Washington, DC: On May 6, 2024, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1] with Japan. This also included a discussion of the findings of the Financial Sector Assessment Program (FSAP) exercise for Japan.[2]
The Japanese economy continues to grow after the pandemic, with broad-based price increases following three decades of low inflation. In 2023Q2, real GDP surpassed the peak level in 2019Q3, and the output gap is estimated to have closed. However, the recovery remains uneven. While goods and services exports have risen above the pre-pandemic peak, private consumption and investment remain below. Headline inflation has been above two percent (y/y) since April 2022. Measures of underlying inflation show that the current above-target inflation is broad-based across products and services for the first time in three decades. The passthrough from inflation to wages has started to pick up. The current account surplus increased to 3.4 percent of GDP in 2023, with the external position in 2023 assessed as broadly in line with the level implied by medium-term fundamentals and desirable policies.
Growth is expected to continue, with a pick-up in consumption later this year. Growth is projected to decelerate to 0.9 percent in 2024, owing to fading of one-off factors supporting growth in 2023, including a surge in tourism. Consumption is expected to pick-up in the latter half of 2024 and 2025 due to the combination of rising nominal wages, following the strong Shunto settlement in 2024, and lower headline inflation lifting real wages. Core inflation is expected to decline gradually as the effect of higher import prices wanes but is projected to stay above the two-percent target until the second half of 2025. The primary fiscal deficit is expected to remain elevated at 6.4 percent in 2024, reflecting the impact of the latest fiscal stimulus package. The current account surplus is expected to increase slightly to 3.5 percent of GDP supported by exports. An aging and declining population will continue to be a major macroeconomic challenge in the medium to long term.
Risks to growth and inflation are broadly balanced. For growth, downside risks include a slowdown in the global economy, deepening geoeconomic fragmentation, and more volatile food and energy prices. On the domestic side, the main downside risks are weak consumption related to negative real wage growth, more acute labor shortages that could constrain activity, and a return to a zero-inflation environment. On the upside, additional recovery of inbound tourism and a stronger global economy could support growth. For inflation, upside risks stem from backward-looking inflation expectations and significantly strong-than-expected wages following the spring wage negotiations. Downside risks could come from a faster decline in global goods and import prices.
The Japanese financial system has withstood a series of shocks but confronts several challenges. Key risks to macrofinancial stability at the current juncture stem from three main sources of vulnerability: the sizable security holdings of financial institutions under mark-to-market accounting, some banks' notable foreign currency exposures, and signs of overheating in parts of the real estate markets. The systemic risk analysis conducted as part of the FSAP suggests that the financial system is broadly resilient to a range of adverse macrofinancial shocks but some areas merit attention and close monitoring. Risks from climate change and growing digitalization, including cyber risks, also need to be carefully monitored. Financial sector policies have been strengthened in recent years, but further steps are warranted to maintain financial stability in an evolving risk environment.
Executive Board Assessment[3]
Executive Directors welcomed that growth of the Japanese economy is expected to continue, supported by a pick‑up in consumption, with broad based price increases following three decades of low inflation. Noting that while risks to growth and inflation are broadly balanced, Directors emphasized the need for steadfast policy implementation against the longer‑term challenge of low productivity growth due to population aging and labor market rigidity.
Directors stressed that fiscal consolidation is needed to rebuild fiscal buffers and ensure debt sustainability, underpinned by both revenue and expenditure measures. In this context, they emphasized that any new spending should be offset by higher revenues or savings elsewhere in the budget given a closed output gap and high debt‑to‑GDP ratio, and that growth‑friendly fiscal consolidation should be supported by a strengthened and more disciplined medium‑term fiscal framework.
Directors agreed that further hikes in the short‑term policy rate should proceed at a gradual pace and be data‑dependent, given balanced risks to inflation and mixed signals in recent data. They concurred that state‑contingent purchases of Japanese Government Bonds by the Bank of Japan will help mitigate excessive shifts in yields that could undermine macro‑financial stability during this historic policy transition. More broadly, Directors emphasized that a clear and effective communication strategy that continues to underscore factors behind the pace of policy rate increases will be key. They underscored that Japan's longstanding commitment to a flexible exchange rate regime will help absorb shocks and support monetary policy's focus on price stability.
Directors supported the key findings and policy recommendations of the 2024 Financial Sector Assessment Program. While welcoming that the financial system is broadly resilient, they noted that market risks for financial institutions warrant close monitoring and potential vulnerabilities in parts of the real estate sector call for a macroprudential response. Directors concurred that the evolving and challenging risk environment underscores the need to fill remaining gaps in the financial sector oversight and crisis management framework. They also agreed that staffing resources need to be increased significantly to enhance the supervision and resolution of financial institutions.
Directors concurred that further structural policies are needed to support fertility, female leaders, startups, and a green economy, with labor market reforms at the forefront of the agenda. They agreed that these reforms should include a further expansion of childcare facilities, progress on workstyle reforms, reducing labor market dualism, and greater firm dynamism.
Table 1. Japan: Selected Economic Indicators, 2020–25
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[1] Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
[2] Under the FSAP, the IMF assesses the stability of the financial system, and not that of individual institutions. The FSAP assists in identifying key sources of systemic risk and suggests policies to help enhance resilience to shocks and contagion. In member countries with financial sectors deemed by the IMF to be systemically important, it is a mandatory part of Article IV surveillance, and in the case of the Japan it is supposed to take place every five years. The last FSAP exercise took place in 2017.
[3] At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.IMF.org/external/np/sec/misc/qualifiers.htm.
