Staff Concluding Statement of the 2023 Article IV Mission

Japan: Staff Concluding Statement of the 2023 Article IV Mission

January 26, 2023

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.

Washington, DC:

The economic recovery in Japan is being supported by pent-up demand,
supply chain improvements, border reopening, and policy support.
Inflation has accelerated in recent months. The policy challenge in the
near term is to ensure that the 2 percent inflation target is reached
durably, without overshooting significantly, while preserving financial
stability. In the medium term, the priority is to reduce fiscal
vulnerabilities and transition to a more dynamic, resilient, and
inclusive economy.

Recent Economic Developments, Outlook, And Risks

Japan is navigating the recovery from the pandemic and the implications of
the war in Ukraine. The government has been gradually relaxing
COVID-19-related restrictions and the borders were reopened with very
limited restrictions in October. Inflation has accelerated in recent
months, with more wide-spread price increases mainly due to pass-through
from the rise in import prices, and Japan core inflation (i.e., excluding
fresh food) recording levels not seen in four decades.

The economic recovery is projected to continue in the near term supported
by pent-up demand, supply chain improvements, border reopening, and policy
support. The output gap is projected to close in 2023. The consumption of
services will be underpinned by savings accumulated during the pandemic.
Exports will rise as order backlogs are cleared and supply side constraints
eased. High corporate profits from a depreciated yen and delays in
implementing earlier projects will support business investment. The primary
fiscal deficit will stay elevated in 2023 following the adoption of the
October 2022 fiscal package. Core inflation is projected to peak in the
first quarter of 2023 and gradually decline to below 2 percent by end-2024
as cost increases from higher import prices wane. The current account
surplus is estimated at 1.8 percent of GDP in 2022, and the external
position is preliminarily assessed as broadly in line with medium-term
fundamentals and desirable policies.

While domestic risks are balanced, there are significant external downside
risks. Downside risks include: 1) deepening geo-economic fragmentation and
geopolitical tensions; 2) an abrupt slowdown of the global economy; 3)
outbreaks of new lethal and highly contagious COVID-19 variants; 4)
lingering supply-side constraints; 5) natural disasters, 6) debt
sustainability, and 7) cyberthreats. In addition, there are risks to the
economy that could arise from an abrupt change of the current monetary
policy framework. Upside risks include a more robust recovery of
consumption, especially services, and a stronger-than-expected recovery of
inbound tourism.

Economic Policies

The main challenge is to calibrate a combination of policies that are
needed in the near term to ensure that the 2 percent inflation target is
reached durably, without overshooting significantly, while preserving
financial stability, and in the medium-term to reduce fiscal
vulnerabilities and transition to a more dynamic, resilient, and inclusive

In the near term, there is very significant uncertainty regarding the
inflation outlook in Japan –with both upside and downside risks. Without
substantial acceleration in wage growth, Japan’s inflation is expected to
fall back below the 2 percent inflation target by end-2024. Hence, an
overall accommodative monetary policy stance remains appropriate.
Nonetheless, upside risks to inflation are more prominent amidst a
narrowing output gap and lower real interest rates. To better manage risks
given increased uncertainty regarding inflation, more flexibility in longer
term yields should be considered. If inflation pressures appear more
persistent, with sustained increase in nominal wage growth and economic
recovery, such flexibility would automatically lead to a rise in long term
rates. Prospectively, this could lead to a smoother transition to a neutral
monetary stance once there is stronger evidence that the inflation target
has been durably achieved. At the same time, it would also make monetary
policy nimble in case further easing is warranted if for example a global
recession materializes. Changes in monetary policy settings should be well
communicated. Macroprudential and other policies should seek to curb
financial sector vulnerabilities. Pandemic-related fiscal support should be
withdrawn more quickly, and new measures limited and targeted only to
vulnerable households. Steps are needed to boost labor income and achieve a
virtuous cycle of income and growth.

Over the medium term, fiscal consolidation must be
growth-friendly—including taking account of the economic situation—and
credible in order to put public debt on a downward path and to rebuild
fiscal buffers. Financial support measures should be limited to viable
firms. Labor market and fiscal reforms are warranted to raise potential
growth, reduce gender inequalities, and offset the drag from fiscal
consolidation. Promoting green and digital investment could help achieve
climate targets and reap the benefits of the digital economy.

Fiscal Policy

Amid the ongoing recovery, rising inflation, tighter labor markets, and a
closing output gap, fiscal policy support should be withdrawn more quickly.
The large fiscal package adopted in October 2022 led to a narrowing of the
already limited fiscal space. Moreover, the package could add to inflation,
which would require a stronger monetary tightening response. Energy
subsidies could have been better targeted to contain fiscal costs, protect
the vulnerable, and encourage efficient energy consumption. As government
spending pressures continue to rise, any additional spending measures
should be targeted and come hand in hand with revenue raising measures.

Under current policies, the public debt-to-GDP ratio will increase steadily
in the medium and long term. The primary deficit in percent of GDP is
projected to decline in the near term as the stimulus measures phase out,
but to rise in the medium and long term to accommodate age-related spending
pressures. Against this backdrop, with the public debt-to-GDP ratio on an
upward path, interest rates could increase suddenly, and sovereign stress
could emerge.

Fiscal consolidation is warranted to rebuild fiscal buffers and ensure debt
sustainability. This should be underpinned by a credible fiscal framework
to reduce the primary fiscal deficit and put the debt-to-GDP ratio on a
clear downward path. The following measures could help bolster the
credibility of the fiscal framework:

· Adopting more realistic projections. GDP growth rates and fiscal balances
projected by the Cabinet Office have historically been too optimistic. The
recent practice of including more realistic assumptions and implementing
sensitivity analysis based on lower potential growth are steps in the right
direction. However, more realistic scenarios are still warranted especially
when discussing medium-term fiscal targets. A fiscal council could be
tasked to evaluate the realism of macro-projections.

· Strengthening the fiscal framework. Budget expenditure ceilings do not
limit actual government expenditures given the established practice of
adopting supplementary budgets. This practice breaks the link between the
annual budget and medium-term fiscal targets. The budget process should be
reformed to ensure binding expenditure ceilings and consistency between the
annual budget and medium-term fiscal targets. The target should be
underpinned by specific measures, and supplementary budgets should be
infrequent and deployed only when exceptionally large macroeconomic shocks

· Balancing debt sustainability while protecting growth. The authorities
should continue to assess the progress towards the FY2025 primary balance
target, weighing fiscal consolidation against the need to provide fiscal
support to preserve growth if adverse shocks materialize.

Fiscal consolidation requires both revenue and expenditure measures. Japan
has relatively low tax revenues and relatively high age-related spending
compared to peers. In this context, fiscal consolidation should include:

· Policies to contain health and long-term care costs. Possible measures
include a mix of reforms to: (i) improve spending efficiency and (ii)
target measures such as increasing copayments for high-income seniors.
These measures could help contain age-related expenditure while preserving
the excellent health outcomes already achieved by Japan’s healthcare

· Policies to increase government revenues. Options for raising revenues
include: unifying and raising the consumption tax standard rate; increasing
corporate taxation; strengthening property taxation by removing the
preferential treatment of residential land; rationalizing allowances and
deductions in personal income taxation; raising the capital income tax
rate; and increasing premiums of social insurance.

· Policies to strengthen the safety net. There seems to be a clear gap in
the safety net for the working poor. In that context, an earned income tax
credit (EITC) scheme, which provides tax credits for low-income earners,
could be considered. An EITC would also help to rationalize existing
untargeted transfers.

Monetary Policy

An accommodative monetary policy stance remains appropriate but needs to be
supported by other policies to achieve the 2 percent inflation target
sustainably, including policies to improve productivity and real wages.

Nonetheless, there is exceptionally high uncertainty around baseline
inflation projections with risks tilted to the upside. Upside risks to
inflation include the delayed effects of exchange rate depreciation, border
reopening, second round effects of imported inflation, fiscal support, and
higher-than-expected wage growth. In addition, Japan’s largely
backward-looking inflation expectations could prolong high inflation once
it emerges. Downside risks arise mainly from a slowdown in the global
economy along with rigidity in inflation expectations and prolonged weak
wage growth due to structural factors in the labor market.

In addition, the Bank of Japan (BoJ) has purchased large amounts of JGBs in
recent months, and it now holds close to 70 percent of outstanding 5-year
and 10-year JGBs. These purchases have reduced liquidity in the JGB market
and distorted the yield curve, with market surveys indicating a sharp
deterioration in bond market functioning. Against this background, the BoJ
modified the yield curve control (YCC) framework at the December monetary
policy meeting.

Hence, as noted above, given the two-sided risks to inflation, more
flexibility in long-term yields would help to avoid abrupt changes later.
This would help better manage inflation risks and also help address the
side-effects of prolonged easing. At the same time, providing clear
guidance on the pre-conditions for a gradual policy rate change in the
future would help anchor market expectations and strengthen the credibility
of the BoJ’s commitment to achieving its inflation target. Well
communicated changes to monetary policy settings will facilitate smoother
transitions and protect financial stability.

In this context, the BoJ could consider the following options to allow
further flexibility and increases in long-term yields: widening the 10-year
target band and/or raising the 10-year target, shortening the yield curve
target, or shifting from a JGB yield target to a quantity target of JGB
purchases. The BoJ would need to carefully assess the pros and cons of each
strategy. For instance, widening the 10-year band around the yield target
would entail a minor adjustment to the current YCC framework, however the
fluctuation range will have to be wide enough for market forces to play a
leading role. On the other hand, moving to a quantity-based approach
instead would not entail defending a particular yield level and the
side-effects that come with it, however the quantity of BoJ’s JGB purchases
would need to be state-contingent and adjusted if yields moved up too
rapidly. Lastly, moving to a shorter-term yield target would help ensure
that the short-term yields (which matters more for real activity) continue
to stay low until the 2 percent target is durably achieved, but the BoJ may
face similar costly side-effects that come with targeting a particular
yield level.

Moreover, in the scenario that significant upside inflation risks
materialize, monetary stimulus withdrawal will have to be much
stronger–short-term rates may have to rise much earlier and above the
neutral rate to anchor inflation back towards its 2 percent target.

During 2022, the authorities intervened in the foreign exchange market
(FXI), which was triggered by significant volatility of the yen. While the
yen depreciation since March 2022 largely reflects interest rate
differentials, empirical analysis suggests that the exchange rate had
depreciated more than implied by underlying drivers after June. In general,
FXI could help lower excessive volatility and keep the pace of the yen’s
movement better aligned with fundamentals and well-functioning markets, but
its effects are likely temporary. In principle, fluctuations in the
exchange rate help absorb shocks. Hence, use of FXI should be limited to
special circumstances such as disorderly market conditions, risks to
financial stability because of sharp yen movements, and/or concerns that
currency movements could de-anchor inflation expectations.

Preserving Financial Stability

The financial sector has been robust to several global headwinds in 2022,
but risks have increased amid monetary policy tightening in other peer
economies and the slowdown in global economic activity. Overall, the
banking sector remains resilient, with capital adequacy and liquidity
ratios above regulatory requirements. Valuation losses on overseas
securities holdings and higher foreign currency funding/hedging costs have
weighed on bank and non-bank financial institutions. While major
internationally active banks have increasingly been relying on more stable
foreign-currency funding sources since mid-2010s, steady efforts to further
improve resilience to US dollar liquidity stress are warranted, including
assessing risks due to unused committed credit lines at elevated levels. A
steeper JGB yield curve would benefit banks in the medium term, however,
short-term costs warrant attention.

The authorities should closely monitor developments in credit risks. The
quality of overseas credit portfolios is in general high, with a large
share of investment-grade loans and low non-performing loans. Nonetheless,
credit exposures, especially those to leveraged overseas borrowers, warrant
attention given global headwinds. Moreover, a global economic slowdown
could weigh on large domestic borrowers. Some regional banks are more
exposed to yen depreciation through credit exposure to non-exporting firms,
but the impact on the overall banking system is limited. Liquidity
conditions of firms with limited ability to pass rising raw material costs
to sales prices should continue to be monitored.

Credit imbalances are high by historical standards, in part driven by the
sharp drop in GDP at the outset of pandemic. Although the growth in housing
prices in Japan has been moderate compared to international peers, the
authorities should remain vigilant to potential vulnerabilities that may
arise due to increasing loan-to-income ratios, the rising share of
borrowers with high debt servicing ratios, and the large fraction of
floating-rate mortgages. Macroprudential policies aiming to curb
vulnerabilities from growth in housing loans could be considered. Moreover,
continued vigilance on credit risks that may arise as pandemic-related
support measures taper and reducing the public credit guarantee ratio for
new loans are warranted.

Supporting the New Form of Capitalism

Achieving the Virtuous Cycle of Income and Growth

The government’s new form of capitalism policies to boost income growth
should focus on three dimensions: labor supply, wage growth, and

· First, policies should continue to promote female and senior labor
supply. To encourage more women to join the labor force, it is essential to
advance the work-style reforms, including through telework. Flexible work
arrangements could help women retain their full-time jobs at childbirth and
improve their career prospects. The social security and tax distortions
related to dependent spouses should be eliminated to allow for voluntary
increases in working hours. Further removing obstacles to the employment of
older persons would improve labor supply.

· Second, the government can encourage higher wage growth through
structural reforms. Reducing labor market duality and improving mobility
can enhance workers’ bargaining power and speed up wage growth. Shifting to
job-based employment and to merit-based pay will support wage growth.

· And third, strengthening the workforce in STEM fields could enhance
innovation, facilitate digitalization, and raise labor productivity. To
raise labor productivity, policies should strengthen training and
reskilling in STEM fields for existing workers, and encourage more students
to pursue STEM careers, especially among women. Raising the returns to STEM
education, including through merit-based promotions and flexible work
arrangements, can help achieve that goal.

Accelerating Startups and Open Innovation

Promoting startups in Japan requires a holistic approach to address the
constraints in the labor market, as well as improving financing options and
entrepreneurial education. The grand design of the new form of capitalism
includes measures to support venture capital, recognizes the constraint of
personal guarantees on entrepreneurship, highlights the importance of
entrepreneurial education, and strengthens the role of universities as
startup hubs. Better availability of venture capital equity funding is
crucial to support startups and innovation. Furthermore, a more flexible
labor market and a gradual shift from the lifetime employment system could
encourage the most talented college graduates to venture and create new
companies and have a reasonable backup option in case startups fail.

The government can encourage corporate investment and innovation through
tax incentives. Staff analysis suggests that Japanese firms are holding
more cash due to their increasing share of intangible capital in the
presence of financial frictions. To encourage firms to invest, fiscal
incentives can be used to increase the return on investment, especially in
ICT technology and R&D.

Transitioning to a Low-Carbon Economy

The country’s green transformation (GX) strategy currently is centered
around public investment in decarbonization, and green technology financed
by GX bonds. The government will also provide incentives for private
funding for green projects. The government is committed to expand carbon
pricing from current low levels from FY2028, but details are yet to be
decided. Sectoral plans to achieve emission targets are being developed by
relevant ministries. The government plans to restart nuclear power plants,
and the development of new facilities is under consideration. On climate
finance, the FSA has published the “Supervisory Guidance on Climate-related
Risk Management and Client Engagement”. In addition, the BoJ and FSA have
completed a pilot scenario analysis exercise on climate-related risks with
major banks and insurers, and the BoJ has disbursed about 0.6 percent of
GDP to banks in its funds-supplying operations to support climate finance.

Japan will need additional policies to reach its climate targets. A
comprehensive policy package with green investments to decarbonize
electricity and transport, the largest sources of emissions, and gradually
rising carbon pricing could help Japan to achieve its targets in a
growth-friendly way. Without carbon pricing at levels that provide strong
incentives for CO2 reduction, it would be difficult and more costly to
achieve the targets. Regulatory actions and the elimination of untargeted
subsidies for gas, electricity, and fuel would also support the transition.
Climate policies should be underpinned by measures to protect vulnerable
people and enable an orderly transition of high emission sectors to low
carbon. Green finance should continue to play a supporting role for the
transition through funding of green and transition activities and
appropriate management of climate-related financial risks.

Continuing the Digital Push and Other Reforms

The Digital Agency should continue to coordinate and implement policies to
digitalize the public sector. Significant progress has been made, including
by expanding the coverage of the “My Number” digital ID cards. But data
sharing between government agencies is still limited, impairing the
government’s ability to conduct targeted transfers to vulnerable
households. In this regard, we welcome the government’s policy to
standardize local government IT systems and facilitate information sharing
among the central government and local governments. Other priorities
outlined by the Digital Agency such as further expanding the coverage of
“My Number” digital ID cards and linking them to the provision of public
and private services are also essential to ensure an inclusive digital
transformation. Policies should also support a safe and inclusive digital
transformation of the private sector, including by enhancing training on IT
skills, ensuring data privacy, digital literacy, consumer protection, and

Reform efforts in other areas, such as corporate governance and trade
policies, should continue. Building on recent progress, corporate
governance reforms could be further strengthened by ensuring effective
corporate governance practices and disclosure. Japan should continue to
work actively with international partners to strengthen the rules-based
multilateral trading system, including ensuring effective WTO dispute

The IMF team would like to thank the authorities and other
interlocutors in Japan for the frank and open discussions.

Japan: Selected Economic Indicators, 2019–24
Nominal GDP: US$ 5,006 Billion (2021) GDP per capita: US$ 39,883 (2021)
Population: 126 Million (2021) Quota: SDR 30.8 billion (2021)
2019 2020 2021 2022 2023 2024
(In percent change)
Real GDP -0.4 -4.3 2.1 1.4 1.8 0.9
Domestic demand 0.0 -3.4 1.1 1.8 1.6 0.9
Private consumption -0.6 -4.7 0.4 2.2 1.8 0.8
Gross Private Fixed Investment 0.2 -5.4 0.4 0.8 2.8 1.9
Business investment -0.7 -4.9 0.8 2.0 3.6 2.3
Residential investment 4.1 -7.9 -1.1 -4.7 -0.7 0.0
Government consumption 1.9 2.4 3.5 1.4 0.1 0.6
Public investment 1.9 3.4 -1.9 -6.8 2.0 1.7
Stockbuilding -0.1 -0.5 0.2 0.6 -0.1 -0.2
Net exports -0.4 -0.8 1.0 -0.4 0.2 0.0
Exports of goods and services -1.5 -11.6 11.7 4.7 3.6 2.0
Imports of goods and services 1.0 -6.8 5.1 7.0 2.4 1.9
Output Gap 0.7 -2.9 -1.6 -0.9 0.1 0.2
(In percent change, period average)
Headline CPI 0.5 0.0 -0.2 2.5 2.8 2.0
GDP deflator 0.6 0.9 -0.2 0.2 1.6 1.0
(In percent of GDP)
General government
Revenue 34.2 35.5 36.6 36.8 35.6 35.5
Expenditure 37.3 44.6 42.8 44.8 42.2 39.7
Overall Balance -3.0 -9.1 -6.2 -8.0 -6.6 -4.2
Primary balance -2.4 -8.4 -5.6 -7.7 -6.5 -4.1
Structural primary balance -2.6 -7.5 -5.6 -7.6 -6.5 -4.2
Public debt, gross 236.4 258.7 255.4 258.3 255.7 256.4
(In percent change, end-of-period)
Base money 2.8 19.2 8.5 -5.0 2.3 3.8
Broad money 2.1 7.4 2.9 3.8 2.8 2.1
Credit to the private sector 3.2 6.1 1.8 4.0 1.8 1.8
Non-financial corporate debt in percent of GDP 139.3 152.1 155.7 154.6 153.6 152.6
(In percent)
Interest rate
Overnight call rate, uncollateralized (end-period) -0.1 0.0 0.0
10-year JGB yield (e.o.p.) -0.1 0.0 0.1
(In billions of USD)
Balance of payments
Current account balance 176.3 147.9 197.3 76.7 129.9 159.5
Percent of GDP 3.4 2.9 3.9 1.8 3.1 3.7
Trade balance 1.4 26.6 15.6 -116.5 -71.1 -41.3
Percent of GDP 0.0 0.5 0.3 -2.8 -1.7 -1.0
Exports of goods, f.o.b. 695.0 630.6 748.6 758.1 779.4 802.9
Imports of goods, f.o.b. 693.6 604.0 732.9 874.6 850.5 844.3
Energy imports 131.9 89.1 127.8 177.3 147.4 135.8
(In percent of GDP)
FDI, net 4.3 1.7 3.6 3.1 3.1 3.1
Portfolio Investment 1.7 0.8 -4.0 -1.6 -1.1 -1.1
(In billions of USD)
Change in reserves 25.5 10.9 62.8 20.0 11.5 11.5
Total reserves minus gold (in billions of US$) 1286.3 1348.2 1356.2
(In units, period average)
Exchange rates
Yen/dollar rate 109.0 106.8 109.8
Yen/euro rate 122.0 121.9 129.9
Real effective exchange rate (ULC-based, 2010=100) 75.1 74.1 70.7
Real effective exchange rate (CPI-based, 2010=100) 76.6 77.3 70.7
(In percent)
Demographic Indicators
Population Growth -0.2 -0.3 -0.3 -0.3 -0.4 -0.5
Old-age dependency 47.6 48.3 48.7 48.9 49.3 49.8
Sources: Haver Analytics; OECD; Japanese authorities; and IMF
staff estimates and projections.

IMF Communications Department


Phone: +1 202 623-7100Email: [email protected]



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