bribery (e.g., appointment of chief prosecutors and police officers to handle foreign bribery cases in the capital and some districts), upgrading some aspects of the legal framework (e.g., the Act on Punishment of Organized Crimes and Control of Crime Proceeds amended to confiscate the proceeds of foreign bribery and criminalize the laundering of such proceeds), introducing the “Agreement²³” and providing further guidance and training to relevant stakeholders (e.g., 225 overseas diplomatic missions).

Authorities’ Views

41. The authorities acknowledge the relevance of the IMF initiative to assess efforts to address issues related to the supply side of corruption, and noted that they had volunteered to be part of this assessment. They stated that they are implementing the OECD Phase 3 recommendations. The authorities noted that they have developed an action plan based on the OECD’s follow-up report on Phase 3 of the Anti-Bribery Convention. As part of that action plan, the legal framework has been strengthened, in part by amending (in June 2017) the Act on Punishment of Organized Crime and Control of Crime Proceeds to include foreign bribery, including revising the associated guidelines. In addition, the Code of Criminal Procedure was amended in 2016 and came into effect in 2018, resulting in increased indictments for foreign bribery. The Ministry of Foreign Affairs (MOFA) has, in line with OECD recommendations, requested overseas diplomatic missions to designate officials as contact points in order to receive inquiries and notifications about foreign bribery cases and gathering of related information. To prevent corruption related to Official Development Assistance (ODA), MOFA also provides consultation services to Japan’s ODA projects. The authorities also noted that they had been strengthening efforts to raise the awareness of the offence of foreign bribery among the Japanese legal profession, businesses, and the general public.

Staff Appraisal

42. The Japanese economy continues to grow above potential, but inflation remains low and downside risks have increased. Underlying growth is expected to remain solid, notwithstanding the scheduled increase in the consumption tax rate in October 2019, with near-term inflation reaching slightly above one percent in light of a still-negative output gap. Over the medium term, growth is projected to moderate and the output gap to close. Following a consumption tax-induced spike in 2020, inflation will rise over the medium term, but will likely remain below the Bank of Japan’s target. Downside risks to the outlook have risen, in line with the cooling global outlook and adverse demographic pressures.

43. Bringing Abenomics to full strength requires reinvigorated policies that are mutually supportive. Near-term fiscal and income policies underpinned by a well-specified medium-term consolidation plan would help support BoJ’s inflation efforts and ensure debt sustainability. Credible macro-structural reforms are imperative to lift long-run growth and stabilize government debt. The confidence and anticipation effects from these reforms should help to avoid deflationary effects. The accommodative stance of monetary policy should be maintained, but measures to clarify forward guidance and strengthen the monetary policy framework should help lift inflation expectations. Finally, strengthened financial sector policies would mitigate the financial risks from demographic headwinds and prolonged low interest rates.

44. Near-term fiscal tightening should be avoided to support reflation and growth momentum. Fiscal measures and stronger income policies should be implemented to support near-term reflation and growth momentum while helping advance accelerated structural reforms. To alleviate the adverse macroeconomic impact from the planned October 2019 consumption tax rate increase, temporary mitigating measures should be carefully designed.

45. For the medium and long-term, a well-specified fiscal framework is needed to reduce policy uncertainty, address demographic challenges, and mitigate debt sustainability risks. The fiscal framework needs to rely on independent and realistic assessments of the economic outlook and budget projections, set out fiscal consolidation measures, and limit the use of supplementary budgets. To protect growth while putting debt on a stable path, medium-term fiscal consolidation should embed a gradual approach with annual consolidation of about 0.5 percent of GDP in the structural primary balance, starting from 2021. Essential steps include gradual and steady increases in the consumption tax rate beyond 10 percent and containment of healthcare spending.

46. An ambitious effort toward labor, product market, and corporate reforms is needed. A high degree of government commitment will strengthen the credibility of the reform program and help counter deflationary effects. Labor market reforms should be prioritized as they would have the largest growth and inflation impact. Training and career opportunities for non-regular workers should be fostered, including via contract reform. Labor supply should be enhanced, including from women, older workers, and foreign workers. Disincentives in the tax and social security system to full-time and regular work should be eliminated, the gender wage gap should be reduced, and childcare and nursing facilities’ availability should be increased. Reforms to corporates and the product market are the second priority, where exit of non-viable SMEs and entry of firms with potential should be increased, together with a reduction in coverage of the credit guarantee system, incentives for alternative sources of SME financing and SME R&D investment, and support for business succession of firms with potential. Continued deregulation in product and services markets is needed together with deeper corporate governance reform. In addition, tariff and non-tariff barriers should be further removed within multilateral trade agreements.

47. The Bank of Japan (BoJ) should maintain its long-term interest rate target while further strengthening the policy framework. The BoJ’s recent emphasis on making the accommodative stance more sustainable by mitigating side-effects is appropriate and complements its shift to a more patient approach to reaching the inflation target. Building on this progress, the relationship between forward guidance on the long-term interest rate target and the inflation target could be clarified and the quantitative guidance on JGB purchases removed. Moreover, to help lift inflation expectations, the BoJ should consider moving closer to a full-fledged inflation targeting framework by publishing BoJ’s staff baseline forecast together with underlying policy assumptions.

48. Financial sector policies should be strengthened to safeguard financial stability and adapt regional financial institutions’ business models to demographic trends. The JFSA’s new supervisory framework is a step in the right direction towards a full risk-based approach. The JFSA should continue to encourage financial institutions (particularly regional) to improve risk management capacity and further enhance financial oversight (including macroprudential framework) to prevent the build-up of systemic risk. The authorities should further engage with regional banks to facilitate the adaptation of their business models to demographic change. Strengthening the crisis management and resolution framework would help reduce expectations of public support and facilitate the smooth exit of unviable financial entities. Moreover, the JFSA could further facilitate financial institutions’ efforts to leverage Fintech and should continue to strengthen crypto-asset oversight.

49. The 2018 external position is projected to be broadly consistent with fundamentals and desirable policies. The recommended policy package is needed to maintain external balance and advancement of multilateralism would help mitigate inward spillovers. The projected 2018 current account balance is preliminarily assessed as in line with the current account level consistent with fundamentals and desirable policies, and the 2018 real exchange rate is also preliminarily assessed as in line with the real exchange rate level consistent with fundamentals and desirable policies. A well-specified medium-term fiscal consolidation plan and bolder structural reforms that support growth and domestic demand—in line with staff’s recommended policy package—are needed to maintain external balance over the medium term. Japan’s leadership in advancing multilateralism can help mitigate inward spillovers from a rise in protectionism.

50. 51. Efforts to improve enforcement against foreign bribery should continue. Efforts to combat the supply side of corruption are welcome, including through greater awareness of the OECD Anti-Bribery Convention. Notwithstanding Japan’s recent efforts to better organize resources to detect and enforce cases of foreign bribery, there are concerns regarding the low level of enforcement of Japan’s offence of bribing foreign public officials, and further enforcement is urged.

52. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

Box 1.

What Explains Low Inflation Expectations in Japan?¹

Despite a recent gradual upward trend of consumer price index (CPI) inflation, a prolonged period of deflation from the mid- 1990s has led to stubbornly-low inflation expectations in Japan. Younger cohorts have lower inflation expectations than older Japanese, due to their limited exposure to inflation. Business competition in some areas and low inflation expectations put pressure on Japanese firms to find ways to maintain current prices despite rising costs.

Inflation expectations across age cohorts. Using micro-level datasets and a University of Tokyo consumer survey, a positive correlation between age and inflation expectations is derived, with younger Japanese having lower inflation expectations than older cohorts (text figure).² This shows that historical experience of inflation, or the lack thereof, plays a role in how individuals form expectations about future price increases.

Product downsizing. With intense business competition in some areas (i.e. mobile-phone related prices and supermarket prices) and low inflation expectations by consumers, Japanese firms search for ways to respond to rising costs by not raising prices. Product downsizing, the practice of substituting identical products with a reduction in size and/or weight, is one solution adopted by some Japanese firms. In particular, product downsizing accounts for about one third of product substitutes within the studied dataset over the last 10 years.³

Stubbornly low inflation. Firms’ reluctance to raise prices further reinforces low inflation and low inflation expectations. According to research from the University of Tokyo, nearly half of the goods items in the CPI basket exhibit an annual rate of price change of near zero (text figure). A large share of near-zero inflation items was observed not only during the period of deflation, but also in recent months, following six-years of monetary easing by the Bank of Japan and a return to positive CPI inflation.⁴ Concentration of zero-price inflation in the distribution of item-level inflation in Japan is significantly different from that observed in other advanced economies, including the United States, where the mode of item-level inflation is centered around three and a half percent (text figure).

¹ Prepared by Gee Hee Hong (APD).² See Diamond, Watanabe and Watanabe (2018), “The Formation of Consumer Inflation Expectations: New Evidence from Japan’s Deflation Experience,” Working Paper CARF-F-422, Center for Advanced Research in Finance.³ See Imai and Watanabe (2018), “Product Downsizing and Hidden Price Increases: Evidence from Japan’s Deflationary Period,” Asian Economic Policy Review.⁴ See Watanabe and Watanabe (2018), “Why Has Japan Failed to Escape from Deflation?” Asian Economic Policy Review.

Box 2.

Challenges for Regional Banks in Japan¹

Regional banks play an important role in prefectural financial intermediation. There are currently 104 regional banks operating in Japan’s 47 prefectures, accounting for 45 percent of outstanding domestic loans. Deposits—which account for about 90 percent of liabilities—are used to extend loans (64 percent of assets), primarily to SMEs and households but also to invest in securities (22 percent). About half of regional banks’ total income now comes from lending operations, while interest income from securities and fee income account for 19 and 17 percent, respectively.

The traditional business model of regional banks is being challenged by adverse demographic trends and prolonged low interest rates. The dependence on regional lending has left many regional banks vulnerable to shrinking and aging prefectural populations.² A smaller and older population typically translates into lower loan demand, increased competition between banks, and lower core profitability (i.e., lending and fee business). In fact, the share of regional banks earning negative core profits rose from 12 percent in 2011 to over 50 percent in 2018 (see figure). Moreover, because deposit growth has proven less sensitive to demographic trends than loan growth, the loan-deposit ratios of regional banks have fallen. Excess liquidity combined with low interest rates have induced banks to search for other higher yielding investment opportunities.

Regional banks should diversify their revenue base to boost income and improve efficiency through better utilization of IT/Fintech and consolidation. Fees and commissions account for a much smaller share of total income in regional banks than that of major banks, and are more concentrated in fund-transfer services and sales of investment trusts. Regional banks have been taking measures to boost and diversify fee-based income, including from business matching and succession. Experience in other countries has shown that unbundling banking services and charging fees for routine banking transactions may also help boost profits, although competitive pressures have prevented Japanese banks from introducing such fees on their own. Moreover, Fintech (including the open API) has the potential to help raise profitability (e.g., by improving the efficiency of human resources and by broadening the customer base through better information and data sharing), but may also increase competition among financial institutions.

Increased risk taking in more sophisticated investments by regional banks should be carefully monitored and managed. Regional banks have increased overseas lending, SME lending to domestic middle-risk firms and real estate sector, as well as holdings of investment trusts—which mainly invested in foreign bonds (41 percent), domestic equities (19 percent), and real estate funds (17 percent) as of end June 2018. Regional banks should enhance their risk management framework, particularly the capacity of credit and market risk assessment. FX funding liquidity risk should also be carefully managed as dollar funding costs rise. By facilitating information and data sharing, Fintech could help improve the real-time monitoring of SME lending and credit risk assessment. Ensuring cybersecurity is another important challenge amid the increased utilization of IT and Fintech.

¹ Prepared by Fei Han (MCM) and Niklas Westelius (APD).² The average prefectural population growth rate fell into negative territory in the early 2000s. By 2015, only a handful of prefectures— mostly those in metropolitan areas—still experienced positive population growth.

Box 3.

Demographics and Structural Reforms¹

Using the IMF’s Global Integrated Monetary and Fiscal Model (GIMF) with newly-added demographic features, staff estimate that Japan’s real GDP will decline by over 25 percent in about 40 years due to demographics and under current policies, while the external current account will decline and public debt will grow. Structural reforms are estimated to significantly reverse the adverse demographic effects and boost real GDP by as much as 15 percent in 40 years relative to the current policies scenario, with labor market reforms having the largest impact. Credible reforms are estimated to reduce the external current account surplus in the medium term and significantly reduce the public debt.

Japan’s baseline scenario under current policies. GIMF simulations over the next 40 years— using the authorities’ demographic projections plus associated age-related health and pension spending projections — point to significant declines in real GDP, consumption, and investment, with a reduction in the external current account and a notable increase in the public debt-to-GDP ratio.²

Reform scenario. Within the structural reform program proposed, labor market reforms are the main driver of estimated real GDP effects. The public debt-to-GDP ratio is estimated to decline due to the GDP increase, including from higher inflation, and also due to the assumed debt reduction from the reform-generated boost in tax revenues. A relative increase in investment drives the reduction in the external current account in the medium term (by over 1 percent of GDP), with the assumed fiscal consolidation dampening the size of the current account reduction. Simulation results shown represent an upper bound as they assume full credibility of reforms, where private sector agents have perfect foresight of the path of the reform program, which generates boosted anticipation effects, including higher inflation. Moreover, results shown assume that the labor market duality reform entails a gradual but full catch up in the productivity of non-regular workers to that of regular workers, providing an upper bound in terms of potential productivity gains (boosting real GDP by over 6 percent in the long run), while it does not assume a significant change in workers’ bargaining power. Alternatively, assuming that only half of the productivity difference (between non-regular and regular workers) is closed, the labor market duality reform is estimated to deliver smaller real GDP gains (by about 3 percentage points in the long run).

¹ Prepared by Mariana Colacelli (APD) and Emilio Fernandez Corugedo (RES), using the authors’ IMF Working Paper 18/248 “Macroeconomic Effects of Japan’s Demographics: Can Structural Reforms Reverse Them?”² Reported results are relative to a projection where productivity and population grow at their recent pace.

Box 4.

Demographics and the Natural Rate of Interest in Japan¹

The aging and shrinking population of Japan could lower the natural rate of interest and, together with low inflation expectations, challenge the Bank of Japan’s efforts to reflate the economy.² The secular stagnation hypothesis posits that fundamental factors including demographics have played a significant role in driving down natural rates in major advanced economies in recent years, by reducing the labor force and slowing productivity growth. Given the effective lower bound and historically low natural rate of interest in Japan, it is difficult to widen the interest rate gap—the gap between the real interest rate and the natural rate—and achieve sufficient monetary easing if demographic change is placing significant downward pressures on the natural rate.

The semi-structural model developed by previous studies is extended, and a Bayesian approach is used to estimate the impact of demographic change on the natural rate of interest in Japan. The empirical framework is based on the work of Laubach and Williams (2003) and Pescatori and Turunen (2016).³ By using the production function approach, the framework explicitly models the impact of demographic changes (particularly total and working-age population growth) on the natural rate through the potential growth channel. Other channels, for example, by increasing the dependency ratio and thereby lowering the savings rate, are not explicitly captured by this model. Having said that, including the dependency ratio as an exogenous variable in the model does not alter the results qualitatively. Moreover, we follow Pescatori and Turunen (2016) and use a Bayesian approach to estimate the model, which incorporates prior information on the output gap and includes other exogenous observables (e.g., excess global savings and risk premium) as potential determinants of the natural rate.

The estimates suggest that demographic changes have contributed to the decline in Japan’s natural rate, with the contribution increasing over time. We find that, since the Global Financial Crisis, the decline in working-age population growth has contributed about -0.3 percentage points (ppts) on average to the estimated negative natural rate—which averaged about -0.7 percent (Bayesian median) during this period. More importantly, such a negative impact is found to be increasing gradually over time, from less than -0.2 ppts in Q1 2010 to -0.4 percentage points in Q1 2018. Other shocks to trend potential growth (such as technology and other productivity shocks), excess global savings, and equity risk premium also played an important role in driving the natural rate.

The results also suggest that Japan’s natural rate has likely fallen into negative territory, highlighting the need to implement structural reforms to boost potential growth and lift the natural rate. With the working-age population growth projected to decline by 2040, the negative demographic impact on the natural rate is likely to increase, which may further limit the role of monetary policy in reflating the economy. These findings highlight the importance of boosting potential growth by, for example, accelerating labor market and other structural reforms (including more active migration policies) to offset the increasingly adverse demographic impact and raise the natural rate in Japan.

¹ Prepared by Fei Han (MCM), using the author’s forthcoming IMF Working Paper “Demographics and Natural Rate of Interest in Japan.”² The natural rate of interest is defined as the real interest rate consistent with output at its potential level and constant inflation.³ See Laubach and Williams (2003), “Measuring the Natural Rate of Interest,” Review of Economics and Statistics, and Pescatori and Turunen (2016), “Lower for Longer: Neutral Rate in the U.S.,” IMF Economic Review.

Box 5.

Crypto-Asset Regulation in Japan¹

Crypto-asset trading in Japan experienced explosive growth in 2017. Since becoming a legal form of payment in April 2017, trading of crypto-assets in both spot and derivatives markets has grown rapidly. However, financial institutions have been cautious about trading crypto-assets or partnering with crypto-asset exchanges (CAEs) due to extremely high price volatility and concerns over cyber risk.² The largely retail investor base has limited direct linkages with the rest of the financial system and hence immediate risks to financial stability appear low. Nonetheless, recent hacking incidents have led to large losses (about $580 million in total) for customers and the hacked exchanges, raising public concerns over cybersecurity and customer protection.

Japan became the first country to regulate CAEs in 2017 through a registration process. Regulation of CAEs in Japan consists of four layers, with the first two legally binding (see figure). The first layer consists of two Acts on payments and AML/CFT, which require CAEs to register with the Japanese Financial Services Agency (JFSA) and to conduct “know-your-customer” procedures. The second layer, created by a Cabinet Office Ordinance, sets forth the detailed rules for CAEs. The third layer is the JFSA’s guidelines for the registration process, which specifies the scope, timeline, and requirements of registration. The last layer encompasses self-regulation as proposed by the Japan Virtual Currency Exchange Association (which consists of the 16 registered CAEs). Self-regulation focuses mainly on business appropriateness (including caps on margin trading), market fairness (including consumer protection), and sound business development.

JFSA has stepped up supervision of all CAEs and tightened regulation. After conducting on-site inspections in the aftermath of the January 2018 hacking incident at Coincheck, the JFSA issued business improvement orders to the exchanges with weak AML/CFT measures or customer protection systems to strengthen their internal control and governance. The JFSA has also strengthened the registration process by implementing more rigorous screening for risk-management procedures.

Managing reputational risk remains a challenge. CAEs are typically more vulnerable to cyber risk than banks. They typically lack the same level of cybersecurity as banks yet provide similar custody services (custody of crypto-assets) to customers. Given that Japan is taking a regulatory approach towards crypto-assets, cyber attacks may result in significant reputational risk for the JFSA in addition to losses for consumers and CAEs. To this end, the JFSA needs to further enhance its resources and expertise in cybersecurity. Clear communication with the public about the JFSA’s role in the regulatory framework may help increase public awareness of the risks involved in crypto-assets and limit the reputational risk. The JFSA’s commitment to promote global cooperation to form regulations on crypto-assets as the chair of the 2019 G20 should help leverage international experiences and contribute to multilateral responses to risk from crypto-assets.

¹ Prepared by Fei Han (MCM) and Todd Schneider (APD).² Two exceptions where financial institutions are partnering with crypto-asset exchanges: i) the purchase of Coincheck (the CAE that was hacked in January 2018) by Monex—an online brokerage partly owned by a regional bank; and ii) the investment by Money Partners Group (one of Japan’s largest FX brokerages) in Kraken (one of the world’s longest-operating crypto-asset exchanges).

Box 6.

Yen Appreciations, Safe Havens, and the Carry Trade¹,²

Rising global interest rates, combined with BoJ’s yield curve control, should weaken the yen and raise inflation. But widening interest rate differentials also encourage investors to take unhedged short positions in yen to earn the interest rate carry. An initial yen appreciation (triggered by global uncertainty and a flight to safety) could result in a sudden unwinding of these positions—amplifying the yen appreciation and undermining BoJ’s efforts to reflate the economy.

Safe haven effects, interest rate differentials and carry trade reversals could drive sudden yen appreciations. Safe haven appreciations occur during heightened market uncertainty when investors move into assets that are perceived as “safe”—such as Japanese government bonds (JGBs). Carry trade is an investment strategy under which investors borrow (short) in a low-interest rate currency (e.g., yen) and invest (long) in a high-interest currency (e.g. the Australian dollar). Because these positions are typically leveraged and unhedged, any initial appreciation of the funding currency can generate a sharp unwinding of these positions, which in turn reinforces the appreciation.

Rising global rates may increase the risk of a sudden and large yen appreciation. Empirical evidence shows that safe haven effects and carry trade reversals can trigger and amplify yen appreciations. For instance, in 2005 the U.S.-Japan interest rate differential rose sharply as the Fed tightened policy, leading to a weaker yen. However, it also spurred an expansion of carry trade (short) positions in the yen. By early 2006, global risk perception had risen and BoJ signaled an exit from quantitative easing. As investors unwound carry trade positions, the yen appreciated sharply (estimates suggest the carry trade reversal explains about 40 percent of the appreciation).

Risks are rising: As in 2006, the current rise in global rates could lead to a large carry trade position and raise the risk of a sudden and large yen appreciation. Empirical evidence also suggests that safe haven effects are likely to be significantly larger in times of heightened uncertainty. The current conjecture of widening U.S.-Japan interest rate differentials, and heightened global policy uncertainty (e.g., due to trade wars), appears particularly conducive exchange rate volatility due to the carry trade activities.

Stay the course: Notwithstanding a potentially higher risk of a sudden yen appreciation, the BoJ should maintain the current accommodative monetary policy stance and the zero-interest rate target on the benchmark 10-year JGB yield. However, the authorities should keep in mind the heightened risk for a sharp yen appreciation and closely monitor carry trade activities.

¹ Prepared by Fei Han (MCM) and Niklas Westelius (APD).² The Box is based on the 2018 Japan Selected Issues Paper “What Drives Rapid Yen Appreciations?”

Table 1.

Japan: Selected Economic Indicators, 2012–19

Sources: IMF, Competitiveness Indicators System; OECD, and IMF staff estimates and projections as of October 2018 World Economic Outlook.

^{^1/}Annual growth rates and contributions are calculated from seasonally adjusted data.

^{^2/}Contribution to GDP growth.

^{^3/}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

^{^4/}Including the effects of consumption tax increases in 2014, 2015, and 2019.

^{^5/}Bank of Japan Measures of Underlying Inflation; excluding fresh food & energy.

Table 1.

Japan: Selected Economic Indicators, 2012–19

Nominal GDP: US$ 4,873 Billion (2017)											GDP per capita: US$ 38,444 (2017)
Population: 127 Million (2017)											Quota: SDR 30.8 billion (2017)
						2012	2013	2014	2015	2016	2017	2018	2019
												Proj.
						(In percent change)
Growth ^1/
	Real GDP					1.5	2.0	0.4	1.4	1.0	1.7	1.1	0.9
	Domestic demand					2.3	2.4	0.4	1.0	0.4	1.2	0.9	1.1
			Private consumption			2.0	2.4	-0.9	0.0	0.1	1.0	0.6	0.8
			Business investment			4.1	3.7	5.4	3.4	0.6	2.9	4.7	3.4
			Residential investment			2.5	8.0	-4.3	-1.0	5.7	2.7	-6.7	0.9
			Government consumption			1.7	1.5	0.5	1.5	1.3	0.4	0.5	1.1
			Public investment			2.7	6.7	0.7	-1.7	-0.1	1.2	-1.8	-5.9
			Stockbuilding ^2/			0.0	-0.4	0.1	0.3	-0.2	-0.1	0.1	0.0
	Net exports ^2/					-0.8	-0.4	0.0	0.3	0.6	0.5	0.1	0.0
			Exports of goods and services ^3/			-0.1	0.8	9.3	2.9	1.7	6.7	3.9	2.1
			Imports of goods and services ^3/			5.4	3.3	8.3	0.8	-1.6	3.4	3.2	2.3
Output Gap						-3.7	-2.2	-2.6	-2.0	-1.8	-0.7	-0.3	0.1
						(In annual average)
Inflation
		CPI ^4/				-0.1	0.3	2.8	0.8	-0.1	0.5	1.2	1.3
		CPI excluding VAT				-0.1	0.3	1.2	0.3	-0.1	0.5	1.2	1.1
		Core Core CPI excluding VAT ^5/				-0.4	-0.2	0.7	0.9	0.6	0.1	…	…
	GDP deflator					-0.8	-0.3	1.7	2.1	0.3	-0.2	0.8	1.5
Unemployment rate						4.3	4.0	3.6	3.4	3.1	2.9	2.9	2.9
						(In percent of GDP)
Government
	General government
			Revenue			30.8	31.6	33.3	34.2	34.1	33.2	33.2	33.3
			Expenditure			39.4	39.5	38.9	38.0	37.8	37.5	36.9	36.0
			Overall Balance			-8.6	-7.9	-5.6	-3.8	-3.7	-4.3	-3.7	-2.8
			Primary balance			-7.5	-7.0	-4.9	-3.2	-2.9	-3.8	-3.3	-2.6
				Structural primary balance		-6.3	-6.4	-4.6	-3.6	-3.4	-3.7	-3.3	-2.6
			Public debt, gross			229.0	232.5	236.1	231.3	235.6	237.6	238.2	236.6
						(In percent change, end-period)
Macro-financial
		Base money				10.7	45.8	36.7	29.1	22.8	9.7	10.6	9.3
		Broad money				2.2	3.5	2.9	3.0	3.9	3.5	3.6	3.1
		Credit to the private sector				2.2	4.1	2.0	1.9	2.4	4.4	3.5	3.0
		Non-financial corporate debt in percent of GDP				143.1	142.0	143.0	137.9	136.9	139.7	146.7	147.0
		Household debt in percent of disposable income				98.3	100.2	100.8	100.5	100.8	101.7	101.1	101.0
						(In percent)
Interest rate
	Overnight call rate, uncollateralized (end-period)					0.1	0.1	0.1	0.0	-0.1	-0.1	…	…
	Three-month CD rate (annual average)					0.3	0.2	0.2	0.2	0.1	0.0	…	…
	Official discount rate (end-period)					0.3	0.3	0.3	0.3	0.3	0.3	0.3	0.3
		10-year JGB yield (e.o.p.)				0.9	0.7	0.6	0.4	0.0	0.1	0.1	0.2
						(In billions of USD)
Balance of payments
		Current account balance				59.7	45.9	36.8	136.4	194.9	196.1	183.7	196.2
					Percent of GDP	1.0	0.9	0.8	3.1	3.9	4.0	3.6	3.8
			Trade balance			-53.9	-90.0	-99.9	-7.4	51.4	44.5	34.7	43.0
					Percent of GDP	-0.9	-1.7	-2.1	-0.2	1.0	0.9	0.7	0.8
				Exports of goods, f.o.b.		776.0	695.0	699.7	622.1	636.3	689.2	750.0	766.6
				Imports of goods, f.o.b.		829.9	784.9	799.7	629.5	585.0	644.8	715.3	723.7
					Energy imports	272.2	257.4	241.8	133.8	94.9	117.8	153.5	150.9
						(In percent of GDP)
FDI, net						1.9	2.8	2.4	3.0	2.7	3.1	2.6	2.8
Portfolio Investment						0.5	-5.4	-0.9	3.0	5.6	-1.1	-0.9	-0.8
						(In billions of USD)
Change in reserves						-37.9	38.7	8.5	5.1	-5.7	23.6	10.5	11.0
Total reserves minus gold (in billions of US$)						1227.2	1237.3	1231.0	1207.1	1188.4	1232.4	…	…
						(In annual average)
Exchange rates
	Yen/dollar rate					79.8	97.6	105.9	121.0	108.8	112.2	109.8	109.3
	Yen/euro rate					102.6	129.6	140.8	134.3	120.4	126.7	130.3	127.9
	Real effective exchange rate (ULC-based, 2010=100)					106.5	86.3	78.2	75.3	85.1	78.3	…	…
	Real effective exchange rate (CPI-based, 2010=100)					100.6	80.4	75.2	70.2	79.6	75.6	…	…
						(In percent)
Demographic Indicators
		Population Growth				-0.2	-0.2	-0.2	-0.1	0.0	-0.2	-0.2	-0.3
		Old-age dependency				37.8	39.8	41.8	43.5	44.8	46.0	46.9	47.8

Sources: IMF, Competitiveness Indicators System; OECD, and IMF staff estimates and projections as of October 2018 World Economic Outlook.

^{^1/}Annual growth rates and contributions are calculated from seasonally adjusted data.

^{^2/}Contribution to GDP growth.

^{^3/}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

^{^4/}Including the effects of consumption tax increases in 2014, 2015, and 2019.

^{^5/}Bank of Japan Measures of Underlying Inflation; excluding fresh food & energy.

Table 1.

Japan: Selected Economic Indicators, 2012–19

Nominal GDP: US$ 4,873 Billion (2017)											GDP per capita: US$ 38,444 (2017)
Population: 127 Million (2017)											Quota: SDR 30.8 billion (2017)
						2012	2013	2014	2015	2016	2017	2018	2019
												Proj.
						(In percent change)
Growth ^1/
	Real GDP					1.5	2.0	0.4	1.4	1.0	1.7	1.1	0.9
	Domestic demand					2.3	2.4	0.4	1.0	0.4	1.2	0.9	1.1
			Private consumption			2.0	2.4	-0.9	0.0	0.1	1.0	0.6	0.8
			Business investment			4.1	3.7	5.4	3.4	0.6	2.9	4.7	3.4
			Residential investment			2.5	8.0	-4.3	-1.0	5.7	2.7	-6.7	0.9
			Government consumption			1.7	1.5	0.5	1.5	1.3	0.4	0.5	1.1
			Public investment			2.7	6.7	0.7	-1.7	-0.1	1.2	-1.8	-5.9
			Stockbuilding ^2/			0.0	-0.4	0.1	0.3	-0.2	-0.1	0.1	0.0
	Net exports ^2/					-0.8	-0.4	0.0	0.3	0.6	0.5	0.1	0.0
			Exports of goods and services ^3/			-0.1	0.8	9.3	2.9	1.7	6.7	3.9	2.1
			Imports of goods and services ^3/			5.4	3.3	8.3	0.8	-1.6	3.4	3.2	2.3
Output Gap						-3.7	-2.2	-2.6	-2.0	-1.8	-0.7	-0.3	0.1
						(In annual average)
Inflation
		CPI ^4/				-0.1	0.3	2.8	0.8	-0.1	0.5	1.2	1.3
		CPI excluding VAT				-0.1	0.3	1.2	0.3	-0.1	0.5	1.2	1.1
		Core Core CPI excluding VAT ^5/				-0.4	-0.2	0.7	0.9	0.6	0.1	…	…
	GDP deflator					-0.8	-0.3	1.7	2.1	0.3	-0.2	0.8	1.5
Unemployment rate						4.3	4.0	3.6	3.4	3.1	2.9	2.9	2.9
						(In percent of GDP)
Government
	General government
			Revenue			30.8	31.6	33.3	34.2	34.1	33.2	33.2	33.3
			Expenditure			39.4	39.5	38.9	38.0	37.8	37.5	36.9	36.0
			Overall Balance			-8.6	-7.9	-5.6	-3.8	-3.7	-4.3	-3.7	-2.8
			Primary balance			-7.5	-7.0	-4.9	-3.2	-2.9	-3.8	-3.3	-2.6
				Structural primary balance		-6.3	-6.4	-4.6	-3.6	-3.4	-3.7	-3.3	-2.6
			Public debt, gross			229.0	232.5	236.1	231.3	235.6	237.6	238.2	236.6
						(In percent change, end-period)
Macro-financial
		Base money				10.7	45.8	36.7	29.1	22.8	9.7	10.6	9.3
		Broad money				2.2	3.5	2.9	3.0	3.9	3.5	3.6	3.1
		Credit to the private sector				2.2	4.1	2.0	1.9	2.4	4.4	3.5	3.0
		Non-financial corporate debt in percent of GDP				143.1	142.0	143.0	137.9	136.9	139.7	146.7	147.0
		Household debt in percent of disposable income				98.3	100.2	100.8	100.5	100.8	101.7	101.1	101.0
						(In percent)
Interest rate
	Overnight call rate, uncollateralized (end-period)					0.1	0.1	0.1	0.0	-0.1	-0.1	…	…
	Three-month CD rate (annual average)					0.3	0.2	0.2	0.2	0.1	0.0	…	…
	Official discount rate (end-period)					0.3	0.3	0.3	0.3	0.3	0.3	0.3	0.3
		10-year JGB yield (e.o.p.)				0.9	0.7	0.6	0.4	0.0	0.1	0.1	0.2
						(In billions of USD)
Balance of payments
		Current account balance				59.7	45.9	36.8	136.4	194.9	196.1	183.7	196.2
					Percent of GDP	1.0	0.9	0.8	3.1	3.9	4.0	3.6	3.8
			Trade balance			-53.9	-90.0	-99.9	-7.4	51.4	44.5	34.7	43.0
					Percent of GDP	-0.9	-1.7	-2.1	-0.2	1.0	0.9	0.7	0.8
				Exports of goods, f.o.b.		776.0	695.0	699.7	622.1	636.3	689.2	750.0	766.6
				Imports of goods, f.o.b.		829.9	784.9	799.7	629.5	585.0	644.8	715.3	723.7
					Energy imports	272.2	257.4	241.8	133.8	94.9	117.8	153.5	150.9
						(In percent of GDP)
FDI, net						1.9	2.8	2.4	3.0	2.7	3.1	2.6	2.8
Portfolio Investment						0.5	-5.4	-0.9	3.0	5.6	-1.1	-0.9	-0.8
						(In billions of USD)
Change in reserves						-37.9	38.7	8.5	5.1	-5.7	23.6	10.5	11.0
Total reserves minus gold (in billions of US$)						1227.2	1237.3	1231.0	1207.1	1188.4	1232.4	…	…
						(In annual average)
Exchange rates
	Yen/dollar rate					79.8	97.6	105.9	121.0	108.8	112.2	109.8	109.3
	Yen/euro rate					102.6	129.6	140.8	134.3	120.4	126.7	130.3	127.9
	Real effective exchange rate (ULC-based, 2010=100)					106.5	86.3	78.2	75.3	85.1	78.3	…	…
	Real effective exchange rate (CPI-based, 2010=100)					100.6	80.4	75.2	70.2	79.6	75.6	…	…
						(In percent)
Demographic Indicators
		Population Growth				-0.2	-0.2	-0.2	-0.1	0.0	-0.2	-0.2	-0.3
		Old-age dependency				37.8	39.8	41.8	43.5	44.8	46.0	46.9	47.8

Sources: IMF, Competitiveness Indicators System; OECD, and IMF staff estimates and projections as of October 2018 World Economic Outlook.

^{^1/}Annual growth rates and contributions are calculated from seasonally adjusted data.

^{^2/}Contribution to GDP growth.

^{^3/}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

^{^4/}Including the effects of consumption tax increases in 2014, 2015, and 2019.

^{^5/}Bank of Japan Measures of Underlying Inflation; excluding fresh food & energy.

Table 2.

Japan: Monetary Authority Accounts and Monetary Survey, 2012–19

Sources: Bank of Japan; Haver, and IMF staff estimations and projections.

^{^1/}Defined as the ratio of credits to the private sector and net credit to other financial instituions to customer deposits.

Table 2.

Japan: Monetary Authority Accounts and Monetary Survey, 2012–19

			2012	2013	2014	2015	2016	2017	2018	2019
									Proj.
			(In trillions of JPY)
Monetary authority
Net foreign assets			6.3	5.0	3.9	2.3	-3.9	-12.4	-11.0	-10.7
NDA			132.2	196.9	272.0	353.9	441.3	492.4	541.6	590.8
	Net domestic credit		143.5	210.8	291.3	374.6	467.1	521.3	570.5	619.7
		Net credit to non-financial public sector	96.1	159.4	222.4	289.1	366.0	397.2	437.2	477.2
		Credit to the private sector	8.5	6.2	6.7	6.7	6.4	6.5	6.7	6.9
		Net credit to financial corporations	38.9	45.2	62.2	78.8	94.7	117.5	126.5	135.5
	Other items net		-11.3	-13.9	-19.3	-20.8	-25.8	-28.9	-28.9	-28.9
Monetary base			138.5	201.8	275.9	356.1	437.4	480.0	530.7	580.1
Monetary survey (depository corporations)
NFA			101.5	113.9	105.6	97.6	94.4	100.8	85.8	90.6
NDA			1,050.2	1,080.4	1,125.1	1,171.2	1,227.7	1,267.8	1,313.5	1,351.8
	Net domestic credit		1,124.8	1,179.4	1,228.2	1,257.9	1,307.5	1,358.7	1,409.3	1,452.7
		Net credit to nonfinancial public sector	482.4	529.0	566.0	587.4	633.2	638.1	668.1	693.1
		Credit to the private sector	516.5	527.0	537.6	547.8	560.9	585.8	606.4	624.8
		Net credit to other financial institutions	125.9	123.4	124.6	122.8	113.4	134.8	134.8	134.8
Other items net			-74.6	-99.0	-103.0	-86.7	-79.9	-90.9	-95.9	-100.9
Broad money			1,144.9	1,184.7	1,219.6	1,256.1	1,305.1	1,352.1	1,399.3	1,442.4
	Currency in circulation		83.1	85.3	88.2	93.6	97.3	101.9	105.2	108.7
	Current deposits		477.7	504.5	530.0	553.5	602.6	650.7	688.5	722.2
	Other deposits		585.5	594.9	601.4	609.1	605.1	599.5	605.5	611.5
			(In percent of GDP)
Net credit to other financial institutions			25.4	24.5	24.3	23.1	21.1	24.7	24.2	23.6
Credit to the private sector from depository corporations			104.4	104.7	104.6	103.0	104.2	107.2	108.9	109.5
Corporate debt (includes loans and securities other than shares)			143.1	142.0	143.0	137.9	136.9	139.7	146.7	147.0
Corporate debt (includes loans and securities other than shares), trillions of JPY			708.2	714.7	734.9	733.8	737.4	763.8	817.3	838.6
Household debt in percent of disposable income			98.3	100.2	100.8	100.5	100.8	101.7	101.1	101.0
			(Y-o-Y growth in percent)
Base money			19.3	60.3	36.7	29.1	22.8	9.7	10.6	9.3
Broad money			2.7	4.1	2.9	3.0	3.9	3.6	3.5	3.1
Credit to the private sector from depository corporations			3.1	2.0	2.0	1.9	2.4	4.4	3.5	3.0
Corporate loans by domestically licenced banks			1.0	2.3	3.1	2.6	2.8	2.6	2.8	2.6
Housing loans			2.1	2.3	1.8	1.9	2.7	2.0	1.9	2.0
Credit to the private sector from all financial institutions			2.6	5.0	-6.1	3.1	1.0	5.1	3.5	3.0
Memorandum items:
	Velocity of broad money		0.4	0.4	0.4	0.4	0.4	0.4	0.4	0.4
	Money multiplier (broad money)		8.3	5.9	4.4	3.5	3.0	2.8	2.6	2.5
	Loan-to-deposit ratio (percent) ^1/		60.4	59.1	58.1	57.6	55.8	57.6	57.3	57.0

Sources: Bank of Japan; Haver, and IMF staff estimations and projections.

^{^1/}Defined as the ratio of credits to the private sector and net credit to other financial instituions to customer deposits.

Table 2.

Japan: Monetary Authority Accounts and Monetary Survey, 2012–19

			2012	2013	2014	2015	2016	2017	2018	2019
									Proj.
			(In trillions of JPY)
Monetary authority
Net foreign assets			6.3	5.0	3.9	2.3	-3.9	-12.4	-11.0	-10.7
NDA			132.2	196.9	272.0	353.9	441.3	492.4	541.6	590.8
	Net domestic credit		143.5	210.8	291.3	374.6	467.1	521.3	570.5	619.7
		Net credit to non-financial public sector	96.1	159.4	222.4	289.1	366.0	397.2	437.2	477.2
		Credit to the private sector	8.5	6.2	6.7	6.7	6.4	6.5	6.7	6.9
		Net credit to financial corporations	38.9	45.2	62.2	78.8	94.7	117.5	126.5	135.5
	Other items net		-11.3	-13.9	-19.3	-20.8	-25.8	-28.9	-28.9	-28.9
Monetary base			138.5	201.8	275.9	356.1	437.4	480.0	530.7	580.1
Monetary survey (depository corporations)
NFA			101.5	113.9	105.6	97.6	94.4	100.8	85.8	90.6
NDA			1,050.2	1,080.4	1,125.1	1,171.2	1,227.7	1,267.8	1,313.5	1,351.8
	Net domestic credit		1,124.8	1,179.4	1,228.2	1,257.9	1,307.5	1,358.7	1,409.3	1,452.7
		Net credit to nonfinancial public sector	482.4	529.0	566.0	587.4	633.2	638.1	668.1	693.1
		Credit to the private sector	516.5	527.0	537.6	547.8	560.9	585.8	606.4	624.8
		Net credit to other financial institutions	125.9	123.4	124.6	122.8	113.4	134.8	134.8	134.8
Other items net			-74.6	-99.0	-103.0	-86.7	-79.9	-90.9	-95.9	-100.9
Broad money			1,144.9	1,184.7	1,219.6	1,256.1	1,305.1	1,352.1	1,399.3	1,442.4
	Currency in circulation		83.1	85.3	88.2	93.6	97.3	101.9	105.2	108.7
	Current deposits		477.7	504.5	530.0	553.5	602.6	650.7	688.5	722.2
	Other deposits		585.5	594.9	601.4	609.1	605.1	599.5	605.5	611.5
			(In percent of GDP)
Net credit to other financial institutions			25.4	24.5	24.3	23.1	21.1	24.7	24.2	23.6
Credit to the private sector from depository corporations			104.4	104.7	104.6	103.0	104.2	107.2	108.9	109.5
Corporate debt (includes loans and securities other than shares)			143.1	142.0	143.0	137.9	136.9	139.7	146.7	147.0
Corporate debt (includes loans and securities other than shares), trillions of JPY			708.2	714.7	734.9	733.8	737.4	763.8	817.3	838.6
Household debt in percent of disposable income			98.3	100.2	100.8	100.5	100.8	101.7	101.1	101.0
			(Y-o-Y growth in percent)
Base money			19.3	60.3	36.7	29.1	22.8	9.7	10.6	9.3
Broad money			2.7	4.1	2.9	3.0	3.9	3.6	3.5	3.1
Credit to the private sector from depository corporations			3.1	2.0	2.0	1.9	2.4	4.4	3.5	3.0
Corporate loans by domestically licenced banks			1.0	2.3	3.1	2.6	2.8	2.6	2.8	2.6
Housing loans			2.1	2.3	1.8	1.9	2.7	2.0	1.9	2.0
Credit to the private sector from all financial institutions			2.6	5.0	-6.1	3.1	1.0	5.1	3.5	3.0
Memorandum items:
	Velocity of broad money		0.4	0.4	0.4	0.4	0.4	0.4	0.4	0.4
	Money multiplier (broad money)		8.3	5.9	4.4	3.5	3.0	2.8	2.6	2.5
	Loan-to-deposit ratio (percent) ^1/		60.4	59.1	58.1	57.6	55.8	57.6	57.3	57.0

Sources: Bank of Japan; Haver, and IMF staff estimations and projections.

^{^1/}Defined as the ratio of credits to the private sector and net credit to other financial instituions to customer deposits.

Table 3.

Japan: External Sector Summary, 2012–19

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

Table 3.

Japan: External Sector Summary, 2012–19

				2012	2013	2014	2015	2016	2017	2018	2019
										Proj.
Balance of payments				(In billions of USD)
Current account balance				59.7	45.9	36.8	136.4	194.9	196.1	183.7	196.2
	Trade balance (goods)			-53.9	-90.0	-99.9	-7.4	51.4	44.5	34.7	43.0
		Exports of goods		776.0	695.0	699.7	622.1	636.3	689.2	750.0	766.6
		Imports of goods		829.9	784.9	799.7	629.5	585.0	644.8	715.3	723.7
			Imports of goods, Oil	196.9	184.9	167.6	88.1	64.9	82.9	108.0	106.2
	Services balance			-47.8	-35.7	-28.8	-16.0	-10.6	-6.5	-4.4	-4.3
		Credits		136.8	135.3	163.2	162.6	167.5	172.8	178.4	184.3
		Debits		184.6	171.0	192.4	175.6	180.9	187.0	191.7	197.8
	Income balance			175.6	181.6	184.6	176.2	173.9	177.0	173.2	178.4
		Credits		229.6	241.3	256.9	248.5	261.3	272.5	253.5	264.7
		Debits		54.0	59.7	72.4	72.3	87.5	95.5	80.2	86.2
	Current net transfers			-14.2	-10.0	-19.0	-16.3	-19.8	-18.9	-19.9	-20.9
Capital account				-1.0	-7.7	-2.0	-2.2	-6.5	-2.6	-3.3	-3.2
Financial account				47.2	-62.5	24.9	163.2	279.8	127.5	148.7	160.3
	Direct investment, net			117.5	144.7	118.6	133.3	134.4	149.7	132.5	144.6
	Portfolio investment, net			28.8	-280.6	-42.2	131.5	276.5	-53.5	-47.0	-44.0
	Other investment, net			-61.1	34.8	-60.1	-106.7	-125.4	7.7	52.8	48.8
Reserve assets				-37.9	38.7	8.5	5.1	-5.7	23.6	10.5	11.0
Errors and omissions, net				-4.8	-42.6	24.1	46.7	75.4	-35.6	0.0	0.0
				(In percent of GDP)
Current account balance				1.0	0.9	0.8	3.1	3.9	4.0	3.6	3.8
	Trade balance (goods)			-0.9	-1.7	-2.1	-0.2	1.0	0.9	0.7	0.8
		Exports of goods		12.5	13.5	14.4	14.2	12.8	14.1	14.8	14.7
		Imports of goods		13.4	15.2	16.5	14.3	11.8	13.2	14.1	13.9
	Services balance			-0.8	-0.7	-0.6	-0.4	-0.2	-0.1	-0.1	-0.1
	Income balance			2.8	3.5	3.8	4.0	3.5	3.6	3.4	3.4
Global assumptions
Exchange Rate (¥/US$)				79.8	97.6	105.9	121.0	108.8	112.2	109.8	109.3
	(Percent change)			0.0	22.3	8.6	14.3	-10.1	3.1	-2.1	-0.5
Oil prices (US$/barrel)				105.0	104.1	96.2	50.8	42.8	52.8	69.4	68.8
	(Percent change)			1.0	-0.9	-7.5	-47.2	-15.7	23.3	31.4	-0.9
Memorandum items :
Nominal GDP (US$ billion)				6,202.2	5,157.2	4,852.6	4,395.5	4,952.6	4,873.7	5,070.6	5,220.6
Net foreign assets (NFA)/GDP, US$ basis				57.7	61.1	62.8	63.3	58.6	59.7	61.7	64.5
Return on NFA (in percent), US$ basis				4.9	5.8	6.1	6.4	6.0	6.1	5.5	5.3
Net export contribution to growth				-0.8	-0.4	0.0	0.3	0.6	0.5	0.1	0.0

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

Table 3.

Japan: External Sector Summary, 2012–19

				2012	2013	2014	2015	2016	2017	2018	2019
										Proj.
Balance of payments				(In billions of USD)
Current account balance				59.7	45.9	36.8	136.4	194.9	196.1	183.7	196.2
	Trade balance (goods)			-53.9	-90.0	-99.9	-7.4	51.4	44.5	34.7	43.0
		Exports of goods		776.0	695.0	699.7	622.1	636.3	689.2	750.0	766.6
		Imports of goods		829.9	784.9	799.7	629.5	585.0	644.8	715.3	723.7
			Imports of goods, Oil	196.9	184.9	167.6	88.1	64.9	82.9	108.0	106.2
	Services balance			-47.8	-35.7	-28.8	-16.0	-10.6	-6.5	-4.4	-4.3
		Credits		136.8	135.3	163.2	162.6	167.5	172.8	178.4	184.3
		Debits		184.6	171.0	192.4	175.6	180.9	187.0	191.7	197.8
	Income balance			175.6	181.6	184.6	176.2	173.9	177.0	173.2	178.4
		Credits		229.6	241.3	256.9	248.5	261.3	272.5	253.5	264.7
		Debits		54.0	59.7	72.4	72.3	87.5	95.5	80.2	86.2
	Current net transfers			-14.2	-10.0	-19.0	-16.3	-19.8	-18.9	-19.9	-20.9
Capital account				-1.0	-7.7	-2.0	-2.2	-6.5	-2.6	-3.3	-3.2
Financial account				47.2	-62.5	24.9	163.2	279.8	127.5	148.7	160.3
	Direct investment, net			117.5	144.7	118.6	133.3	134.4	149.7	132.5	144.6
	Portfolio investment, net			28.8	-280.6	-42.2	131.5	276.5	-53.5	-47.0	-44.0
	Other investment, net			-61.1	34.8	-60.1	-106.7	-125.4	7.7	52.8	48.8
Reserve assets				-37.9	38.7	8.5	5.1	-5.7	23.6	10.5	11.0
Errors and omissions, net				-4.8	-42.6	24.1	46.7	75.4	-35.6	0.0	0.0
				(In percent of GDP)
Current account balance				1.0	0.9	0.8	3.1	3.9	4.0	3.6	3.8
	Trade balance (goods)			-0.9	-1.7	-2.1	-0.2	1.0	0.9	0.7	0.8
		Exports of goods		12.5	13.5	14.4	14.2	12.8	14.1	14.8	14.7
		Imports of goods		13.4	15.2	16.5	14.3	11.8	13.2	14.1	13.9
	Services balance			-0.8	-0.7	-0.6	-0.4	-0.2	-0.1	-0.1	-0.1
	Income balance			2.8	3.5	3.8	4.0	3.5	3.6	3.4	3.4
Global assumptions
Exchange Rate (¥/US$)				79.8	97.6	105.9	121.0	108.8	112.2	109.8	109.3
	(Percent change)			0.0	22.3	8.6	14.3	-10.1	3.1	-2.1	-0.5
Oil prices (US$/barrel)				105.0	104.1	96.2	50.8	42.8	52.8	69.4	68.8
	(Percent change)			1.0	-0.9	-7.5	-47.2	-15.7	23.3	31.4	-0.9
Memorandum items :

Adjustment needs by 2030				7
	Improve structural primary balance by 0.5 percent of GDP to stabilize debt			5
	Increase in health and long-term care spending			2
Options for adjustment
	Increase consumption tax rate from 8 to 15 percent			3.5
	Health and long-term care reform (potential gains by 2030)			Up to 2
			Curb growth rate of health spending
			Increase the share of out-of-pocket spending
	Other potential options			Up to 2.5
		Personal income tax reform
			i) Broaden personal income tax base	0.5 – 1
			ii) Eliminate preferential tax treatment for pension benefit income	0.25
			iii) Targeted tax credits ^2/	-
		Increase property tax		+
		Raise pension eligiblity age to 67 or higher		0.25
		Containing non-social security expenditure in percent of GDP		Up to 1

Adjustment needs by 2030				7
	Improve structural primary balance by 0.5 percent of GDP to stabilize debt			5
	Increase in health and long-term care spending			2
Options for adjustment
	Increase consumption tax rate from 8 to 15 percent			3.5
	Health and long-term care reform (potential gains by 2030)			Up to 2
			Curb growth rate of health spending
			Increase the share of out-of-pocket spending
	Other potential options			Up to 2.5
		Personal income tax reform
			i) Broaden personal income tax base	0.5 – 1
			ii) Eliminate preferential tax treatment for pension benefit income	0.25
			iii) Targeted tax credits ^2/	-
		Increase property tax		+
		Raise pension eligiblity age to 67 or higher		0.25
		Containing non-social security expenditure in percent of GDP		Up to 1

Topics

Countries

Series

About

Resources

Abstract

Recent Developments

Authorities’ Views

Outlook and Risks

Authorities’ Views

Policies: Navigating Demographic Headwinds

A. Fiscal Policy—Near-Term Support and Long-Term Sustainability

Authorities’ Views

B. Macro-Structural Agenda—Reinvigorated Reforms

Authorities’ Views

C. Monetary Policy—In for the Long Haul

Authorities’ Views

D. Financial Sector Policies—Containing Risks

Authorities’ Views

E. External Position and Spillovers

Authorities’ Views

F. Efforts in Tackling the Supply-Side of Corruption

Authorities’ Views

Staff Appraisal