Japan’s government needs to implement structural reforms to boost the potential growth rate or it may be forced to launch more fiscal stimulus to meet the Bank of Japan’s 2% inflation goal, the International Monetary Fund says.
Failure to include credible structural reforms in Prime Minister Shinzo Abe’s economic policies, known as “Abenomics,” would slow economic growth in Japan as well as in Asia, the IMF warned in an update to its World Economic Outlook.
The IMF welcomed Japan’s plan to raise its sales tax to pay for welfare costs but said the government’s decision to offset the blow with stimulus spending means it is under pressure to compile a fiscal discipline plan as soon as possible.
“Structural reforms will be critical to open up the additional policy space that may be needed to bring inflation up to the 2% target, “the IMF said in its report.
Abe’s government will finalise a 5 trillion yen stimulus package in December. The measures will include tax breaks for companies and home owners, but the government has yet to decide how it will spend most of the money.
The IMF acknowledged that stimulus spending is likely to have a short-term benefit and that the economy could grow more than it forecast in 2014.
Japan’s economy will grow 2% this year and then slow to 1.2% in 2014 due to the sales tax hike, the IMF said.
Those forecasts were little changed from July, when the IMF said Japan’s GDP will expand 2.1% this year and 1.1% next year.
Failure to deliver on structural reforms would shave 0.75 percentage point from Japan’s GDP growth, while growth in Asia would decrease by 1.0 percentage point, the IMF said.
The Japanese government has already made two big announcements this year on economic reforms, but the plans have fallen short on detail, causing some investors to question whether Abe can deliver policies to fundamentally change the economy.
Abe swept to power in December by promising bold steps to jolt the economy from its two-decade long torpor. Since then, the prime minister has overseen a massive dose of fiscal and monetary stimulus that’s buoyed investor and business confidence.
However, the IMF cautioned that without steps to raise productivity, such as increasing female workers and raising the retirement age, it will be difficult to boost business investment and inflation expectations over the long term.
This would jeopardise the BOJ’s target of reaching 2% inflation by 2015. If there is limited room for further monetary policy easing, then the government would have to use fiscal policy to narrow the negative output gap, according to the IMF.
More spending would risk higher yields, the report said, as Japan’s outstanding debt burden is the worst among major economies at 1,000 trillion yen, or twice the size of its GDP.
Abe announced earlier this month that the government will raise the 5% sales tax to 8% next year, an important step toward fiscal prudence. However, there are doubts whether the government will carry out an additional tax hike to 10% scheduled in 2015.
The BOJ offered an intense burst of stimulus in April, pledging to double the supply of money to end 15 years of deflation and meet its 2% inflation goal in roughly two years. It has stood pat on policy since then.
The BOJ’s strategy rests on buying 7.5 trillion yen of long-term government bonds per month, which is the equivalent of roughly 70% of newly issued government debt.