Japan: 2019 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for Japan

International Monetary Fund. Asia and Pacific Dept

doi:10.5089/9781513529394.002.A001

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Japan: 2019 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:: 10 Feb 2020

eISBN:: 9781513529394

ISBN:: 9781513529394

Language:: English

Keywords:: ISCR; CR; CPI headline inflation; Japan; BOJ's core-core inflation; core inflation; core inflation forecast; Japan-EU trade agreements; stimulus package; Inflation; Consumption taxes; Aging; Global; inflation expectation; fiscal policy; interest rate; consumer sentiment

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2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Japan

Abstract

2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Japan

Recent Developments

1. Growth is above potential despite external headwinds, but inflation momentum remains modest. Private consumption and public spending supported growth in the first three quarters of 2019. Exports and export-driven investment have softened in line with weaker external conditions and rising uncertainty. Private consumption frontloading ahead of the October consumption tax rate increase appears to have been smaller than in 2014. However, post tax-hike, durable goods consumption decelerated as much as in 2014, while non-durable goods consumption was also dampened by typhoons. ¹ Real GDP growth is estimated to be above potential at 1.0 percent in 2019. While unemployment is at its lowest rate since 1993, total hours worked are declining and the output gap remains negative. ² Inflation expectations and wage growth remain weak (Annex I). Headline inflation momentum has eased, and core-core inflation (excluding food and energy) remains stable at around 0.5 percent.

2. Financial conditions remain loose and financial stability risks are rising. The banking system remains well capitalized and liquid in aggregate, but the sustained low yield and highly competitive environment have compressed banks’ net interest margins and undermined their profitability, spurring them to take greater risks. In their search for yield, the megabanks have increased their investment in foreign high-yield securities—including collateralized loan obligations (CLOs)—raising their dependence on foreign currency funding. Facing increasingly severe profitability challenges, the regional banks have raised their lending to financially vulnerable firms domestically, until recently expanding rapidly lending to the real estate sector. Since the returns on this lending by regional banks have not been commensurate with the risks involved, their capital adequacy ratios have been declining. To support their profitability, insurers have been shifting their investments from domestic bonds to higher yielding foreign debt instruments.

3. The Bank of Japan (BoJ) has kept policy rates stable since 2016, while significantly reducing bond purchases. Since the introduction of its Yield Curve Control (YCC) framework in September 2016, the BoJ has maintained a negative short-term interest rate (at -10 bps) and a zero-percent yield target for 10-year Japanese Government Bonds (JGBs). This has resulted in a significant reduction in JGB purchases—reducing the annual change of JGB holdings to ¥19 trillion, well below the BoJ’s current guidance of ¥80 trillion (Annex II). The BoJ has modified its forward guidance by gradually extending its commitment to keep short- and long-term interest rates at their present or lower levels, adding also in October 2019 that its interest rate policy would be state-contingent on the path of inflation. With inflation below the BoJ’s two percent CPI headline inflation target, a weakening external environment, and policy easing by other major central banks, BoJ faces pressure for further stimulus.

4. The consumption tax rate was increased by two percentage points as planned on October 1, together with measures to smooth demand volatility and mitigate the impact on the economy. These measures include: (i) a point-reward program for cashless payments in SMEs (Annex III); (ii) a tax allowance for automobile and house purchases; (iii) infrastructure investment; and (iv) additional spending for childcare and tertiary education. Together with a smaller rate increase (2 versus 3-percentage points in 2014), and exemption of food, non-alcoholic beverages and newspapers, these measures appear to have made frontloading of demand smaller than in 2014. However, for some durable goods, a last-minute pickup in demand was observed in September, followed by a drop in October exacerbated by the effects of Typhoon Hagibis.

5. Structural reforms are moving forward, although the impact of some measures has been lost in the implementation process.

Work Style Reform. Plans to implement “equal pay for equal work” regulations starting in April 2020 include guidelines to eliminate “irrational gaps” between regular and non-regular workers in the same firm, with oversight by national labor bureaus. However, this is unlikely to deliver higher productivity and wages as the gaps are vaguely defined and the system relies on workers’ request to the firm for information and explanation of gaps. Similarly, the cap on overtime (in effect for large firms since April 2019) does not appear to have increased productivity so far as it is relatively high (100 hours per month), and survey data do not yet indicate a systematic reduction in working hours. ³ On the positive side, almost 40 percent of surveyed firms report adopting some form of flexible work style, 20 percent are overhauling performance-evaluation systems, and 20 percent are improving training.
Foreign labor. A new residency status for foreign workers was enacted in April 2019 (Box 1), allowing higher inflows of specified-skilled workers into industries suffering serious labor shortages, including nursing, restaurants, construction, and agriculture. However, the relatively strict qualification requirements—in most cases workers cannot bring family members or stay more than five years, and must also pass Japanese language and skills tests—have limited the inflow of foreign workers.
Corporate governance. June 2018 revisions to the 2015 Corporate Governance Code have not substantially reduced cross-shareholding, although shareholders have reportedly increased activism and votes against management. Supporting investor activism, the Government Pension Investment Fund (GPIF) introduced incentives for its external asset managers to increase activism in the domestic equity portfolio. On the other hand, through its exchange-traded fund (ETF) purchases the BoJ has become one of the largest shareholders of listed companies, leaving less scope for activist investors. Further, the Financial Services Agency (FSA) plans to ease restrictions on banks’ investments in other banks by relaxing capital requirements for non-internationally active banks to facilitate investment and support financial assistance to potentially distressed banks. Finally, the government amended the foreign investment law in November 2019, by subjecting foreign investment in national security-related industries to greater scrutiny (with plans to cover aerospace, electricity, telecommunications, broadcasting, railway, software). ⁴

6. Japan has made substantial progress on trade relations. The Japan-EU Economic Partnership and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) took effect in February 2019 and December 2018, respectively. Japan and the U.S. signed agreements in October 2019 regarding market access for agricultural and industrial goods, as well as on digital trade, and these agreements took effect in January 2020. ⁵ Negotiations have advanced on the Regional Comprehensive Economic Partnership. Japan’s strengthened procedures for exports to Korea of materials critical for producing semiconductors and displays (including hydrogen fluoride), as well as reciprocal suspension of streamlined export procedures, may have affected their exports from Japan to Korea, albeit with limited macroeconomic effects so far. Exports from Japan to Korea of automobiles and tourism have also fallen. ⁶

Authorities’ Views

7. The authorites noted that the economy is expanding at a moderate pace, although the weakening global growth has affected export, production and business sentiment. The authorities highlighted that despite weakening overseas economies, corporate profits remain high, private consumption remains unaffected, and business fixed investment—particularly related to labor-augmenting technology—has supported private investment. However, the authorities also noted that inflation has been relatively weak, compared to the economic expansion and tight labor market conditions. They assessed that the consumption tax rate increase was implemented without significant trouble in October, and that their countermeasures had thus far helped contain overall consumption volatility. On trade, they plan to continue advancing bilateral and regional trade agreements. The BoJ emphasized that the reduction in JGB purchases is consistent with the guidelines for market operations under the YCC framework and in part reflects downward pressures on yields from global developments and the recent increase in demand by foreign investors. The FSA assessed the financial system as stable, but will continue to closely monitor the functioning of financial intermediation and excessive risk taking by financial institutions.

Resilient Growth Outlook AMID Significant Risks

8. The economy is expected to continue its expansion in the near term, and while inflation is edging up, is unlikely to reach BoJ’s two-percent target over the medium term. Growth in 2020–21 will be supported by domestic demand, with the assistance of the December 2019 fiscal stimulus package—offsetting an expected fall in net exports. Adverse external conditions will dampen export-driven private investment and manufacturing. However, non-manufacturing investment is expected to stay firm due to investment in labor-saving technologies. Over the medium term, external conditions will improve and support growth in converging to potential, contributing to a gradual reduction in the output gap. Expected and actual inflation are projected to remain below target under current policies.

9. Japan faces significant risks (Annex IV). A rise in the Economic Policy Uncertainty Index, an increase in financial stability risks, and consumer and investor confidence at multi-year lows, all suggest a rising risk profile. Given the importance of manufacturing in the Japanese economy, a further slowdown of global manufacturing will hurt Japan’s exports and investment—potentially turning into a significant downside growth risk if the slowdown spills over to services. In the event of a major downturn in economic activity, the authorities should stand ready with a coordinated policy response including growth-enhancing fiscal stimulus supported by continued accommodative monetary policy.

10. Several risks weigh on the near-term outlook (Annexes V-VI). Domestically, a sharper and more-protracted fall in consumption in the wake of the consumption tax rate increase is an immediate downside risk. External risks are dominated by weaker-than-expected global growth (particularly in China) and further de-globalization. An abrupt deterioration in market sentiment (e.g., via a disorderly Brexit or geopolitical tensions) could heighten risk aversion, safe haven yen appreciation, and macro-financial risks. Disruptions in U.S. dollar funding markets could increase the cost of funding for some Japanese banks (Annex VII).

11. Medium-term risks are dominated by spillovers from adverse demographics.

Financial sector risks. The adoption of riskier asset allocations by financial institutions to support their profitability as population aging delivers a low yield environment (by supporting saving and restraining investment during the earlier pre-retirement phase of aging) may tighten their capital adequacy constraints, undermining domestic credit growth. Market risks from a collapse in equity prices could generate large valuation losses for banks, insurers and pension funds. In addition, the aging and shrinking of the population would decrease demand for financial assets, placing downward pressure on asset prices.
External imbalances. Aging is expected to reduce the public and private saving-investment balance in more advanced phases of aging (particularly the post-retirement phase). On the public side, age-related fiscal spending (particularly healthcare and pensions) will rise during advanced phases of aging, increasing fiscal pressures to save during the earlier phases of aging. Related fiscal consolidation could lead to the re-emergence of excessive external imbalances if consolidation is advanced—increasing the public saving-investment balance—without a medium-term fiscal framework or structural reforms to help boost domestic demand during the earlier phases of aging.
Public debt sustainability and bond market stress. Growing demographic-fiscal pressures could heighten debt sustainability concerns and trigger bond market stress. Higher risk premia could increase debt service and refinancing risks for the sovereign—with adverse feedback effects on the financial system and the real economy (Annex VIII).
Housing market stress. While likely a tail risk, oversupply of housing due to a declining population could put downward pressure on house prices—raising risks for household and regional bank balance sheets. ⁷

Authorities’ Views

12. The authorities agreed that Japan faces a range of risks, and noted that financial institutions remain resilient to adverse shocks. The authorities consider that a longer-than-expected drag from overseas economies and heightened global uncertainty are the main risks to near-term growth. Regarding inflation, the authorities noted a flattening Phillips Curve and the sluggish adjustment of household and firm’s inflation expectations as important risk factors that would constrain the increase of CPI inflation. Responding to demographic-fiscal pressures, they highlighted the social security reform package to be drawn up by mid-2020 to help maintain debt sustainability. The authorities noted that financial institutions are facing increasing profitability challenges, but argued that they remain resilient to adverse shocks, given adequate capital buffers.

Economic Policies for an Aging and Shrinking Population

13. Japan’s macroeconomic challenges will intensify due to severe demographic headwinds. ⁸ Official projections anticipate that the population will age and shrink by over 25 percent in the next 40 years (Box 2). ⁹ This will depress growth and productivity due to a reduced and aging labor force, and magnify fiscal challenges as age-related spending rises while the tax base shrinks. Labor market rigidities also limit productivity growth and hamper pass-through of demand stimulus to real wages and prices.

14. Abenomics—now entering its seventh year—has eased financial conditions, reduced the fiscal deficit, and raised employment and female labor force participation. ¹⁰ Nonetheless, reflation efforts have fallen short and under current policies the public debt-to-GDP ratio will continue to rise. Implementation of the ‘third arrow’ of Abenomics (structural reforms) has been slow. Bottlenecks remain in labor, product, and service markets, exacerbated by demographic trends.

15. Comprehensive and mutually reinforcing policies are needed to lift current and expected inflation, stabilize debt, and raise potential growth. ¹¹ The main elements are: (i) supportive near-term fiscal policy and continued monetary accommodation to help reflation; (ii) a well-specified fiscal framework centered on gradual increases in the consumption tax rate and cuts to age-related expenditures to reduce debt sustainability risks; (iii) structural reforms to lift long-run growth and support reflation; and (iv) strengthened financial sector policies to contain build-up of systemic risks and help make the accommodative monetary policy stance more sustainable.

Monetary and financial policies: BoJ’s accommodative monetary policy stance should be maintained. Meanwhile, monetary and financial sector policies should be better coordinated to enhance monetary policy sustainability and mitigate financial stability risks. Specifically (i) strengthening the monetary policy framework would help lift inflation expectations and improve policy flexibility; and (ii) adjusting the YCC framework, consider tightening macroprudential policy by activating the countercyclical capital buffer, and supporting regional bank consolidation could help address low profitability and discourage excessive risk taking.
Fiscal policy: Near-term fiscal and income policies should complement BoJ’s reflation efforts and the implementation of structural reforms. The authorities’ medium-term fiscal consolidation plan should be based on realistic growth assumptions and lay out concrete fiscal measures which will reduce policy uncertainty and boost demand, providing additional near-term fiscal space while ensuring fiscal sustainability.
Structural reforms: Structural reforms are imperative to lift long-run growth potential and stabilize government debt. Deflationary supply-side effects would be offset by near-term demand that is bolstered by strengthened confidence, enhanced expectations and more effective monetary transmission (e.g., through a higher natural real interest rate).

A. Monetary and Financial Policies—Coordination and Sustainability

16. The YCC framework has made monetary accommodation more sustainable, but has not yet revived inflation or inflation expectations. The effective monetary stimulus of YCC—as measured through the short-term interest rate gap—has been limited. Reasons include: the low natural rate of interest due to adverse demographic trends; ¹² and the inability to further reduce the real interest rate due to the effective lower bound and low inflation expectations. In the absence of structural reforms to raise the natural rate of interest (by boosting productivity growth), and with the financial side effects of prolonged monetary accommodation becoming more acute, finding a means to raise inflation expectations is critical (Annex IX). The authorities agreed with staff on the need to continue with monetary easing and accelerate structural reforms to help maintain reflation momentum, and that the YCC framework has enhanced the sustainability of monetary stimulus.

17. A flattening yield curve is undermining financial sector profitability and encouraging risk taking. Relative to one year ago, the BoJ’s sustained accommodative monetary policy and recent declines in global bond yields have flattened the JGB yield curve and pushed yields into negative territory up to the 10-year maturity. This has reduced net lending margins and investment income of banks, insurers and pension funds—which have substantial JGB holdings—spurring them to adopt riskier asset allocations. To alleviate financial stability concerns and ensure durable monetary stimulus, actions are needed to strengthen and activate macroprudential policy and adjust the YCC framework.

18. The monetary policy framework could be further strengthened to enhance policy credibility and predictability. The BoJ should maintain its accommodative policy stance while considering measures that could strengthen the monetary policy framework. Specifically: ¹³^,¹⁴

Reviewing the price stability target. Given increased attention to structural drivers of low inflation—both global (e.g., technological progress) and domestic (e.g., demographic trends)— an updated assessment of the inflation level consistent with the price stability objective could be carried out. The review would provide the BoJ with an opportunity to: (i) reconfirm its commitment to the target; (ii) increase policy flexibility by introducing an inflation range around the target; and (iii) emphasize the medium- to long-term nature of achieving the price stability objective. This could allow the BoJ to more flexibly address competing policy objectives such as financial stability.
Increasing policy flexibility. The BoJ could introduce a range around its current inflation target while emphasizing the medium- to long-term nature of achieving the price stability objective. This would enable the BoJ to more flexibly address competing policy objectives such as financial stability while at the same time acknowledge uncertainty around the optimal level of inflation. Careful market communication would be needed to avoid being misinterpreted as a move towards monetary policy normalization.
Strengthening the conduct of monetary policy. BoJ could enhance its current “two perspective” policy strategy—assessing whether the near-term inflation outlook is consistent with the price stability objective, and examining the risks most relevant to the conduct of monetary policy—by adopting Inflation Forecast Targeting (IFT). IFT would improve policy credibility and predictability by making monetary policy respond more systematically to deviations of BoJ’s inflation forecast from the price stability target ¹⁵
Improving communication with financial markets and the public. The BoJ’s policy guidance should be simplified by: abandoning the quantity guidance on JGB purchases; and at the same time delinking the overshooting commitment from the monetary base. Consistent with an IFT strategy, Board members’ forecasts currently published in the BoJ’s Outlook Report could be replaced by a BoJ staff forecast consistent with the agreed policy path. ¹⁶

19. To safeguard financial stability as the financial cycle matures, and thereby make the accommodative stance of monetary policy more sustainable, the BoJ and FSA could consider:

Adjusting the YCC framework. The BoJ may be able to mitigate the impact of its prolonged accommodative monetary policy on financial institutions’ profitability through steepening the JGB yield curve—by shifting the zero percent JGB yield target from the 10-year to a shorter maturity, and reducing purchases of JGBs with longer term residual maturities. This could raise the investment income of financial institutions and boost public sentiment by increasing the rates of return on insurance and pension products while only slightly tightening financial conditions. This is because economic activity is most responsive to short- to medium-term interest rates—as corporate and household financing is mostly dependent on those rates, and most variable rate loans are linked to TIBOR, while the average duration of fixed rate loans is 3 to 4 years (see text chart). However, a careful analysis of the balance sheets of different categories of financial institutions would be called for, to assess whether future profit gains would exceed losses on existing JGB holdings. ¹⁷ Moreover, such a move would need to be communicated carefully to markets, to help ensure that it is not interpreted as signaling the end of monetary accommodation. Over time, the profitability challenges facing financial institutions such as regional banks call for restructuring and business model adjustment.
Activating the countercyclical capital buffer (CCyB) (Annex X). Total credit has been growing faster than nominal GDP, financial conditions remain loose, and financial vulnerabilities are rising. To pro-actively build-up the banking system’s resilience to increasing systemic risk, the FSA should consider raising the CCyB from its current level of zero percent, while expanding its coverage to the domestic credit exposures of all domestic banks, not just internationally active ones. This should have very limited effects on bank credit and output growth in the short run, while materially reducing the probability and severity of a banking crisis over the medium run.

20. To address structural macrofinancial challenges arising from the sustained low yield environment and population aging, the FSA should implement some key outstanding recommendations of the 2017 FSAP (Annex XI):

Strengthening macroprudential supervision and regulation. As the financial cycle matures, the FSA should continue to strengthen its financial sector supervision and regulation, by intensifying its risk assessment process and completing its macroprudential policy toolkit, to better identify and mitigate the build-up of systemic risk. In particular, it should establish a legal basis for sectoral macroprudential policy tools to manage housing market related risks, such as possibly regionally differentiated loan-to-value or debt-service-to-income limits on mortgage loans.
Intensifying microprudential supervision and regulation. The FSA should also continue to encourage banks to improve their risk management and resilience through robust microprudential supervision and regulation, by fostering more forward-looking loan-loss provisioning. It should also be granted the power to set Pillar 2 capital buffer add-ons, to tailor individual banks’ capital requirements to better fit their risk profiles.
Supporting business model adjustment and consolidation in regional banks. To ensure their soundness in the face of challenging profitability outlooks, the FSA should continue to encourage regional banks to diversify their revenue sources, while raising their efficiency by adopting IT/Fintech and consolidating. The FSA and BoJ should work jointly to assist regional banks in their reform efforts, including by supporting legislative reform efforts to: (i) introduce timebound exemptions for regional banks from anti-trust laws for mergers and consolidation; and (ii) proposals to provide financial assistance for the consolidation of regional banks, by reducing deposit insurance fees for banks that do so merge.
Addressing other financial sector policy issues. The FSA should strengthen its crisis management and resolution framework, by for example extending the coverage of Total Loss-Absorbing Capacity requirements to all domestic systemically-important banks (D-SIBs). It should also continue to take steps towards introducing an economic-value-based solvency regime for the insurance sector, and strengthen oversight of virtual asset service providers by ensuring they are subject to AML/CFT supervision in line with international standards.

Authorities’ Views

21. The BoJ stressed that while inflation has been somewhat weak, the momentum toward achieving the price stability target is maintained. The BoJ emphasized that monetary stimulus continues to be effective—as evidenced by accommodative financial conditions and a tight labor market—and that inflation expectations showed weakness primarily due to actual low inflation. Hence, the BoJ argued that raising actual inflation, by maintaining positive output gap for as long as possible, is key to achieve 2 percent medium- to long-term inflation expectations. To that end, the authorities recognized the need to continue with powerful monetary easing and mitigate financial sector side effects as well as accelerate structural reforms in order to enhance the effectiveness of monetary policy.

22. The BoJ did not see a need to adjust the monetary policy communication framework. The BoJ argued that the guidelines for market operations regarding JGB purchases do not create ambiguity as the public and financial markets understand that controlling short and long-term interest rates is the main element of the YCC and the actual amount of JGBs to be purchased is a result of achieving the desired shape of the yield curve. Also, the BoJ did not see a need to review the price stability target, because ensuring room to reduce interest rates in the long run is important and 2 percent target has been adopted by central banks in other advanced economies. The BoJ did not see a need to adopt an inflation target range, because the Bank has conducted monetary policy in a flexible way, taking account of developments in economic activity and prices as well as financial conditions. Moreover, the BoJ stressed that replacing Board members’ forecasts with a staff forecast would reduce policy transparency by making the views of individual members unavailable to the public. As for shifting its zero percent YCC target from the 10-year JGB yield to a shorter maturity, the Bank did not see a need to do so, because the Bank judges that the current framework is working well, while the Bank has struck a balance between effects and side effects. In addition, the BoJ argued that although the Bank has ETFs, it is legally not the shareholder of listed companies as the Act on Investment Trusts and Investment Corporations stipulates that the settlor company of an ETF shall exercise voting rights of securities held as ETFs property.

23. The authorities assessed the financial system as stable, with financial intermediation not overheating. The authorities explained that property and equity prices have been rising, but are not overvalued. The authorities observed that household and nonfinancial corporate debt have been rising, but the leverage is not excessive. It also noted that bank lending to the real estate sector has stopped growing rapidly. Against this backdrop, the authorities argued that the banking system is resilient to severe adverse shocks, with capital and liquidity buffers well above regulatory requirements. For these reasons, the authorities do not think that activating the CCyB is warranted at the current juncture. However, the authorities emphasized that they will continue to closely monitor increases in household and corporate indebtedness, the functioning of financial intermediation, and excessive risk taking by financial institutions.

24. The FSA explained that its revamped financial supervisory framework is forward-looking and risk-based. The FSA explained that its new Early Warning Mechanism for financial institutions: (i) identifies banks with concerns for securing medium-term profitability and soundness; (ii) engages management of these banks with respect to their business models; and (iii) if necessary, takes further administrative actions to improve their business management. The FSA noted that regional banks face increasing profitability challenges, with their core net profitability on a downward trend, but that their capital buffers remain adequate for now. It argued that regional banks should develop their sustainable business model to adapt to the sustained low-yield environment, and aging and shrinking of the population, by measures such as revenue diversification, efficiency gains, and consolidation. Governor Kuroda noted that the BoJ and FSA are working jointly to assist regional banks in their reform efforts.

B. Fiscal Policy—Flexibility and Coordination

25. The December 2019 stimulus package will moderate the decline in growth in 2020, and should be accompanied by a clear commitment to long-term fiscal sustainability. The stimulus package will help navigate a deteriorating external environment and related drop in consumer and investor sentiment, and overcome the likely post-Summer 2020 Olympics slowdown. While Japan has some fiscal space—helped by limited funding risks and low borrowing costs—the high level of public debt, adverse demographics, and projected rise in social security spending call for a renewed and well-communicated approach to defining medium- and long-term fiscal targets.

Japan: Comprehensive Economic Measures to Create a Future with Security and Growth (the Cabinet Decision of December 5th, 2019)

^{^1/}This includes a government loan program (Fiscal Investment and Loan Program) and private sector financing.

Near-Term Fiscal Support

26. A broadly neutral fiscal stance is appropriate for 2020 and could, if warranted, be extended to 2021—together with continued monetary accommodation. The increase in consumption tax revenue is expected to be largely offset by expenditure increases and revenue losses from the mitigating measures, making the 2019 fiscal stance broadly neutral. The December 2019 stimulus package is projected to make also the 2020 fiscal stance broadly neutral, while the 2021 fiscal stance would be contractionary (by about 0.6 percent of GDP) under current policies as the effects of the package fade. Given downside risks and the need to avoid a pro-cyclical fiscal tightening that might undermine growth momentum, a neutral fiscal stance might also be called for in 2021, unless economic data outturns are stronger than expected. Fiscal measures in the near term could:

Address the devastation caused by natural disasters. In response to recent natural disasters, prompt fiscal measures should support efforts to rebuild infrastructure and provide relief to affected vulnerable population.
Extend consumption tax countermeasures in 2020. Some key measures to cushion the impact of the October 2019 consumption tax rate increase are set to expire before the end of 2020, while economic activity is expected to soften post-Summer 2020 Olympics. Alternatively, an exit strategy from those measures should be carefully designed to minimize volatility of private consumption and cushion any impact on the most vulnerable. For example, as the point reward program carries the potential to make private consumption volatile when the measure expires in June 2020, the authorities could instead phase out the reward rate towards the end of 2020, or replace the program with another measure that carries a similar economic impact.
Increase wages of workers in the childcare, health and long-term care sectors further. While it is critical to contain growth in social security spending, rising demand for these services needs to be matched by supply-side measures to ensure adequate staffing and quality of service.
Reinforce income policies and protect the most vulnerable. A clear government commitment is needed for more effective corporate tax incentives for wage increases, higher minimum wages, and an increase in administratively-controlled wages and social transfers. To support reflation, administered prices should be set by a mechanism that better reflects costs, with safeguards for low-income households.
Support structural reforms. Fiscal measures should raise childcare availability and strengthen firms’ incentives to further increase firms’ provision of childcare and nursing-care, enhance non-regular workers’ productivity (i.e. training and career prospects), and boost R&D investment.
Measures to lessen the impact on the agriculture sector of opening up to trade. In completing trade agreements with the European Union, ten other Pacific countries, and the United States, which open up the Japanese domestic market to increased agricultural imports, Japan revised its measures to support domestic farmers and boost agricultural exports. These recent trade agreements call for strengthening the competitiveness of agriculture—incentivizing value-added products (including exports of wagyu beef), facilitating the scale-up of small-sized farms, and enhancing rural infrastructure spending. The recently-adopted fiscal stimulus package also includes measures to bolster preparedness of farm facilities against typhoons and other natural disasters.

Table 1.

Japan: Countermeasures for the 2019 Consumption Tax Rate

Sources: Ministry of Finance, the Cabinet Office, IMF staff estimates.

Medium- and Long-Term Fiscal Strategy

27. A well-specified framework is needed to ensure fiscal sustainability and reduce debt, lower uncertainty, and support reflation and growth. While the government has set a primary balance target for FY2025, credibility would benefit from realism of assumptions and specificity of measures to achieve the target. The presence of a clear and credible fiscal framework would help diminish policy uncertainty, and likely bolster corporate investment and reduce households’ precautionary saving (see Annex XII for examples of countries with a medium-term fiscal framework). Several steps could help bolster the credibility of fiscal policy:

Adopt realistic growth and fiscal projections. Realistic assumptions for TFP growth and public spending growth would add credibility and help anchor fiscal policy discussions. Staff estimates that gradual reductions in the structural primary balance of about 0.5 percent of GDP annually from 2022, accompanied by a comprehensive policy package with accelerated structural reforms, would help put the debt-to-GDP ratio on a downward path over the long term.
Factor in aging costs. It is important to continuously assess and incorporate aging costs in macro-fiscal projections. Staff scenarios suggest that to finance aging costs, the consumption tax rate would need to increase gradually to 15 percent by 2030 and to 20 percent by 2050. ¹⁸ The consumption tax rate increases should be done gradually on a regular (preferably legislated) schedule to smooth the economic impact and minimize policy uncertainty. The cost of postponing adjustment is substantial and would benefit the current elderly to the detriment of future generations.
Strengthen redistribution effects and address inequality. Japan’s capital gains tax (part of financial income taxes which also include taxes on dividends and interest) is a flat rate of 20 percent, with some exemptions intended to promote household financial investment. The capital gains tax rate rose from the reduced rate of 10 percent to 20 percent in 2014. The rate of taxation on capital gains should be gradually increased to 30 percent, starting in 2022. A higher capital gains tax rate―with the current exemptions kept in place―would help contain income inequality by imposing a relatively heavier burden on the wealthy. Alternatively, re-introduction of a wealth tax could be considered. ¹⁹ A new wealth tax with zero or very few exemptions, a high threshold, and a low flat rate would minimize administrative costs and help limit capital flight, while addressing inequality and collecting meaningful revenue. ²⁰ A wealth tax could be less detrimental to productivity because those with similar wealth pay similar taxes regardless of productivity, while a higher capital gains tax could implicitly penalize entrepreneurs with higher productivity.
Raise the carbon tax. To strengthen incentives to reduce energy use and shift to clean energy sources, a higher carbon tax should be considered, together with measures to support vulnerable households. ²¹ Time-bound grandfathering or a phased-in approach could mitigate a potential short-term adverse impact on investment and consumption, while incentivizing business and households to move gradually towards low-emission sources.
Improve the transparency of the budgetary framework. There have been ten supplementary budgets since the beginning of Abenomics in late 2012. Limiting the frequency and size of supplementary budgets would help reduce policy uncertainty and increase the effectiveness of macroeconomic demand support.

Japan: Options for Fiscal Policy Adjustment by 2030 (in percent of GDP) ^1/

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

28. Reform of public social security programs is the essential second leg of fiscal consolidation. Without meaningful change to pension, health, and long-term care spending, fiscal sustainability may remain out of reach. The authorities intend to move ahead with social security reform, as recommended by staff, noting that such reforms will help achieve their fiscal consolidation targets. The authorities’ plan to draw up a comprehensive reform package by mid-2020 is welcome, and should involve the following:

Pension. Recent projections indicate a funding gap under conservative scenarios if the committed replacement ratio (of 50 percent) is maintained. Reforms should focus on improving pension sustainability and intergenerational equity. Options include encouraging the elderly working population to defer pension drawdowns and lengthen the contribution period, as well as expanding the contributions base. While the government’s recent initiative to provide additional pension benefits to low-income pensioners is a welcome step from the perspective of intra-generational equity, the distributional impact could be strengthened by financing this initiative with a reduction in pension benefits for the wealthy (instead of financing it with consumption tax revenues). In addition, social security and tax reforms should remove disincentives to full-time and regular work to help address gender inequality. ²²
Healthcare and long-term care. The prospect of continually rising healthcare expenditures, driven by population aging and use of advanced and expensive health-technology, present a sizeable challenge to Japan’s fiscal sustainability. ²³ Reforms could focus on: (i) improving efficiency through wider use of generic drugs and rationalization of in- and outpatient care; ²⁴ (ii) increasing the share of out-of-pocket spending for those over 75 years old and the wealthy elderly, with safeguards for vulnerable households; and (iii) reducing the scope of covered services and drugs. On long-term care, the authorities should explore measures to contain costs, including rationalizing services to those with lower-care needs.

Strengthening Policy Coordination

29. Strengthening the effectiveness of coordination between monetary and fiscal policy remains a high priority—both to revitalizing the economy and achieving the 2 percent inflation target and—looking forward—dealing with a changing economic environment and potential new shocks. The basis for such coordination has been established in the January 2013 Joint Statement (by Cabinet Office, Ministry of Finance, and Bank of Japan), which lays out coordinated measures to revitalize the economy and achieve the 2 percent inflation target, including regular review of the progress in the conduct of macroeconomic policies by the Council on Economic and Fiscal Policy. ²⁵ This mechanism should be used to its full potential to ensure that fiscal and monetary policies work in tandem toward mutually reinforcing objectives of growth and reflation.

Authorities’ Views

30. The authorities agreed with staff on the need for near-term fiscal policy to support the economy, as the outlook is clouded largely by rising global uncertainty. They highlighted that the December 2019 economic measures contains various measures to mitigate the adverse economic impact of recent natural disasters, and would help the economy navigate through the global headwinds and realize sustainable growth mainly led by private demand beyond the 2020 Olympics.

31. The authorities consider that their medium-term macro-fiscal projections are based on realistic assumptions. In a scenario that current economic policies show solid results, the total factor productivity growth rate is assumed to rise based on past performance. They revised the assumption downward, reflecting views of private sector representatives in the Council of Economic and Fiscal Policy, when they set the FY2025 primary-balance target. In addition, they have another projection with more prudent assumptions that the economy will grow approximately at the rate of current potential growth. They deemed that aging-related costs are duly taken into account in their projections of social security expenditures.

32. The authorities explained that they have already laid out fiscal consolidation plan and have steadily implemented it. So far, they have been steadily implementing “the New Plan to Advance Economic and Fiscal Revitalization”, which was decided by the Cabinet in June 2018. Based on this plan, the Council of Economic and Fiscal Policy (CEFP), chaired by Prime Minister, established “the Reform Time Schedule” to clarify the concrete actions to be implemented for each fiscal year and set Key Performance Indicators (KPI) over 140 expenditure-related areas, such as social security, infrastructure and education. The Council will revise the schedule every year and an experts committee under the CEFP, which consists of academics on economics and public finance and experts in various fields, calls senior officials of ministries in charge to explain their progress toward KPI to set by the schedule, evaluating it.

33. There is a gap between the authorities’ FY2025 primary-balance target and the projected path of primary balances without additional policy measures, thus they recognized that they will continue to implement reforms along with the plan to fill the gap. The authorities highlighted that the social security reform package (to be finalized in mid-2020) is expected to contribute into pursuing their fiscal consolidation target. The authorities stressed that the objective of the comprehensive social security reform is to rebalance the so-called “people who support” and “people who are supported,” and expressed their intention to continue to pursue measures to contain social security expenditures by social security reform and promotion of further labor participation.

34. The authorities were of the view that due consideration has been given to inequality issues. The authorities emphasized recent tax and expenditure measures that have helped contain economic inequality, including: (i) an increase in the personal income tax rate for the top bracket from 40 to 45 percent (effective since 2015), (ii) a reduction of various deductions for high-income earners (effective since 2013, 2016, 2017 and 2020), (iii) an increase in the tax rate on financial investment income from 10 to 20 percent (effective since 2014), (iv) an increase in the inheritance tax (effective since 2015), and (v) the additional pension benefits to low-income pensioners (effective since October 2019). To support gender equality and women in the labor market, the authorities continue to increase childcare availability, and they consider that the 2017 revision of the spousal tax deduction is designed to reduce incentive for part-time workers to limit their working hours.

35. The authorities stressed that existing policy coordination frameworks, including the 2013 Joint Statement, already deliver coordinated monetary and fiscal policy. They view the 2013 Joint Statement as still relevant and appropriate at the current economic juncture and stressed that they will continue to enact policy coordination while also maintaining the independence of each government authority.

C. Structural Reforms—Reflation and Growth

36. Structural reforms are essential to navigate Japan’s demographic headwinds. Aging and depopulation will depress productivity growth and investment— shrinking real GDP growth. Staff analysis finds that worsening demographics could reduce real GDP by 25 percent in four decades under current policies (relative to a scenario where recent growth performance is maintained, see text chart). ²⁶

37. The structural reform agenda should support reflation, while boosting productivity, labor supply, and investment. Staff simulations suggest that credible implementation of the reforms outlined below, accompanied by a continued accommodative monetary stance and public debt stabilization, can help reflation and increase real GDP by as much as 15 percent in four decades, relative to a current-policies scenario—this could offset as much as 60 percent of the demographic-driven slowdown in real GDP growth. ²⁷ Reflation would be achieved by a demand boost from confidence effects—as firms and households increase investment and consumption due to higher expected capital returns and permanent income—in excess of the contemporaneous supply boost from the reform plan, with simulations showing about a 1 percentage point increase in inflation in the long run. ²⁸ By contrast, a not-fully-believed path of reforms would not help reflation, and would deliver significantly smaller increases in near-term real GDP (see text chart). To strengthen reform credibility and confidence effects, specific steps to enhance the government commitment—a communication strategy and/or legislation—would be central in supporting reflation.

38. The reform agenda should prioritize reflation and growth (text chart shows indicative reform estimates and ranges for these impacts).

Top-tier: Labor market reforms that increase productivity and labor supply The authorities should improve the 2018 Work Style Reform (WSR) to boost productivity and wages (see text table for details), and should introduce measures to further increase labor supply including by strengthening firms’ incentives to support women in the labor force (Box 3). Staff simulations suggest that credible top-tier reforms could offset up to 40 percent of the demographic-related slowdown in real GDP growth in four decades.
Second-tier: Regulatory and corporate reforms to lift productivity and investment Product and service sectors deregulation, SME reforms and corporate governance reforms should be advanced to lift productivity and investment (see text table for detailed recommendations). ²⁹ Broader adoption of automation and Artificial Intelligence (AI) could also boost productivity, but distributional concerns should be considered to ensure gains are spread evenly across occupations and regions. ³⁰ Staff simulations suggest that credible second-tier reforms could offset up to 20 percent of the demographic-related slowdown in real GDP growth in four decades.
Third-tier: Trade liberalization and foreign direct investment (FDI) promotion to strengthen investment and growth Further removal of tariff and non-tariff barriers in the context of high-standard multilateral trade agreements would boost Japanese investment and growth. Staff simulations suggest that implementation of CPTPP and Japan-EU trade agreements could offset up to 4 percent of the demographic-related slowdown in real GDP growth in four decades.

Authorities’ Views

39. The authorities emphasized the significant progress with structural reforms and their continued commitment to reform plans. The authorities noted that the ongoing implementation of the Work Style Reform will boost productivity, by improving skill of labors and encouraging firm’s investment, and will raise wages, while also reducing excessive overtime. In addition, the authorities noted that upcoming implementation of “equal pay for equal work” is expected to enable every worker to be fairly evaluated and to work with higher motivation. They are also considering measures to secure employment opportunities beyond age of 65. Regarding women in the labor market, they plan to hold consultations about workplace regulation and gender equality, and they highlighted the incentives provided by a public procurement system that supports women, including in managerial positions. The authorities noted that the number of female board members in listed firms continues to rise. They highlighted the 2019 plans to abolish the regulated retail electricity tariff in 2020. In April 2016, electricity retail sale was fully liberalized, and as a general rule, retail tariff was abolished. The authorities described they established Farmland Institutions to increase agricultural productivity by facilitating farmland consolidation through leasing, including private firms. The ongoing discussion on corporate governance reform aims to increase the quality of dialogue between asset managers and firms. The authorities stressed that the recently updated foreign investment law aims to further promote FDI conducive to sound economic growth and ensure minimal review of FDI that could pose risks to national security. They acknowledged their global leadership role in advancing bilateral and regional trade agreements.

Table 2.

Japan: Priority Structural Reforms: Top-Tier Reforms

Table 2.

Japan: Priority Structural Reforms: Top-Tier Reforms

Policy area	Key measures planned by the authorities and status	IMF assessment and advice
Top-tier reforms
Work Style Reform (WSR)	WSR legislation done in 2018, including three pillars: (i)mandatory caps on overtime; (ii) equal pay for equal work; and (iii) exemption from work hour regulations (including overtime limits) for highly-paid professionals. Guidelines for the implementation of the “equal pay for equal work” pillar were completed in 2019, indicating that its implementation will start in April 2020.B6	To help reflation, WSR should be complemented by a stronger reporting framework of firms’ wage gaps and job descriptions. WSR could also be complemented with sanctions for firms that do not comply with the “equal pay for equal work” pillar. In addition, programs to increase training and career opportunities of non-regular workers, including via contract reform, will help raise productivity and real wages and decrease labor market duality. WSR should be carefully implemented in order not to hinder firms’ growth.
Female and Older Worker Labor Force Participation	WSR includes measures to limit overtime. Female and older worker LFP have continued to rise since “Abenomics” started.	WSR efforts to reduce excessive overtime will help further boost LFP. In addition, measures to help increase female labor supply include: eliminating disincentives in the social security and tax systems to full-time and regular work; increasing availability of childcare and nursing facilities; incentivizing gender-balanced management in the private and public sectors; outlawing discriminatory workplace regulations (i.e. dress code); and reducing the gender wage gap. Encouraging managerial practices rewarding productivity could further boost productivity and labor force participation, as could abolishing firms’ right to set a mandatory retirement age.
Foreign labor	New residency status put in place in April 2019, to allow for higher inflows of specified-skill workers in sectors with labor shortages. WSR includes considerations to increase the use of foreign human resources, especially high-skilled. Special Economic Zones (SEZ) encourage use of foreign human resources.	The government’s recent efforts to increase foreign labor should be pushed forward.

Table 2.

Japan: Priority Structural Reforms: Top-Tier Reforms

Policy area	Key measures planned by the authorities and status	IMF assessment and advice
Top-tier reforms
Work Style Reform (WSR)	WSR legislation done in 2018, including three pillars: (i)mandatory caps on overtime; (ii) equal pay for equal work; and (iii) exemption from work hour regulations (including overtime limits) for highly-paid professionals. Guidelines for the implementation of the “equal pay for equal work” pillar were completed in 2019, indicating that its implementation will start in April 2020.B6	To help reflation, WSR should be complemented by a stronger reporting framework of firms’ wage gaps and job descriptions. WSR could also be complemented with sanctions for firms that do not comply with the “equal pay for equal work” pillar. In addition, programs to increase training and career opportunities of non-regular workers, including via contract reform, will help raise productivity and real wages and decrease labor market duality. WSR should be carefully implemented in order not to hinder firms’ growth.
Female and Older Worker Labor Force Participation	WSR includes measures to limit overtime. Female and older worker LFP have continued to rise since “Abenomics” started.	WSR efforts to reduce excessive overtime will help further boost LFP. In addition, measures to help increase female labor supply include: eliminating disincentives in the social security and tax systems to full-time and regular work; increasing availability of childcare and nursing facilities; incentivizing gender-balanced management in the private and public sectors; outlawing discriminatory workplace regulations (i.e. dress code); and reducing the gender wage gap. Encouraging managerial practices rewarding productivity could further boost productivity and labor force participation, as could abolishing firms’ right to set a mandatory retirement age.
Foreign labor	New residency status put in place in April 2019, to allow for higher inflows of specified-skill workers in sectors with labor shortages. WSR includes considerations to increase the use of foreign human resources, especially high-skilled. Special Economic Zones (SEZ) encourage use of foreign human resources.	The government’s recent efforts to increase foreign labor should be pushed forward.

Table 3.

Japan: Priority Structural Reforms: Second-Tier Reforms

Table 3.

Japan: Priority Structural Reforms: Second-Tier Reforms

Policy area	Key measures planned by the authorities and status	IMF assessment and advice
Second-tier reforms
Product and service sectors deregulation	Deregulation efforts in the right direction have taken place within electricity, gas, and agricultural sector.	Continued deregulation will help increase productivity and investment, including by lowering barriers to entry, removing incumbents’ protections in some industries (gas and telecom), and deregulating professional services. Further deregulation in agriculture needed (including elimination of subsidy support and allowing majority holdings of private companies in agricultural enterprises).
SME reforms	Since April 2018, the coverage of credit guarantees to SMEs from Safety Net Program No.5 was lowered from 100 to 80 percent, while a new Safety Net Guarantee program was established for the event of a substantive crisis with 100 percent guarantee.	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 (i.e. asset-based lending and venture capital), supporting SME R&D investment, and supporting succession of aging CEOs in firms with high growth potential (which would also avoid exit of partner companies in the supply chain).
Corporate governance	Japan’s Stewardship code for institutional investors introduced in February 2014 and revised in May 2017, with public consultation for further revision ongoing as of end-2019. Companies Act amended in June 2014 to encourage appointment of outside directors. Corporate governance code (requiring at least two outside directors on “comply or explain” basis) introduced in June 2015. June 2018 revisions to the 2015 code to incentivize a reduction in cross-shareholdings and more independent directors, and more transparent procedures to appoint and dismiss a CEO.	Significant progress has been made, but more should be done to materially affect corporate behavior. 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.
Special Economic Zones	Ten areas were designated in 2014–15--including Tokyo and Osaka. Deregulation efforts include easing restrictions on land use and medical practices, agriculture reform, labor reform, and creation of new businesses.	SEZ used as a laboratory for reforms to be implemented at the national level, but measures discussed at the local level have been slow to progress.

Table 3.

Japan: Priority Structural Reforms: Second-Tier Reforms

Policy area	Key measures planned by the authorities and status	IMF assessment and advice
Second-tier reforms
Product and service sectors deregulation	Deregulation efforts in the right direction have taken place within electricity, gas, and agricultural sector.	Continued deregulation will help increase productivity and investment, including by lowering barriers to entry, removing incumbents’ protections in some industries (gas and telecom), and deregulating professional services. Further deregulation in agriculture needed (including elimination of subsidy support and allowing majority holdings of private companies in agricultural enterprises).
SME reforms	Since April 2018, the coverage of credit guarantees to SMEs from Safety Net Program No.5 was lowered from 100 to 80 percent, while a new Safety Net Guarantee program was established for the event of a substantive crisis with 100 percent guarantee.	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 (i.e. asset-based lending and venture capital), supporting SME R&D investment, and supporting succession of aging CEOs in firms with high growth potential (which would also avoid exit of partner companies in the supply chain).
Corporate governance	Japan’s Stewardship code for institutional investors introduced in February 2014 and revised in May 2017, with public consultation for further revision ongoing as of end-2019. Companies Act amended in June 2014 to encourage appointment of outside directors. Corporate governance code (requiring at least two outside directors on “comply or explain” basis) introduced in June 2015. June 2018 revisions to the 2015 code to incentivize a reduction in cross-shareholdings and more independent directors, and more transparent procedures to appoint and dismiss a CEO.	Significant progress has been made, but more should be done to materially affect corporate behavior. 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.
Special Economic Zones	Ten areas were designated in 2014–15--including Tokyo and Osaka. Deregulation efforts include easing restrictions on land use and medical practices, agriculture reform, labor reform, and creation of new businesses.	SEZ used as a laboratory for reforms to be implemented at the national level, but measures discussed at the local level have been slow to progress.

D. External Position and Spillovers to and from Japan

40. Japan’s external current account (CA) surplus decreased by 0.6 percentage points to 3.5 percent of GDP in 2018, while the income balance remained stable.

Income balance: Japan’s income surplus—arising from its large net foreign assets (NFA) position and high net returns—accounted for the bulk of the 2018 CA surplus. Japan’s income surplus was significantly higher than other G7 countries, mainly due to relatively: (i) high yields on foreign assets; (ii) low FDI and portfolio debt liabilities; and (iii) low yields on portfolio debt liabilities. ³¹ Japan’s income balance has been rising since the mid-1990s, in line with growing corporate saving. However, the overall CA surplus has been relatively stable, as dissaving by the public and household sectors has offset rising corporate saving (Annex XIII and Box 4).
Current account: Higher energy prices were an important driver of the decrease in the CA surplus in 2018, with the goods trade balance falling to 0.2 percent of GDP. The CA surplus is estimated to have shrunk further in 2019 to about 3.3 percent of GDP, reflecting a smaller goods trade balance—with exports decreasing more than imports—due to adverse external conditions. Through November 2019, the yen appreciated by 2.5 percent (in real effective terms) relative to end-2018.

41. The 2019 external position is preliminarily assessed as broadly consistent with fundamentals and desirable policies. As with the 2019 External Sector Report, the estimated 2019 CA balance is preliminarily assessed as broadly consistent with medium-term fundamentals and desirable policies. Based on this CA assessment, the 2019 real exchange rate is also preliminarily assessed as in line with the real exchange rate level consistent with fundamentals and desirable policies (Annex XIV). 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 balances that are not excessive. Staff estimates that credible implementation of structural reforms outlined above would reduce the external current account surplus by over 1 percent of GDP in the medium term.

42. Slower growth or a tightening of financial conditions in Japan could have significant adverse outward spillovers. While the size of outward spillovers from Japan have become smaller over time, staff estimates suggest that a 1 percent decline in Japan’s GDP generates output losses in other Asian countries of about 0.2 percent on average after one year. ³² In addition, a prospective tightening of financial conditions in Japan could slow positive spillovers from Japanese portfolio and FDI outflows and from overseas diversification by Japanese institutional investors. This could lead to a deterioration of global financial conditions and potentially disrupt global capital flows, particularly to regional emerging markets and developing countries. On the other hand, Japan’s capital outflows might be increased by the October 2019 reclassification of the assets of Japan’s Government Pension Investment Fund (GPIF), which allows it to continue shifting its portfolio allocation from domestic bonds towards foreign bonds offering higher returns. ³³ Higher overseas investment by GPIF will export both loose financial conditions from Japan during normal times, and tight financial conditions during times of stress when GPIF retrenches its foreign exposures.

43. Further advancement of multilateralism would help mitigate adverse inward spillovers to Japan from an escalation of global trade disputes and yen appreciation.

Global uncertainty. A more accommodative monetary stance by other major central banks, along with heightened global uncertainty from trade and geopolitical tensions, could lead to appreciation of the yen—undermining BoJ’s reflation efforts. ³⁴
Trade and FDI flows. Japan’s trade and FDI regimes are relatively open, while agriculture ranks as less open among G20 economies (text chart). ³⁵ However, ongoing global trade tensions and any further escalation could reduce Japan’s net exports, investment, and growth—including from direct and indirect effects via global value chains and adverse spillovers to Japan’s financial sector. ³⁶
Japan and multilateralism. Japan’s leadership in advancing multilateralism—within an open, stable, and transparent rules-based international trade system—will help mitigate adverse inward spillovers from a rise in protectionism or global uncertainty.

Authorities’ Views

44. The authorities agreed with the preliminary 2019 external assessment and related policy recommendations, but reiterated concerns regarding the methodology. The authorities argued that continued proper implementation of structural reforms and fiscal consolidation in the medium-term also contributes to maintaining external balance by supporting growth, wages and domestic demand. The authorities have implemented tax incentives to promote investment and wage growth in the corporate sector. However, the authorities continue to have concerns over the REER assessment and the EBA methodology: (i) they assess that the trade balance and income balance’s low REER semi-elasticities indicate the lack of potential external adjustment via REER; and (ii) they argue that EBA should account for different implications on value creation, including the varying propensity to consume between shareholders and workers (instead of treating equally the income from the income and trade balances). They also argue that the large unexplained portion of the EBA CA gap does not by itself prove the existence of important bottlenecks to investment and consumption. Moreover, they are of the view that a large and positive NFA position (as in Japan), with its implied large income account surplus, does not pose global financial stability risks per se. They consider that a more appropriate framework to study risks from global imbalances should focus on the sustainability of external gross liabilities.

45. The authorities did not see significant outward spillovers from Japan at this time, while they agree that multilateralism can mitigate inward spillovers from global trade disputes. They agree that the weakening of the global economy has reduced Japan’s growth, and they consider that further trade disputes’ escalation can significantly affect Japan. They view their continued advancement of multilateralism as a significant force to counterbalance any further rise in protectionism.

E. Supply-Side of Transnational Corruption ³⁷

46. Japan has made progress in the fight against foreign bribery in recent years. The 2019 evaluation report by the OECD Working Group on Bribery in International Business Transactions (WGB) noted that Japan had made a number of improvements since its last evaluation. ³⁸ Most notably, in 2017, Japan amended its law to allow the confiscation of the proceeds of foreign bribery and also criminalized the laundering of such proceeds. ³⁹ This closed a significant and long-standing loophole in Japan’s implementation of the OECD Anti-Bribery Convention. Japan also introduced a new Agreement Procedure in June 2018 to encourage cooperation by those with first-hand knowledge of certain types of crimes, including foreign bribery. This could potentially enable Japan to investigate and prosecute such cases more effectively. In addition, Japan’s agency for official development assistance has debarred five Japanese and foreign companies for foreign bribery since December 2011, which constitutes a potentially powerful tool for addressing foreign bribery.

47. Concerns remain about the lack of proactivity in pursuing foreign bribery cases and the low level of investigations and convictions. Japan urgently needs to improve its foreign bribery enforcement, notably by: (i) enhancing the use of coercive investigative measures to obtain evidence in foreign bribery cases; (ii) streamlining the Ministry of Justice’s procedures for transmitting allegations to prosecutors in order to prevent undue delays in opening investigations; and (iii) ensuring that decisions to investigate or prosecute foreign bribery cases is free from undue Executive influence, including the Ministry of Economy, Trade and Industry and the Ministry of Justice. ⁴⁰

48. Japan should enhance its legal framework as well as its outreach to the private sector. In particular, Japan should: (i) review its legislation to ensure that it has jurisdiction to prosecute Japanese companies that engage in bribery abroad, even when the individuals involved were neither Japanese nationals nor in Japan; ⁴¹ (ii) extend the limitations period for prosecuting foreign bribery cases; (iii) ensure that the sanctions for natural and legal persons are effective, proportionate, and dissuasive; (iv) broaden the scope of its whistleblower protections; and (v) further raise awareness of the foreign bribery offence within the private sector.

Authorities’ Views

49. 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 in the process of implementing the OECD Phase 4 recommendations following the adoption of the WGB’s Phase 4 Report of Japan in June 2019. Through implementing the Phase 3 recommendations, the legal framework has been strengthened by the amendment of the Act on Punishment of Organized Crime and Control of Crime Proceeds that allowed the confiscation of the proceeds of foreign bribery and criminalized the laundering of such proceeds, as well as the amendment of the Code of Criminal Procedure that introduced the Agreement Procedure. In addition, the authorities have been making persistent efforts and allocating resources to investigate and prosecute foreign bribery cases. 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 as widely as possible. 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

50. Japan’s economy is growing above potential despite external headwinds, but inflation momentum remains modest and downside risks have increased. Moderate growth in domestic demand is being eroded by the weaker external environment. Frontloading of private consumption ahead of the October 2019 consumption tax rate increase appears to have been smaller than in 2014. Underlying growth is expected to remain solid with near-term inflation reaching about one half of one percent, with a still-negative output gap. Over the medium term, growth is projected to moderate to near potential, inflation is expected to edge up slowly but remain below the Bank of Japan’s two-percent target, and the output gap will gradually close. Japan faces significant risks, including a more-protracted fall in consumption following the tax rate increase, weaker-than-expected global growth, and rising adverse demographic pressures.

51. Japan’s macroeconomic challenges will intensify as its population ages and shrinks. While the strategy of Abenomics remains appropriate, a comprehensive and coordinated effort is needed to boost potential growth, lift current and expected inflation, and stabilize public debt. The accommodative stance of monetary policy should be maintained, complemented by measures to strengthen the monetary policy framework and enhance policy sustainability, to help raise inflation expectations. Strengthened financial sector policies, including tightening of macroprudential policy and support for regional bank consolidation, would help contain the build-up of financial risks stemming from demographic headwinds and prolonged low interest rates. Near-term fiscal support will help sustain domestic demand as well as the implementation of structural reforms. Over the longer term, a well-specified fiscal framework centered on gradual increases in the consumption tax rate and cuts to age-related expenditures would help reduce debt sustainability risks. Implementation of structural reforms will support long-run growth and reflation.

52. The Bank of Japan (BoJ) should maintain its short- and long-term interest rate targets to support growth and inflation, while considering measures to enhance policy sustainability. The BoJ’s recent emphasis on making the accommodative stance more sustainable by mitigating side-effects on the financial system is appropriate. Building on this progress, an updated assessment of the inflation level consistent with the price stability objective could be carried out. The review would provide the BoJ with an opportunity to reconfirm its commitment to the target, increase policy flexibility by introducing an inflation range around the target, and emphasize the medium- to long-term nature of achieving the price stability objective. This would allow the BoJ to more flexibly address competing policy objectives such as financial stability.

53. Financial sector policies should be strengthened to safeguard financial stability and make the accommodative stance of monetary policy more sustainable. The financial authorities should consider tightening macroprudential policy by raising the countercyclical capital buffer above its current zero percent level, to pro-actively build-up the resilience of the banking sector to rising systemic risk. The Financial Services Agency (FSA) should also continue to strengthen its financial sector supervision and regulation, by intensifying its risk assessment process and completing its macroprudential policy toolkit to better identify and mitigate the build-up of systemic risk. The FSA should continue to engage with regional banks to facilitate the adaptation of their business models to demographic change, including by encouraging regional banks to ensure their soundness through revenue diversification, better utilization of IT/Fintech, and consolidation.

54. A broadly neutral fiscal stance is appropriate for the near term, together with continued monetary accommodation. The December 2019 stimulus package is projected to make the 2020 fiscal stance broadly neutral, while under current policies the 2021 fiscal stance is projected to be contractionary. Given downside risks and the need to avoid a pro-cyclical fiscal tightening that might undermine growth momentum, a neutral fiscal stance might also be called for in 2021, unless economic data outturns are stronger than expected. Additional fiscal measures in the near term could include: extending the duration of consumption tax countermeasures; further increasing wages of workers in the childcare, health and long-term care sectors; reinforcing income policies; and supporting structural reforms.

55. A well-specified medium-term fiscal framework is needed to reduce debt, lower uncertainty, and support reflation and growth. While the government has set a primary balance target for FY2025, credibility would benefit from greater realism in the assumptions for productivity, growth, and public spending, as well as more specificity with respect to measures to achieve the target. A clear fiscal framework would help diminish policy uncertainty, likely bolster corporate investment, and reduce households’ precautionary saving. Steps to that end could include: adopting realistic growth and fiscal projections; factoring in aging costs in macro-fiscal projections; strengthening redistribution effects by raising the rate of taxation on capital gains or re-introducing a wealth tax; and raising the carbon tax. Reform of public social security programs is the essential second component of fiscal consolidation. Reforms should focus on improving pension sustainability and intergenerational equity, while healthcare reforms should include measures to increase the share of out-of-pocket spending for those over 75 years old and the wealthy elderly.

56. Implementation of an ambitious agenda of labor, product market, and corporate reforms is essential to help offset the effects of demographic headwinds. Bold implementation of such reforms would boost productivity and support reflation, and could offset as much as 60 percent of the demographic-driven slowdown in real GDP growth. Labor market reforms should be prioritized as they would have the largest growth and inflation impact. The authorities should improve on the 2018 Work Style Reform, emphasizing additional training and career opportunities for non-regular workers. Labor supply should be enhanced, including from women, older workers, and foreign workers. Reforms to corporates and the product market are the second-highest priority, where deregulation of product and service sectors, corporate governance reforms, and SME reform with support for alternative sources of financing and business succession would help lift productivity and investment.

57. The 2019 external position is preliminarily assessed to be broadly consistent with fundamentals and desirable policies, while outward spillovers from Japan can be sizeable. A well-specified medium-term fiscal framework and bolder structural reforms that support growth and domestic demand are needed to maintain external balance. As with the 2019 External Sector Report, the estimated 2019 current account balance is preliminarily assessed as broadly consistent with medium-term fundamentals and desirable policies. Based on this current account assessment, the 2019 real exchange rate is also preliminarily assessed as in line with the real exchange rate level consistent with fundamentals and desirable policies. Slower growth or a tightening of financial conditions in Japan could generate significant outward spillovers in the form of slower growth in other Asian countries and a deterioration of global financial conditions.

58. Efforts to improve enforcement against foreign bribery should continue. Efforts to combat the supply side of transnational corruption are welcome, including through Japan’s amendment of its law to allow the confiscation of the proceeds of foreign bribery and criminalization of the laundering of such proceeds. This closed a long-standing loophole in Japan’s implementation of the OECD Anti-Bribery Convention. The 2019 report of the OECD Working Group on Bribery in International Business Transactions noted that Japan had made a number of improvements since its last evaluation. Notwithstanding the recognition of Japan’s recent improvements, concerns remain regarding the low level of enforcement of cases of foreign bribery of Japanese and foreign public officials, and greater efforts in raising the number of such investigations and convictions is urged.

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

Box 1.

Foreign Workers in Japan¹

Japan’s share of foreign workers is low but has grown under Abenomics. Foreign workers have been increasing since the inception of Abenomics in late-2012, with the share of foreign employment rising from 1.1 percent in 2012 to 2.0 percent in 2017. Vietnam, China and the Philippines accounted for most of the foreign labor inflows into Japan over 2012–17, with manufacturing, hotels/restaurants, and wholesale/retail as the top-employing sectors.

Japan has recently started opening up to larger foreign labor inflows. In April 2017, the government updated the Japanese Green Card for Highly Skilled Foreign Professionals by reducing the period of stay required before applying for permanent residence from five years to one. In November 2017, the government extended the residency of technical interns from three to five years.

In April 2019, Japan officially opened its doors to foreign workers with a wider set of skills.

Under the amended Immigration Control and Refugee Recognition Act, passed by the Diet in December 2018, foreigners qualifying for the new Specified Skills Visa Status are able to enter Japan to work in designated sectors (including agriculture, nursing care, construction, specific manufacturing industries, and food and hospitality services) for a maximum period of five years (Category 1 visa status). The period of stay under a Category 1 visa is limited to five years, and workers are not able to bring family members.
The new system also offers a possible path to long-term immigration via the Category 2 residence status, intended for workers with more advanced skills. The notion behind the reform is that Category 1 workers could upgrade their status to Category 2 if they qualify by passing an examination and meeting other conditions.

Preliminary indications suggest that the 2019 reforms have had limited success. At the time of inception, there was an expectation that around 340,000 workers would be granted Category 1 visas between 2019 and 2024, in addition to the inflow of technical trainees—Japan accepted around 480,000 trainees between 2013 and 2017. However, with a slow pace in the admissions process, take-up of Category 1 visas has been limited. As of end-November 2019, around 3,500 applicants had passed required exams to apply, with 1,770 visas granted but only 1,000 foreign workers in Japan (with processed new visas).

¹ Prepared by Mariana Colacelli and Todd Schneider (both APD).

Box 2.

Nagi-town: A Case Study of Child-Friendly Policies¹

Nagi-town is a small town located in Okayama Prefecture in western Japan, with a population of about 6,000. Nagi-town’s strong child-friendly policies have made it stand out as a success story in achieving a higher fertility rate. After Nagi-town residents turned down a merger with an adjacent municipality in a referendum held in 2002, the town office stepped up its efforts to raise fertility, driven by concerns that Nagi-town’s economic viability would be in danger with further population declines.

Beginning in 2012, the town office became officially committed to providing full-fledged support to families with children. Measures and policies that have made Nagi-town child friendly include:

Financial benefits. Benefits include one-time payouts for child birth on a rising scale from ¥100,000 (about US$900) for the first child up to ¥400,000 (about US$3,600) for the fifth child, with free healthcare for children until their graduation from high school.
Cooperative community. Financial benefits are not all that matters to families with children. Hospitality and mutual support offered by the local community are equally valued by them. At “Child Home,” a community center run by mothers themselves with the help of experienced advisors, new parents get to know other parents through various social events. When parents need temporary help, elderly volunteers readily provide care for their children.
Housing. Availability of spacious houses with affordable rents is another attraction for families with children. The town office took the lead in developing three new residential districts in the town, which has 21 houses that are currently rented to families with children.
Employment opportunities. While Nagi-town does not have easy access to big cities or major manufacturing hubs, the town office strives to create and find decent jobs for the young working generation. It developed a small industrial park which accommodates 18 firms, most of which are small to medium-sized manufacturers. It strengthened its job-matching capability by creating a one-stop facility for part-time job seekers and firms with small employment needs. As more women desire to continue to work after childbirth, the only childcare facility in town has approached its capacity, and the town office decided to build a new facility with a larger childcare capacity.

The above measures contributed to a doubling of Nagi-town’s total fertility rate (the number of children per woman) from 1.4 in 2005 to 2.8 in 2014.² This compares with the evolution of Japan’s total fertility rate, which has risen only modestly over that same period. “Each measure is not unique [to Nagi] and is replicable by other municipalities. But it is our comprehensive approach that has led parents to feel that they can have a third or fourth baby here”, noted a senior Nagi-town official who himself has three children. This case study of Nagi-town provides useful lessons for other Japanese towns and prefectures, indicating that multi-faceted child-friendly policy support can have a meaningful impact on the fertility rate.

¹ Prepared by Takuma Hisanaga (APD).² The total fertility rate in a specific year is defined as the total number of children that would be born to each woman if she were to live to the end of her child-bearing years and give birth to children in alignment with the prevailing age-specific fertility rates. This indicator is measured in children per woman.

Box 3.

Government Initiatives to Promote Gender Equality in Japan¹

The government has several measures in place to support women in the workplace. Recent regulation (including the 2015 Act on Promotion of Women’s Participation and Advancement in the Workplace) forms the basis for encouraging the advancement of women by supporting work-life balance. The Act encourages employers in the private and public sectors to formulate and publish action plans to address challenges faced by women in the workplace and to promote work-life balance. Firms with more than 300 employees (100 employees since 2019) are required to publish action plans and information on at least one of: (i) the record on providing job opportunities for women (e.g. percentage of women among new hires or in managerial positions); and (ii) the record on supporting work-life balance and a suitable work environment (e.g. data on overtime hours, and percentage of employees taking parental leave by gender).

Through the public procurement process, the government has provided incentives to firms to uphold measures that support women in the workplace. In 2016 the government introduced Eruboshi certification (or “L-Stars” and “Platinum L-Stars”) to officially certify employers with outstanding performance on women’s participation and advancement in the workplace. Specific criteria used to obtain Eruboshi certification include: (i) formulation of an action plan; (ii) documentation and dissemination of the action plan within the firm; (iii) documentation on achievements pertaining to women’s participation and advancement; and (iv) announcement of the action plan to the general public. In making decisions on public procurement contracts, in addition to considering the price, central and local governments take into account if firms have Eruboshi certification. Extra points are given to Eruboshi-certified firms that bid for a government contract, with the specific allocation of points decided by the ministries that conduct the procurement.

There has been significant progress in responding to the government measures supporting gender equality in the workplace.

Regarding action plans to promote gender equality: As of June 2019, all central government agencies and local governments have submitted their action plans. In the private sector, 15,983 firms (96.7 percent of employers with more than 300 workers) have submitted action plans, while 10,645 have published data on key metrics stipulated in the law.
Regarding public procurement incentives: Since the April 2016 certification came into effect, the government signed 13,600 contracts with Eruboshi-certified companies for purchases worth a total of ¥1.34 trillion (0.24 percent of GDP) in FY2017. As of June 2019, 870 companies nationwide have been awarded Eruboshi certificates in recognition of their excellence in advancing women in the workplace.

¹ Prepared by Albe Gjonbalaj and Mariana Colacelli (both APD).

Box 4.

What Explains the Decline in Japanese Consumer Confidence?¹

Japan’s consumer sentiment has deteriorated significantly since mid-2018 for all age-groups, with the largest decline observed for young Japanese. According to the monthly consumer confidence index, Japanese consumer sentiment softened for the twelfth consecutive month in October 2019, hitting a record-low level since the survey began in April 2013. While the index recovered mildly in November, it has not returned to the level seen earlier this year. By age-group, the decline was broad-based, while sentiment weakened the most for the youngest cohort (age below 29 years).

The decline in consumer confidence is largely due to idiosyncratic factors. The consumption tax rate increase of October 2019 weakened Japanese consumers’ perceptions of the strength of the economy and household purchasing power. Compared to the decline in confidence at the time of the consumption tax rate increase of 2014, the decline was larger this year, despite the smaller increase in the tax rate. Heightened global uncertainty due to the ongoing trade tensions is also likely to have dampened consumer confidence, beginning in 2018.

In addition, structural factors related to adverse demographics may have played a role. Concerns about the sustainability of the social security system—in the face of adverse demographic trends and perceptions of longer life expectancy—may have constrained consumption activities and dampened sentiment. One piece of evidence for such concerns is the increase in saving rates in recent years, a trend that precedes recent global trade tensions. Saving rates increased for all age groups and are higher for younger cohorts than older cohorts (see text figure). However, the rate of increase in saving rates is noticeably larger for retirees (those above age 65 years), which is difficult to reconcile with a standard Modigliani life-cycle hypothesis. One possible explanation is the accompanying increase in life-expectancy overtime. Uncertainty about the health of any given individual’s personal finance, in the context of a longer-than- expected life expectancy, could dampen consumer confidence and incentivize consumers, including retirees, to continue to save more even after their retirement.

¹ Prepared by Gee Hee Hong (APD).

Table 4.

Japan: Selected Economic Indicators, 2017–21

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

Table 4.

Japan: Selected Economic Indicators, 2017–21

Nominal GDP: US$ 4,954 Billion (2018)						GDP per capita: US$ 39,166 (2018)
Population: 126 Million (2018)						Quota: SDR 30.8 billion (2018)
					2017	2018	2019	2020	2021
							Est.	Proj.
					(In percent change)
Growth
	Real GDP				2.2	0.3	1.0	0.7	0.5
	Domestic demand				1.6	0.3	1.1	1.0	0.6
		Private consumption			1.3	0.0	0.5	-0.1	0.6
		Business investment			4.0	2.1	1.7	1.0	3.0
		Residential investment			1.7	-6.7	2.4	-1.7	0.1
		Government consumption			0.2	0.9	2.1	2.8	0.4
		Public investment			0.5	0.3	2.7	5.5	-6.1
		Stockbuilding			0.1	0.0	0.1	-0.1	0.0
	Net exports				0.5	0.0	-0.2	-0.2	-0.2
		Exports of goods and services			6.8	3.4	-1.8	-0.4	2.0
		Imports of goods and services			3.4	3.4	-0.6	0.6	2.8
Output Gap					-0.3	-0.7	-0.3	-0.2	-0.3
					(In annual average)
Inflation
	Headline CPI				0.5	1.0	0.6	1.1	1.2
	GDP deflator				-0.2	-0.1	0.6	1.0	0.5
					(In percent of GDP)
Government
	General government
		Revenue			34.2	33.8	34.0	34.6	34.6
		Expenditure			37.3	37.4	37.6	38.0	37.4
		Overall Balance			-3.1	-3.6	-3.6	-3.5	-2.8
		Primary balance			-2.7	-3.3	-3.4	-3.5	-2.9
		Structural primary balance			-2.9	-3.1	-3.3	-3.4	-2.8
		Public debt, gross			234.6	237.9	239.0	239.8	241.1
					(In percent change, end-period)
Macro-financial
	Base money				9.7	5.0	6.6	6.1	5.2
	Broad money				3.5	2.4	2.8	2.0	2.2
	Credit to the private sector				4.0	1.5	2.9	2.5	2.5
	Non-financial corporate debt in percent of GDP				138.5	141.2	142.5	143.4	144.8
					(In percent)
Interest rate
	Overnight call rate, uncollateralized (end-period)				-0.1	-0.1	…	…	…
	Three-month CD rate (annual average)				0.0	0.0	…	…	…
	Official discount rate (end-period)				0.3	0.3	0.3	0.3	0.3
	10-year JGB yield (e.o.p.)				0.1	0.1	-0.1	0.0	0.1
					(In billions of USD)
Balance of payments
	Current account balance				202.0	175.3	170.4	180.6	184.8
				Percent of GDP	4.1	3.5	3.3	3.4	3.4
		Trade balance			44.1	11.6	2.5	-4.3	-10.1
				Percent of GDP	0.9	0.2	0.0	-0.1	-0.2
			Exports of goods, f.o.b.		688.9	735.9	701.3	681.5	693.5
			Imports of goods, f.o.b.		644.9	724.3	698.7	685.9	703.6
			Energy imports		117.8	148.5	130.7	124.1	117.3
					(In percent of GDP)
FDI, net					3.2	2.7	2.8	2.9	2.9
Portfolio Investment					-1.0	1.8	1.4	1.2	1.1
					(In billions of USD)
Change in reserves					23.6	24.0	11.0	11.5	11.5
Total reserves minus gold (in billions of US$)					1232.4	1239.4	…	…	…
					(In annual average)
Exchange rates
	Yen/dollar rate				112.2	110.4	…	…	…
	Yen/euro rate				126.7	130.5	…	…	…
	Real effective exchange rate (ULC-based, 2010=100)				78.7	77.6	…	…	…
	Real effective exchange rate (CPI-based, 2010=100)				75.0	74.4	…	…	…
					(In percent)
Demographic Indicators
	Population Growth				-0.2	-0.2	-0.2	-0.3	-0.4
	Old-age dependency				46.0	46.9	47.6	48.4	49.0

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

Table 4.

Japan: Selected Economic Indicators, 2017–21

Nominal GDP: US$ 4,954 Billion (2018)						GDP per capita: US$ 39,166 (2018)
Population: 126 Million (2018)						Quota: SDR 30.8 billion (2018)
					2017	2018	2019	2020	2021
							Est.	Proj.
					(In percent change)
Growth
	Real GDP				2.2	0.3	1.0	0.7	0.5
	Domestic demand				1.6	0.3	1.1	1.0	0.6
		Private consumption			1.3	0.0	0.5	-0.1	0.6
		Business investment			4.0	2.1	1.7	1.0	3.0
		Residential investment			1.7	-6.7	2.4	-1.7	0.1
		Government consumption			0.2	0.9	2.1	2.8	0.4
		Public investment			0.5	0.3	2.7	5.5	-6.1
		Stockbuilding			0.1	0.0	0.1	-0.1	0.0
	Net exports				0.5	0.0	-0.2	-0.2	-0.2
		Exports of goods and services			6.8	3.4	-1.8	-0.4	2.0
		Imports of goods and services			3.4	3.4	-0.6	0.6	2.8
Output Gap					-0.3	-0.7	-0.3	-0.2	-0.3
					(In annual average)
Inflation
	Headline CPI				0.5	1.0	0.6	1.1	1.2
	GDP deflator				-0.2	-0.1	0.6	1.0	0.5
					(In percent of GDP)
Government
	General government
		Revenue			34.2	33.8	34.0	34.6	34.6
		Expenditure			37.3	37.4	37.6	38.0	37.4
		Overall Balance			-3.1	-3.6	-3.6	-3.5	-2.8
		Primary balance			-2.7	-3.3	-3.4	-3.5	-2.9
		Structural primary balance			-2.9	-3.1	-3.3	-3.4	-2.8
		Public debt, gross			234.6	237.9	239.0	239.8	241.1
					(In percent change, end-period)
Macro-financial
	Base money				9.7	5.0	6.6	6.1	5.2
	Broad money				3.5	2.4	2.8	2.0	2.2
	Credit to the private sector				4.0	1.5	2.9	2.5	2.5
	Non-financial corporate debt in percent of GDP				138.5	141.2	142.5	143.4	144.8
					(In percent)
Interest rate
	Overnight call rate, uncollateralized (end-period)				-0.1	-0.1	…	…	…
	Three-month CD rate (annual average)				0.0	0.0	…	…	…
	Official discount rate (end-period)				0.3	0.3	0.3	0.3	0.3
	10-year JGB yield (e.o.p.)				0.1	0.1	-0.1	0.0	0.1
					(In billions of USD)
Balance of payments
	Current account balance				202.0	175.3	170.4	180.6	184.8
				Percent of GDP	4.1	3.5	3.3	3.4	3.4
		Trade balance			44.1	11.6	2.5	-4.3	-10.1
				Percent of GDP	0.9	0.2	0.0	-0.1	-0.2
			Exports of goods, f.o.b.		688.9	735.9	701.3	681.5	693.5
			Imports of goods, f.o.b.		644.9	724.3	698.7	685.9	703.6
			Energy imports		117.8	148.5	130.7	124.1	117.3
					(In percent of GDP)
FDI, net					3.2	2.7	2.8	2.9	2.9
Portfolio Investment					-1.0	1.8	1.4	1.2	1.1
					(In billions of USD)
Change in reserves					23.6	24.0	11.0	11.5	11.5
Total reserves minus gold (in billions of US$)					1232.4	1239.4	…	…	…
					(In annual average)
Exchange rates
	Yen/dollar rate				112.2	110.4	…	…	…
	Yen/euro rate				126.7	130.5	…	…	…
	Real effective exchange rate (ULC-based, 2010=100)				78.7	77.6	…	…	…
	Real effective exchange rate (CPI-based, 2010=100)				75.0	74.4	…	…	…
					(In percent)
Demographic Indicators
	Population Growth				-0.2	-0.2	-0.2	-0.3	-0.4
	Old-age dependency				46.0	46.9	47.6	48.4	49.0

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

Table 5.

Japan: Monetary Authority Accounts and Monetary Survey, 2014–21

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 institutions to customer deposits.

Table 5.

Japan: Monetary Authority Accounts and Monetary Survey, 2014–21

			2014	2015	2016	2017	2018	2019	2020	2021
								Est.	Proj.
			(In trillions of JPY)
Monetary authority
Net foreign assets			3.9	2.3	-3.9	-12.4	-17.7	-18.7	-14.9	-14.5
NDA			272.0	353.9	441.3	492.4	521.9	556.1	585.3	614.5
	Net domestic credit		291.3	374.6	467.0	521.3	548.1	582.3	611.5	640.7
		Net credit to non-financial public sector	222.3	287.3	361.4	390.8	412.7	437.7	457.7	477.7
		Credit to the private sector	6.7	6.8	6.6	6.6	6.0	6.2	6.4	6.6
		Net credit to financial corporations	62.3	80.5	99.0	123.8	129.4	138.4	147.4	156.4
	Other items net		-19.3	-20.8	-25.7	-28.8	-26.3	-26.3	-26.3	-26.3
Monetary base			275.9	356.1	437.4	480.0	504.2	537.4	570.3	599.9
Monetary survey (depository corporations)
NFA			82.4	73.4	72.2	75.4	73.1	71.2	73.8	76.3
NDA			1,149.1	1,196.8	1,251.4	1,293.0	1,328.0	1,351.0	1,377.1	1,406.7
	Net domestic credit		1,244.5	1,286.2	1,343.4	1,401.9	1,416.5	1,444.5	1,475.6	1,510.1
		Net credit to nonfinancial public sector	570.6	590.7	636.7	646.1	652.1	662.7	678.6	697.2
		Credit to the private sector	538.8	548.9	564.6	587.1	596.0	613.4	628.6	644.5
		Net credit to other financial institutions	135.0	146.5	142.1	168.7	168.3	168.3	168.3	168.3
Other items net			-95.4	-89.4	-92.0	-108.9	-88.4	-93.4	-98.4	-103.4
Broad money			1,219.8	1,256.6	1,305.7	1,351.1	1,383.8	1,422.2	1,451.0	1,483.0
	Currency in circulation		88.2	93.6	97.3	101.9	105.5	109.0	112.6	116.3
	Current deposits		529.7	553.2	614.3	662.2	702.6	731.5	750.6	773.0
	Other deposits		601.9	609.9	594.1	587.0	575.7	581.7	587.7	593.7
			(In percent of GDP)
Net credit to other financial institutions			26.3	27.6	26.5	30.9	30.8	30.3	29.8	29.5
Credit to the private sector from depository corporations			104.8	103.3	105.4	107.6	108.9	110.3	111.2	112.9
Corporate debt (includes loans and securities other than shares)			142.1	137.5	137.1	138.5	141.2	142.5	143.4	144.8
Corporate debt (includes loans and securities other than shares), trillions of JPY			730.1	730.4	734.3	755.9	772.4	792.7	810.9	826.8
Household debt in percent of disposable income			100.6	100.2	100.8	102.8	99.3	99.1	99.0	98.3
			(Y-o-Y growth in percent)
Base money			36.7	29.1	22.8	9.7	5.0	6.6	6.1	5.2
Broad money			2.9	3.0	3.9	3.5	2.4	2.8	2.0	2.2
Credit to the private sector from depository corporations			1.6	1.9	2.9	4.0	1.5	2.9	2.5	2.5
Corporate loans by domestically licenced banks			3.1	2.6	2.9	2.6	2.9	2.8	2.2	3.1
Housing loans			1.8	1.8	2.6	2.5	1.9	2.3	1.9	1.9
Credit to the private sector from all financial institutions			-6.2	2.9	1.8	5.0	0.6	2.1	1.8	1.9
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)		4.4	3.5	3.0	2.8	2.7	2.6	2.5	2.5
	Loan-to-deposit ratio (percent) ^1/		55.7	54.8	54.7	54.6	54.3	53.9	53.6	59.5

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 institutions to customer deposits.

Table 5.

Japan: Monetary Authority Accounts and Monetary Survey, 2014–21

			2014	2015	2016	2017	2018	2019	2020	2021
								Est.	Proj.
			(In trillions of JPY)
Monetary authority
Net foreign assets			3.9	2.3	-3.9	-12.4	-17.7	-18.7	-14.9	-14.5
NDA			272.0	353.9	441.3	492.4	521.9	556.1	585.3	614.5
	Net domestic credit		291.3	374.6	467.0	521.3	548.1	582.3	611.5	640.7
		Net credit to non-financial public sector	222.3	287.3	361.4	390.8	412.7	437.7	457.7	477.7
		Credit to the private sector	6.7	6.8	6.6	6.6	6.0	6.2	6.4	6.6
		Net credit to financial corporations	62.3	80.5	99.0	123.8	129.4	138.4	147.4	156.4
	Other items net		-19.3	-20.8	-25.7	-28.8	-26.3	-26.3	-26.3	-26.3
Monetary base			275.9	356.1	437.4	480.0	504.2	537.4	570.3	599.9
Monetary survey (depository corporations)
NFA			82.4	73.4	72.2	75.4	73.1	71.2	73.8	76.3
NDA			1,149.1	1,196.8	1,251.4	1,293.0	1,328.0	1,351.0	1,377.1	1,406.7
	Net domestic credit		1,244.5	1,286.2	1,343.4	1,401.9	1,416.5	1,444.5	1,475.6	1,510.1
		Net credit to nonfinancial public sector	570.6	590.7	636.7	646.1	652.1	662.7	678.6	697.2
		Credit to the private sector	538.8	548.9	564.6	587.1	596.0	613.4	628.6	644.5
		Net credit to other financial institutions	135.0	146.5	142.1	168.7	168.3	168.3	168.3	168.3
Other items net			-95.4	-89.4	-92.0	-108.9	-88.4	-93.4	-98.4	-103.4
Broad money			1,219.8	1,256.6	1,305.7	1,351.1	1,383.8	1,422.2	1,451.0	1,483.0
	Currency in circulation		88.2	93.6	97.3	101.9	105.5	109.0	112.6	116.3
	Current deposits		529.7	553.2	614.3	662.2	702.6	731.5	750.6	773.0
	Other deposits		601.9	609.9	594.1	587.0	575.7	581.7	587.7	593.7
			(In percent of GDP)
Net credit to other financial institutions			26.3	27.6	26.5	30.9	30.8	30.3	29.8	29.5
Credit to the private sector from depository corporations			104.8	103.3	105.4	107.6	108.9	110.3	111.2	112.9
Corporate debt (includes loans and securities other than shares)			142.1	137.5	137.1	138.5	141.2	142.5	143.4	144.8
Corporate debt (includes loans and securities other than shares), trillions of JPY			730.1	730.4	734.3	755.9	772.4	792.7	810.9	826.8
Household debt in percent of disposable income			100.6	100.2	100.8	102.8	99.3	99.1	99.0	98.3
			(Y-o-Y growth in percent)
Base money			36.7	29.1	22.8	9.7	5.0	6.6	6.1	5.2
Broad money			2.9	3.0	3.9	3.5	2.4	2.8	2.0	2.2
Credit to the private sector from depository corporations			1.6	1.9	2.9	4.0	1.5	2.9	2.5	2.5
Corporate loans by domestically licenced banks			3.1	2.6	2.9	2.6	2.9	2.8	2.2	3.1
Housing loans			1.8	1.8	2.6	2.5	1.9	2.3	1.9	1.9
Credit to the private sector from all financial institutions			-6.2	2.9	1.8	5.0	0.6	2.1	1.8	1.9
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)		4.4	3.5	3.0	2.8	2.7	2.6	2.5	2.5
	Loan-to-deposit ratio (percent) ^1/		55.7	54.8	54.7	54.6	54.3	53.9	53.6	59.5

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 institutions to customer deposits.

Table 6.

Japan: External Sector Summary, 2014–21

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

Table 6.

Japan: External Sector Summary, 2014–21

				2014	2015	2016	2017	2018	2019	2020	2021
									Est.	Proj.
Balance of payments				(In billions of USD)
Current account balance				36.8	136.4	197.9	202.0	175.3	170.4	180.6	184.8
	Trade balance (goods)			-99.9	-7.4	51.4	44.1	11.6	2.5	-4.3	-10.1
		Exports of goods		699.7	622.1	636.3	688.9	735.9	701.3	681.5	693.5
		Imports of goods		799.7	629.5	585.0	644.9	724.3	698.7	685.9	703.6
			Imports of goods, Oil	167.6	88.1	64.9	82.9	105.6	92.9	88.2	83.4
	Services balance			-28.8	-16.0	-10.6	-6.2	-7.2	-7.2	-1.5	-2.0
		Credits		163.2	162.6	167.5	172.8	178.4	184.3	197.2	204.3
		Debits		192.4	175.6	180.9	187.0	191.7	197.8	205.8	213.6
	Income balance			184.6	176.2	176.9	183.0	189.3	194.6	206.9	218.3
		Credits		256.9	248.5	266.0	279.0	297.6	292.9	316.7	336.2
		Debits		72.4	72.3	89.1	95.9	108.3	98.2	109.7	117.7
	Current net transfers			-19.0	-16.3	-19.8	-19.0	-18.4	-19.4	-20.4	-21.4
Capital account				-2.0	-2.2	-6.5	-2.5	-1.9	-3.0	-3.5	-4.0
Financial account				24.9	163.2	282.9	136.4	181.8	154.0	163.7	167.4
	Direct investment, net			118.6	133.3	137.5	153.4	132.9	143.8	152.4	156.1
	Portfolio investment, net			-42.2	131.5	276.5	-50.6	91.5	72.4	63.4	59.7
	Other investment, net			-60.1	-106.7	-125.4	10.0	-66.6	-73.1	-63.6	-59.9
Reserve assets				8.5	5.1	-5.7	23.6	24.0	11.0	11.5	11.5
Errors and omissions, net				24.1	46.7	75.4	-32.7	9.4	0.0	0.0	0.0
				(In percent of GDP)
Current account balance				0.8	3.1	4.0	4.1	3.5	3.3	3.4	3.4
	Trade balance (goods)			-2.1	-0.2	1.0	0.9	0.2	0.0	-0.1	-0.2
		Exports of goods		14.4	14.2	12.9	14.2	14.9	13.7	12.9	12.7
		Imports of goods		16.5	14.3	11.9	13.2	14.6	13.7	13.0	12.9
	Services balance			-0.6	-0.4	-0.2	-0.1	-0.1	-0.1	0.0	0.0
	Income balance			3.8	4.0	3.6	3.8	3.8	3.8	3.9	4.0
Global assumptions
Oil prices (US$/barrel)				96.2	50.8	42.8	52.8	68.3	60.6	58.0	55.3
	(Percent change)			-7.5	-47.2	-15.7	23.3	29.4	-11.3	-4.3	-4.7
Memorandum items :
Nominal GDP (US$ billion)				4,852.6	4,390.0	4,925.0	4,867.3	4,954.2	5,103.9	5,269.8	5,446.7
Net foreign assets (NFA)/GDP, US$ basis				60.6	61.1	58.9	59.9	61.2	62.7	64.1	65.3
Return on NFA (in percent), US$ basis				6.3	6.6	6.1	6.3	6.3	6.1	6.1	6.1
Net export contribution to growth				0.0	0.3	0.6	0.5	0.0	-0.2	-0.2	-0.2

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

Table 6.

Japan: External Sector Summary, 2014–21

				2014	2015	2016	2017	2018	2019	2020	2021
									Est.	Proj.
Balance of payments				(In billions of USD)
Current account balance				36.8	136.4	197.9	202.0	175.3	170.4	180.6	184.8
	Trade balance (goods)			-99.9	-7.4	51.4	44.1	11.6	2.5	-4.3	-10.1
		Exports of goods		699.7	622.1	636.3	688.9	735.9	701.3	681.5	693.5
		Imports of goods		799.7	629.5	585.0	644.9	724.3	698.7	685.9	703.6
			Imports of goods, Oil	167.6	88.1	64.9	82.9	105.6	92.9	88.2	83.4
	Services balance			-28.8	-16.0	-10.6	-6.2	-7.2	-7.2	-1.5	-2.0
		Credits		163.2	162.6	167.5	172.8	178.4	184.3	197.2	204.3
		Debits		192.4	175.6	180.9	187.0	191.7	197.8	205.8	213.6
	Income balance			184.6	176.2	176.9	183.0	189.3	194.6	206.9	218.3
		Credits		256.9	248.5	266.0	279.0	297.6	292.9	316.7	336.2
		Debits		72.4	72.3	89.1	95.9	108.3	98.2	109.7	117.7
	Current net transfers			-19.0	-16.3	-19.8	-19.0	-18.4	-19.4	-20.4	-21.4
Capital account				-2.0	-2.2	-6.5	-2.5	-1.9	-3.0	-3.5	-4.0
Financial account				24.9	163.2	282.9	136.4	181.8	154.0	163.7	167.4
	Direct investment, net			118.6	133.3	137.5	153.4	132.9	143.8	152.4	156.1
	Portfolio investment, net			-42.2	131.5	276.5	-50.6	91.5	72.4	63.4	59.7
	Other investment, net			-60.1	-106.7	-125.4	10.0	-66.6	-73.1	-63.6	-59.9
Reserve assets				8.5	5.1	-5.7	23.6	24.0	11.0	11.5	11.5
Errors and omissions, net				24.1	46.7	75.4	-32.7	9.4	0.0	0.0	0.0
				(In percent of GDP)
Current account balance				0.8	3.1	4.0	4.1	3.5	3.3	3.4	3.4
	Trade balance (goods)			-2.1	-0.2	1.0	0.9	0.2	0.0	-0.1	-0.2
		Exports of goods		14.4	14.2	12.9	14.2	14.9	13.7	12.9	12.7
		Imports of goods		16.5	14.3	11.9	13.2	14.6	13.7	13.0	12.9
	Services balance			-0.6	-0.4	-0.2	-0.1	-0.1	-0.1	0.0	0.0
	Income balance			3.8	4.0	3.6	3.8	3.8	3.8	3.9	4.0
Global assumptions
Oil prices (US$/barrel)				96.2	50.8	42.8	52.8	68.3	60.6	58.0	55.3
	(Percent change)			-7.5	-47.2	-15.7	23.3	29.4	-11.3	-4.3	-4.7
Memorandum items :
Nominal GDP (US$ billion)				4,852.6	4,390.0	4,925.0	4,867.3	4,954.2	5,103.9	5,269.8	5,446.7
Net foreign assets (NFA)/GDP, US$ basis				60.6	61.1	58.9	59.9	61.2	62.7	64.1	65.3
Return on NFA (in percent), US$ basis				6.3	6.6	6.1	6.3	6.3	6.1	6.1	6.1
Net export contribution to growth				0.0	0.3	0.6	0.5	0.0	-0.2	-0.2	-0.2

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

Table 7.

Japan: General Government Operations, 2014–21

(In Percent of GDP)

Sources: Japan Cabinet Office; IMF staff estimates and projections.

^{^1/}Including fines.

^{^2/}Fiscal year basis.

^{^3/}In percent of potential GDP.

^{^4/}Market value basis.

^{^5/}Nonconsolidated basis.

Three pillars
	(i) Recovery and reconstruction from disasters, and ensuring safety and security (ii) Focused assistance to those who are overcoming the economic downside risks (iii) Investing for the future and maintenance and improvement of economic vitality after the Tokyo Olympics and Paralympics
Total size: ¥26 trillion (4.6 percent of GDP) ^1/
	Expenditure of central and local governments: ¥9.4 trillion (1.7 percent of GDP) Financing by the FY2019 supplementary budget (general account): ¥4.3 trillion (0.8 percent of GDP)

Three pillars
	(i) Recovery and reconstruction from disasters, and ensuring safety and security (ii) Focused assistance to those who are overcoming the economic downside risks (iii) Investing for the future and maintenance and improvement of economic vitality after the Tokyo Olympics and Paralympics
Total size: ¥26 trillion (4.6 percent of GDP) ^1/
	Expenditure of central and local governments: ¥9.4 trillion (1.7 percent of GDP) Financing by the FY2019 supplementary budget (general account): ¥4.3 trillion (0.8 percent of GDP)

Options
	Increase consumption tax rate from 10 to 15 percent		2.5
	Health and long-term care reform (potential gains by 2030)		Up to 2
		Curb growth rate of health and long-term spending
		Increase healthcare and long-term care copayments
	Other options		Up to 1.5
		Re-introduce wealth tax/ Raise capital gains tax	Up to 0.3
		Increase carbon tax	0.2
		Containing non-social security expenditures	Up to 1
Total potential savings			Up to 6.0

Options
	Increase consumption tax rate from 10 to 15 percent		2.5
	Health and long-term care reform (potential gains by 2030)		Up to 2
		Curb growth rate of health and long-term spending
		Increase healthcare and long-term care copayments
	Other options		Up to 1.5
		Re-introduce wealth tax/ Raise capital gains tax	Up to 0.3
		Increase carbon tax	0.2
		Containing non-social security expenditures	Up to 1
Total potential savings			Up to 6.0

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Abstract

Recent Developments

Authorities’ Views

Resilient Growth Outlook AMID Significant Risks

Authorities’ Views

Economic Policies for an Aging and Shrinking Population

A. Monetary and Financial Policies—Coordination and Sustainability

Authorities’ Views

B. Fiscal Policy—Flexibility and Coordination

Near-Term Fiscal Support

Medium- and Long-Term Fiscal Strategy

Strengthening Policy Coordination

Authorities’ Views

C. Structural Reforms—Reflation and Growth

Authorities’ Views

D. External Position and Spillovers to and from Japan

Authorities’ Views

E. Supply-Side of Transnational Corruption 37

Authorities’ Views

Staff Appraisal

E. Supply-Side of Transnational Corruption ³⁷