Japan’s economic growth has decelerated due to subdued private consumption and investment, leading to a loss in inflationary momentum, as per the International Monetary Fund’s (IMF) Executive Board’s assessment following a consultation in late July. Despite favorable financial conditions, declining stock prices and a strengthening yen have contributed to a slight tightening of financial conditions.

In response to the weakening domestic and global economic landscape, Japanese authorities have implemented additional monetary and fiscal measures. These include adopting a negative interest rate policy, planning for further fiscal stimulus, and delaying a planned consumption tax increase from 2017 by two and a half years.

However, the IMF anticipates subdued growth and inflation prospects. While private consumption is expected to increase modestly, the global recovery and trade remain weak. Increased uncertainty, particularly after the Brexit referendum, and the recent appreciation of the yen are likely to hinder net exports and investment. Consequently, the economy is projected to grow at a moderate 0.3% in 2016, slowing further to 0.1% in 2017, excluding potential stimulus measures. Medium-term growth is anticipated to align with the declining potential growth rate, while inflation is projected to reach approximately 1%.

The IMF highlights low confidence in economic growth prospects as a factor limiting investment and credit demand. Additionally, labor market duality and inflexibility are suppressing wage growth. The financial sector’s support for risk-taking remains limited, while inconsistent fiscal policies and optimistic growth assumptions in medium-term budget projections contribute to policy uncertainty. These factors, along with weak monetary transmission and sluggish wage-price dynamics, are preventing inflation expectations from rising, posing a communication and credibility challenge for the Bank of Japan (BoJ).

Adding to these challenges are global economic weakness and volatility. Weak global growth and overcapacity in the traded goods sector have limited the positive impact of a weaker yen on exports. Declining commodity prices have failed to stimulate activity as anticipated, instead pressuring headline inflation and compelling the BoJ to repeatedly extend its timeline for achieving the inflation target. Concerns in emerging markets and adjustments to the expected monetary policy trajectory in advanced economies have also contributed to financial market volatility and increased demand for safe-haven assets.

Executive Directors acknowledged the initial successes of Abenomics and the authorities’ resolute policy implementation to stimulate growth and inflation. However, they observed that growth remains subdued and deflation persists due to weak consumption, lackluster private investment, and sluggish exports. Directors recognized significant headwinds from a weak global recovery, exchange rate appreciation and volatility, and unfavorable demographics. They generally concurred that a comprehensive and coordinated policy upgrade is necessary to achieve the ambitious growth, reflation, and fiscal consolidation targets.

Directors emphasized the importance of structural reforms as a crucial element of the revitalized Abenomics strategy. These reforms are aimed at enhancing productivity, labor supply, and potential growth. They support labor market reforms that address duality and promote labor force participation among women, older workers, and foreign workers. As part of a comprehensive policy mix, Directors generally saw a role for policies that could stimulate wage-price dynamics without excessive intervention in market mechanisms. In this context, they welcomed the decision to raise minimum wage growth and recommended exploring options to incentivize companies to increase wages and adopt flexible labor contracts.

Furthermore, Directors commended the authorities for maintaining a sound and stable financial sector. However, they noted potential financial stability risks arising from prolonged unconventional monetary policies and delays in achieving reflation and fiscal sustainability. Therefore, they encouraged the authorities to continue strengthening macroprudential policies and enhance monitoring of government bond market liquidity, financial institutions’ profitability, and foreign exchange risks. Continued efforts to improve the resilience of regional banks and inter-agency coordination were also encouraged.