2012 Article IV Consultation with Japan Concluding Statement of the IMF Mission

The Japanese economy has shown remarkable resilience and adaptability in the aftermath of the Great East Japan earthquake and is now experiencing a recovery. Risks, however, have shifted decidedly to the downside, with the turmoil in Europe intensifying and other advanced and key emerging market economies showing signs of slowing. Moreover, to address the longstanding challenges of high public debt, low growth, and deflation, Japan needs to move forcefully on many fronts to take advantage of synergies among policies. The immediate priority is passage of the current tax and social security reform, which would bolster confidence and help create a more conducive environment for monetary easing. It would also help maintain financial sector stability, given increased fiscal and financial sector linkages. An exit from deflation and accelerated structural reforms would raise growth and support fiscal adjustment. This statement summarizes the findings of the Article IV consultation and the recent Financial Sector Assessment Program (FSAP) Update.

I. Outlook and Risks

1. Despite the devastation of the earthquake and tsunami, the impact on growth proved to be shortlived. Real GDP declined by ¾ percent in 2011 but grew at an annualized rate of 4¾ percent in the first quarter of 2012. Moreover, the financial sector has remained stable and the current account has continued to record a sizeable surplus.

2. Looking ahead, reconstruction will drive the recovery.Growth is expected to reach about 2 percent in 2012 supported by public reconstruction spending of around 1½ percent of GDP and a recovery in consumer demand (text table). A weak external environment, especially in Europe, is likely to dampen demand for exports and weigh on business sentiment. For 2013, real GDP growth is projected to slow slightly to 1¾ percent as reconstruction winds down. While headline inflation has risen modestly, IMF staff expect inflation to remain around zero in the next two years, under current policies, as a result of the still wide output gap and declining commodity prices.

3. Risks to the outlook have shifted decidedly to the downside. An escalation of the European turmoil or a sharper-than-expected slowing of the Chinese economy would hurt Japanese exports and growth. Moreover, an intensification of the flight to safety in financial markets could lead to exchange rate volatility, further appreciate the yen and depress equity prices and business and consumer confidence. With the complete closure of all nuclear plants, an unusually hot summer could disrupt economic activity. This risk would be mitigated, however, by the extent of conservation efforts already being taken. On the upside, a faster than expected recovery in Japanese consumer and business sentiment would lift domestic demand, while a reopening of some nuclear power plants would limit the disruption in economic activity.