Japan s Economic Challenges

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1 Japan s Economic Challenges LUC EVERAERT ASIA PACIFIC DEPARTMENT INTERNATIONAL MONETARY FUND UNIVERSITY OF TOKYO JANUARY 18, 216 1

2 Global Overview I. Global outlook and risks II. Prospects for Japan III. Policies i 2

3 I. Global Outlook and Risks Key developments that will shape the outlook Asynchronous monetary policies in AEs China rebalancing Trade slowdown Commodity price volatility Risks Volatility in global financial conditions and exchange rates Significant ifi China and EM slowdown Structurally weak growth in AEs Persistently lower commodity prices 3

4 A protracted recovery in advanced economies I. Global outlook and risks 4

5 weaker prospects in emerging markets I. Global outlook and risks 5

6 Asynchronous monetary policy in AEs Source: Presentation of IMF s Economic Counselor, Maurice Obstfeld, on World Economic and Market Developments to the IMF s Board on January 15, 216. I. Global outlook and risks 6

7 China is rebalancing Source: Presentation of IMF s Economic Counselor, Maurice Obstfeld, on World Economic and Market Developments to the IMF s Board on January 15, 216. I. Global outlook and risks 7

8 Trade slowdown Source: Presentation of IMF s Economic Counselor, Maurice Obstfeld, on World Economic and Market Developments to the IMF s Board on January 15, 216. I. Global outlook and risks 8

9 Commodity prices Source: Presentation of IMF s Economic Counselor, Maurice Obstfeld, on World Economic and Market Developments to the IMF s Board on January 15, 216. I. Global outlook and risks 9

10 Inflation slowdown in AEs Source: Presentation of IMF s Economic Counselor, Maurice Obstfeld, on World Economic and Market Developments to the IMF s Board on January 15, 216. I. Global outlook and risks 1

11 Japan: slow and bumpy Contributions to Growth (In percent) Private consumption Private gross fixed investment Private inventory Government spending Net exports GDP growth 21A1 211A1 212A1 213A1 214A1 215A1 216A1 217A1 218A1 Source: Haver Analytics and IMF staff estimates. II. Prospects for Japan

12 Financial conditions have improved under QQE Corporate-Government Bonds Spreads (5Y) (In percentage points) 3 Japan: Real Interest Rate (In percent) 2 2 AA-rated A-rated BBB-rated Real Lending Rate (1 year inflation swaps) 1/ Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Dec-15 Source: Bloomberg. Real 1-year JGB Rate (1 year inflation swaps) -2 Oct-1 Oct-11 Oct-12 Oct-13 Oct-14 Oct-15 1/ Based on average long-term bank-loan rate. Sources: CEIC; and Haver Analytics. II. Prospects for Japan 12

13 but there is further scope for portfolio rebalancing Currency, Deposits & Government Bonds Holdings (215Q3) (In percent of total portfolio) Q3 Cha ange in Share Other Financial Intermediaries Rebalancing Corporate Pensions Historical fluctuation (2 Std Dev) Banks Public Pensions Insurance Households Share of Currency, Deposits, and Government Securities Sources: Bank of Japan Flow of Funds, Haver, and IMF Staff Estimates Japan: YoY Growth in Bank Lending to Corporates (In percent) 6 Total Large corporations 5 SMEs Individuals Credit to Private Sector Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Source: CEIC. II. Prospects for Japan 13

14 A favorable investment environment II. Prospects for Japan 14

15 With structural headwinds II. Prospects for Japan 15

16 An ever tighter labor market Labor Market Unemployment Rate (%) Job opening to application ratio (RHS) Labor Force Growth Rate (YoY, RHS) 1/ Oct- Oct-3 Oct-6 Oct-9 Oct-12 Oct-15 Source: Haver Analytics. 1/ 3-month moving average. II. Prospects for Japan 16

17 But still subdued consumption Real Compensation and Real Consumption (21=1, 1 YoY) Q1 211Q1 212Q1 213Q1 214Q1 215Q1 215Q3 Source: Haver Analytics. II. Prospects for Japan Total Compensation and Inflation (In percent, yoy) Nominal wage (yoy) 3 3. Employment (yoy) 2.5 Total compensation (yoy) 2. Inflation Real Compensation of Employees. Private Consumption Q1 213Q3 214Q1 214Q3 215Q1 215Q3 Sources: Ministry of Intenal Affairs and Communications, Ministry of Health, Labour & Welfare; and IMF staff calculations. 17

18 Inflation likely to remain below the 2 percent target Inflation (y/y, percent) Tankan Survey: Inflation Outlook Headline w/o VAT Core (ex. fresh food) w/o VAT Core core (ex. Food and energy) w/o VAT Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Source: Haver Analytics. II. Prospects for Japan Year ahead 3Yearahead ahead 5 Year ahead 214Q1 214Q2 214Q3 214Q4 215Q1 215Q2 215Q3 215Q4 Source: Haver Analytics. 18

19 How large are the demographic headwinds to growth? II. Prospects for Japan 19

20 What can we expect from structural reforms? Maximum Impact of Path-Breaking Structural Reforms (Cumulative impact on the level of GDP) Corporate governance reform (See IMF WPs by Aoyagi and Ganelli, 214; Galen, 214) Financial sector reforms that raise risk capital as well as SMEs restructuring (Peterson Institute, 212) TPP (Peterson Institute, 212) Product market reform (SEZs, Agricultural, Electricity) Gains from ending deflation Reducing labor duality (See Aoyagi and Ganelli, IMF WP, 213) Foreign labor (See IMF 213 Art IV) Female labor participation (See OECD, 215 forthcoming) Maximum Impact (cumulative) II. Prospects for Japan 2

21 III. Policies: IMF Staff Advice Structural Policies Fiscal Policy Monetary Policy Boost labor supply Reform labor market contracts to remove duality Deregulate product and services markets Credible medium-term consolidation plan Flexible cyclical fiscal policy to maintain growth momentum Stronger fiscal institutions i i Accommodative policy with readiness to ease further and keeping all options open Strengthen communication and monetary policy framework Additional wage round supported by comply or explain rules or tax policy; incentives to convert non-regular to regular workers Higher-than-usual minimum wage increases Forward-looking increases in public sector wages and administratively controlled prices Incomes Policies g p g y Financial Policies Enhance risk capital provision Jumpstart securitization Unwind cross-shareholdings h and promote consolidation in the financial i system. III. Policies 21

22 Need for a regime shift? Phillips Curve ll items less fo ood and energ gy w/o VAT effe ect ( YoY) CPI a A: 83Q1-95Q4 B: 96Q1-12Q3 y=.3x+2 y=.1x-.2 C: 12Q4-15Q3 y=.2x Output Gap Sources: Cabinet Office; Bank of Japan; and IMF staff estimates. III. Policies 22

23 Incomes and labor market policies could be used to raise wages and reduce labor market duality Nonregular Workers and Wage Growth (year-on-year percent change) 3 Changes in part-time wages 2 Composition effect Change in full-time wages 1 Share of nonregular workers (right side) 1/ -1-2 (% of staff) Real wage and productivity growth (In percent, ) Real wage growth Q3 23Q3 25Q3 27Q3 29Q3 211Q3 213Q3 215Q3 Sources: Haver Analytics; and IMF staff estimates. 1/ Yearly Average. III. Policies Labor productivity growth Sources: OECD, and IMF staff calculations. 23

24 More fiscal consolidation in the medium-term is needed to secure fiscal sustainability Japan: Public Finances (Percent of GDP) 3 Fiscal impulse (RHS) Gross debt 25 Output t gap (RHS) Projection Sources: CAO; and IMF staff estimates Note: Fiscal impulse is changes in the structural primary balance. -8 III. Policies 24

25 The BoJ needs to stand ready to ease further and enhance communication to guide markets Share of JGB holdings by the Bank of Japan Potential Portfolio Rebalancing under QQE2, (Percent) Oct. 211 Oct. 212 Oct. 214 Dec. 219-QQE Dec. 219-QQE2 9% 9.% 12.1% 22.3% QQE-2 QQE 61.1% 45.6% Outstanding JGBs Source: IMF staff calculations Uses deficit projections to forecast outstanding amount of JGBs (size of the bubble). III. Policies (trillion yen) Bank of Japan Public pension funds Sources: IMF staff projections. Insurance companies Private banks (major and regional) Japan Post bank 25

26 Thank You 26

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