IMF Calls for Japan to Rein In Debt

Japan's key task is to bring down its high public debt-to-GDP ratio

Recent turmoil in Europe increased Japan's vulnerability to sovereign risk

Fiscal adjustment to focus on gradual increase in consumption tax

In their Article IV report—a regular assessment—of the world’s second largest economy, the economists said Japan’s key challenge is to bring down its high public debt-to-GDP ratio, one of the highest among advanced countries. Tokyo recently announced a fiscal strategy to curb debt and limit deficits.

“Bringing down the debt ratio will require a large and protracted adjustment and, with global scrutiny of public finances on the rise, the need for early and credible fiscal adjustment has increased,” said James Gordon, IMF mission chief for Japan. “We welcome the government’s proposed fiscal strategy and look forward to further details,” Gordon added.

The IMF believes Tokyo’s new fiscal strategy would be boosted by a gradual increase in the consumption tax, and that adjustment should begin next year, with authorities aiming for a 1 percent of GDP annual reduction in the primary deficit over the next decade.

Strengthening recovery

The economy is rebounding from one of its deepest recessions in postwar history. The recovery gained strength in recent months, fueled by robust exports and policy stimulus. The IMF expects Japan’s GDP growth to rise to 2.4 percent in 2010 and forecasts an easing of deflation.

The pace of the recovery meanwhile is likely to moderate in the second half of the year as stimulus measures expire and export growth levels off, with projected growth of 1.8 percent in 2011. But “uncertainty surrounding the outlook remains large including from renewed financial market volatility,” says the IMF report.

Credible reforms

Despite the projected upturn, the recent turmoil in Europe has highlighted Japan’s vulnerability to sovereign risk. At a meeting of the IMF’s Executive Board last week to discuss the findings of the report, the Board’s directors voiced support for comprehensive tax reform, limits on non-social security spending growth, and reforms to entitlement programs. They also encouraged authorities to strengthen the credibility of their fiscal plans by introducing a cap on public debt.

“A fiscal...