IMF Concludes 2022 Article IV Consultation with Japan

On April 1, 2022, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1]with Japan.

The Japanese economy is recovering from the pandemic amid strong policy support and high vaccination levels. Japan had much lower rates of COVID-related infections and deaths than most advanced economies, including due to containment measures. Following a contraction of 4.5 percent in 2020, real GDP growth is estimated to have grown by 1.6 percent in 2021. Reflecting high energy prices, inflation has risen gradually during 2021 but remains well below the 2 percent inflation target. The current account surplus was 2.9 percent of GDP in 2021, and, on a preliminary basis, the external position is assessed as broadly in line with medium-term fundamentals and desirable policies. Business bankruptcies and non-performing loans are at historical lows due to strong fiscal and monetary support as well as liquidity and credit supply facilitated by regulatory easing measures. The banking system remains well-capitalized and liquid, and near-term vulnerabilities are contained.

GDP growth is projected at 2.4 percent in 2022 amid continued strong policy support, the high vaccination rate, and easing global supply constraints. Consumption will lead the recovery, with pent-up demand being unwound. As pandemic-related uncertainty and supply constraints subside, investment is seen to bounce back. The pace of recovery for domestic demand will be slowed by higher commodity prices and elevated uncertainty related to the Ukraine conflict. External demand will also be affected by the geopolitical tensions, mainly due to an expected slowdown in Europe. Inflation is expected to pick up, spurred by higher import prices and stronger domestic demand, with headline CPI inflation projected at 1.0 percent in 2022. An ageing and declining population will continue to weigh in the medium to long term. Significant scarring effects are unlikely, as the strong policy support has kept unemployment low. Fiscal buffers should be rebuilt gradually over the medium and long term in a growth-friendly manner to preserve the ability to respond to shocks. Monetary policy accommodation is warranted while taking further measures to make that stance more sustainable. Digital and green transformation could be leveraged to promote strong, sustainable, and inclusive growth after the pandemic. Reinvigorating reforms to increase labor supply, boost productivity, and support investment would lift potential growth and facilitate reflation.

Executive Board Assessment[2]

Executive Directors commended the authorities’ strong policy support and steady progress on the vaccine rollout, which are supporting the recovery from the pandemic. Directors noted that uncertainty around the pandemic and the war in Ukraine pose significant downside risks. They stressed the importance of efforts to increase productivity and achieve inclusive and sustainable growth.

Directors emphasized that near-term fiscal policy should remain flexible and supportive, until the recovery becomes entrenched, while increasingly shifting toward more targeted measures. They underscored the need for a well-specified medium-term fiscal consolidation strategy that preserves growth to put public debt on a downward path and strengthen the ability to respond to shocks.

Directors agreed that accommodative monetary policy remains appropriate. A number of Directors expressed the view that further refinements to the monetary policy framework could help to safeguard financial stability, while some took note of the authorities’ view that the current framework is effective and flexible. Directors emphasized that clear communication would help to enhance monetary policy effectiveness. Given that the effective lower bound is a constraint for Japan, most Directors considered that comprehensive and mutually reinforcing fiscal, monetary, and structural policies are essential to provide the necessary support to lift inflation durably to its target.

Directors welcomed that financial stability has been maintained and underscored that financial supervision should remain vigilant to contain vulnerabilities. They agreed that pandemic-related financial support should be scaled down as the pandemic recedes. Noting the challenges associated with prolonged low interest rates and rising demographic pressures, Directors urged the authorities to further strengthen financial supervision and regulation, broaden the scope of the systemic risk assessment, and enhance the macroprudential policy toolkit.

Directors encouraged the authorities to leverage the planned digital and green transformation to promote strong, sustainable, and inclusive growth. They welcomed Japan’s carbon neutrality commitment, noting the important role that carbon pricing could play, and highlighted the need for further efforts to deliver on related targets. Directors noted that recent initiatives to promote digitalization in the private sector and establish the centralized Digital Agency should help to accelerate digitalization. They recommended avoiding job displacement of unskilled workers to ensure an inclusive digital transition.

Against the backdrop of an aging and shrinking population, Directors called for an acceleration of reforms to increase labor supply, productivity, and wages, particularly of female and older workers. They stressed that corporate governance and regulatory reforms should be broadened and deepened to improve business dynamism and spur investment. Directors welcomed Japan’s continued multilateral and regional efforts to promote open, stable, and transparent trade policies.