Japan’s Bumpy Growth Path Puts Premium on Structural Reforms

“Abenomics” gaining traction, but self-sustaining growth not assured

Growth set to resume following recent contraction

Ambitious structural reforms and concrete fiscal measures urgently needed

The IMF report found that “Abenomics”—a three-pronged approach to reflate the economy through monetary, fiscal, and structural policies—is progressing well, but unevenly across the three arrows, with medium-term risks remaining substantial. Aggressive monetary easing by the Bank of Japan has contributed to a pickup in actual and expected inflation. Growth has been well above potential, labor markets continue to tighten, and credit growth has turned positive, including to small- and medium-sized enterprises.

“We expect Japan’s economy to grow by about 1.6 percent this year, before slowing to 1.1 percent in 2015 as a result of fiscal adjustment,” said Jerry Schiff, Deputy Director in the IMF’s Asia and Pacific Department and head of the mission that conducted the assessment. “Inflation is expected to rise temporarily to 2.8 percent on average for 2014 due to recent increase in consumption tax rate, and we expect the Bank of Japan’s 2 percent target will be achieved over the medium term.”

Growth path to be bumpy

After strong first-quarter growth driven by rush demand ahead of the consumption tax increase, the economy is expected to contract in the second quarter. Nonetheless, conditions are in place for the economy to weather well the effects of the consumption tax rise and see a return to a moderate pace of recovery in the second half of the year. Private consumption already rebounded in May after a large drop in April.

However, the report notes that the recovery has so far relied on fiscal and monetary stimulus, with still tentative investment and export growth. The rise in inflation too has depended to a large extent on the weakening of the yen. These factors raise questions about the sustainability of the recovery over the medium term. “Implementing high-impact structural reforms will be essential to maintain confidence and competitiveness and avoid a scenario where monetary policy would be overburdened, which would be detrimental for Japan, as well as other countries in the region,” said Schiff.

Structural reforms vital

Since the introduction of the new growth strategy in June 2013, reforms are progressing in several areas and the government recently adopted an updated strategy. These reforms will take time given the range of economic...