SINGAPORE, March 4, 2025 – The Japanese economy is projected to grow at 1.3 percent in 2025, driven by sustained wage gains, strong business investments, and resilient performance in goods exports and tourism. While inflation has eased, it is expected to remain above the Bank of Japan’s (BOJ) target, with CPI (excluding fresh food) inflation estimated to average 2.2 percent in 2025. Amid ongoing uncertainties surrounding the growth and inflation outlook, the BOJ should maintain a flexible, data-driven approach to monetary policy. Meanwhile, with public debt at elevated levels and rising fiscal pressures due to an aging population, stronger fiscal consolidation efforts will be needed to strengthen fiscal resilience.
These policy recommendations are highlighted in the 2024 Annual Consultation Report on Japan published today by the ASEAN+3 Macroeconomic Research Office (AMRO). The report is based on AMRO’s Annual Consultation Visit to Japan which was completed on November 22, 2024, and data and information available up to December 13, 2024.
Recent developments and outlook
Japan’s economic growth moderated to 0.1 percent in 2024 following the post-pandemic rebound. Although the economy contracted sharply in Q1 2024, growth rebounded over the subsequent three quarters, driven by strong consumption as wage hikes from the “Shunto” wage negotiations began to take effect. Wage increases are expected to remain high on account of a tight labor market and a shift in firm behavior. Corporate earnings are also expected to contribute to higher wages and increased capital investment in 2025, further boosting domestic demand. Goods exports and tourism are projected to remain robust, provided there is no sharp slowdown in major global economies.
While inflation slowed in 2024, CPI (excluding fresh food) inflation remained above the inflation target at 3.0 percent in December. Stripping out fresh food and energy, “core-core” CPI inflation was stable at 2.4 percent in the last two months of 2024 after increasing in successive months since July.
Amid a positive shift in firms’ wage- and price-setting behavior, the BOJ terminated its yield curve control and negative-interest rate policy in March 2024, and renormalized its monetary policy framework using short-term interest rate as its main policy instrument.
Japan’s current account surplus remained substantial at 4.8 percent of GDP in 2024, up from 3.8 percent in 2023. The larger surplus primarily reflects a narrower trade deficit and a higher primary income surplus. While automobile exports were negatively affected by factory closures related to safety certification issues, exports of semiconductors and semiconductor equipment surged reflecting the upswing in the tech cycle.
Credit growth expanded by over 3.3 percent in 2024, driven by resilient domestic demand and accommodative lending stance of banks. The overall banking system remains sound, supported by strong asset quality, adequate capital buffers, and robust profitability.
The fiscal deficit is projected to widen to 3.6 percent of GDP in FY2024 from 2.9 percent in FY2023 despite the gradual phase-out of some economic support packages. This increase reflects a sharper decline in revenue due to a temporary income tax cut, lower carryover revenue from the previous year, and higher spending from a supplementary budget amounting to JPY13.9 trillion. While public debt has been declining steadily after a significant increase during the COVID-19 pandemic, it remains high, at 240.6 percent of GDP in FY2024.
Risks, vulnerabilities, and challenges
Japan’s macrofinancial outlook is skewed to the downside, reflecting substantial uncertainties, particularly from external factors. Key risks include a spike in global commodity prices triggered by escalating geopolitical tensions and a pronounced economic slowdown in other major economies.
On the domestic front, a slowdown in wage growth could undermine the BOJ’s efforts to achieve its 2-percent inflation target. Conversely, a significant overshoot of inflation above its target could force a sharp tightening of monetary policy, straining households and businesses. Higher interest rates would also challenge fiscal sustainability by driving up interest payments on the government’s substantial debt.
Policy recommendations
Amid uncertainties about the future trajectory of inflation and a gradual firming of the wage-price virtuous cycle in the economy, the BOJ should maintain a flexible and data-driven approach to monetary policy. The BOJ should continue to raise the short-term policy rate once there is firm evidence that underlying inflation is sustainably anchored at 2 percent and economic activity remains robust. The pace of rate hikes should remain gradual and data dependent. In addition, the BOJ should maintain its gradual, predictable and flexible approach to reduce its outstanding stock of Japanese government bonds as well as maintain clear communication with market participants.
Persistently large fiscal deficits and the frequent use of supplementary budgets have weakened fiscal discipline and undermined the alignment of annual budgets with the medium-term fiscal plan. As spending pressures rise over time due to an aging population, a comprehensive fiscal consolidation strategy is needed for rebuilding fiscal buffers over the medium term. This strategy should combine revenue mobilization with expenditure rationalization.
Key priorities for fiscal policy include tax policy reform and enhancing revenue administration, reforming the social security system, and curbing healthcare and long-term care expenditures. Broad subsidies for households and corporations, such as those for utilities and petroleum, should be phased out in favor of more targeted support for low-income households. Furthermore, strengthening the linkages between spending reviews, evidence-based policymaking, and medium-term fiscal planning can improve the efficiency of public spending.
To raise the long-term growth potential of the economy, the government should continue to promote strategic sectors, revitalize regional economies, and strengthen research and development. To tackle labor market challenges, policy efforts could adopt a two-pronged approach: boosting labor productivity through reskilling and upskilling while welcoming foreign workers to address shortages in specific sectors or professions.
About AMRO
The ASEAN+3 Macroeconomic Research Office (AMRO) is an international organization established to contribute toward securing macroeconomic and financial resilience and stability of the ASEAN+3 region, comprising 10 members of the Association of Southeast Asian Nations (ASEAN) and China; Hong Kong, China; Japan; and Korea. AMRO’s mandate is to conduct macroeconomic surveillance, support regional financial arrangements, and provide technical assistance to the members. In addition, AMRO also serves as a regional knowledge hub and provides support to ASEAN+3 financial cooperation.
About AMRO’s Annual Consultation Report
The Annual Consultation Report was prepared in fulfillment of AMRO’s mandate. AMRO is committed to monitoring, analyzing and reporting to its members on their macroeconomic status and financial soundness. It also helps identify relevant risks and vulnerabilities, and assists members, if requested, in the timely formulation of policy recommendations to mitigate such risks.