IMF urges Japan to address debt and reform economy

IMF urges Japan to address debt and reform economy

Recently, there has even been hope that Japan might move away from its persistent deflation, yet the IMF continues to urge Tokyo to do more.

The International Monetary Fund urged Japan last week to develop plans to raise growth over the medium term and address its growing debt burden. Since Prime Minister Abe began to enact his plan of fiscal and monetary stimulus last year, Japan has seen a significant uptick in its economic prospects. Recently, there has even been hope that Japan might move away from its persistent deflation. However, in its annual bilateral consultations, the IMF reminded Japan that “Abenomics” would not be successful over time unless it was fully implemented – including dramatic structural reforms and a commitment to bring down debt by 11% of GDP over the next decade. Projections show Japan’s GDP growing 2.0% this year and a more modest 1.2% in 2014, but without moving forward on reforms, the IMF sees risks of “bond market stress” and “slower European growth.”

In the report, the IMF evaluated the potential impact of a fully implemented “Abenomics” package. In this scenario, “authorities [the Japanese government] adopt ambitious structural reforms that raise trend growth from 1 to 2 percent over the next decade.” This would raise future incomes and with increased demand, Japan would likely be able to meet its inflation target of 2%.

Importantly, the IMF believes that these “ambitious structural reforms” are necessary to ensure that the previous enacted stimulus succeeds. The aggressive easing by the Bank of Japan and the short-term government fiscal support have worked to temporarily raise growth and inflation expectations. But the IMF makes clear that these gains will not be sustained over the medium term unless Abe enacts more dramatic changes and commits to a clear timetable.

Shinzō Abe

Japan’s Prime Minister Shinzō Abe is under IMF review. ‘Abenomics’ will need structural reform and debt reduction to be successful in the long term

The IMF strongly encourages Japan to address its labor market to make it more efficient and productive. As it is now, Japan restricts firms’ ability to fire workers, forcing companies to retain unproductive workers and limiting the ability for new hires to move up. This has resulted in a “dual labor market”, where non-regular and temporary workers make up an increasingly larger share of the employed. The IMF estimates that this share has increased from below 20% in the 1990s to roughly 35%. These workers receive less protection and have lower compensation than traditional employees.

According to the report, “the macroeconomic costs of excessive labor market duality are likely to be substantial”  and should be addressed by “measures to strengthen job matching” and “clarifying the legal framework.” Adding immigration reform to these steps would make the Japanese labor market more flexible, allowing workers to move to industries, where they are needed and making firms more nimble. This would go far to boost growth, especially when paired with Japan’s entrance to the Trans Pacific Partnership.

Japan’s fiscal challenge also looms large. The fiscal stimulus enacted in February allocated an additional 1.4% of GDP in new spending, increasing the IMF’s projection for the structural primary balance for 2013 to -8.9%. Net debt has grown to 134% of GDP, while the gross figures are substantially higher at 238%. While yields on government debt have remained extremely low, if markets reevaluate perceptions of the Japanese government’s ability to repay, that debt burden would become prohibitive. As the report notes, “even a modest increase of risk premia by 100 basis points could undermine financial stability.”

This makes the planned increases in the consumption tax from 5% to 10% in the next two years vital. The hike is “critical to maintain confidence in the ability of the government to address the fiscal problem.” However, even after combining the increased revenue from this tax with reduced stimulus expenditures, the IMF estimates an additional 5.5% of structural fiscal adjustment will be needed. In order to meet this goal, Japan will have to contemplate steps such as further increasing the consumption tax, raising the eligibility for pensions to 67, and cut deeper in spending. Without such additional measures, the government’s current baseline plan would leave the net debt to GDP ratio expanding to a huge 210%.

As recent reports have shown that the Japanese economy failed to meet growth expectations in the second quarter, Abe’s commitment to the consumption tax increase will be an important litmus test for his plans. While there might be a temptation to delay the first income tax hike, Abe would be better served in pairing the increase with bold reforms. Showing that determination might help soften the impact on consumption. A combination of the reforms outlined above with a strong fiscal consolidation plan would raise Japan’s growth in the medium term, more than compensating for increased taxes . Throughout this year, the IMF has repeatedly referred to “three-speed growth” with emerging markets leading the way and the US picking up, while Europe and Japan remain stagnant. If Japan can join the US in “up-shifting” to a higher speed, the global economy would be markedly better off.

All quotes and figures cited are from the IMF 2013 Article IV Consultation with Japan, released August 5th, unless noted otherwise.


Categories: Asia Pacific, Economics

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Ned Pagliarulo

Ned Pagliarulo works for a Japanese press company, reporting on economics and government statistics. Ned received a BA in History with a minor in Japanese from Georgetown University in 2012.