SINGAPORE, February 22, 2019 – The Japanese economy is expected to maintain moderate growth around its potential amid headwinds from global trade conflicts and domestic structural challenges, according to the 2018 Annual Consultation Report on Japan published by the ASEAN+3 Macroeconomic Research Office (AMRO) today. The report was prepared on the basis of AMRO’s Annual Consultation Visit to the country in October/November 2018 and data availability as of December 28, 2018.

The Japanese economy is projected to grow at 0.8 percent in FY2018 before easing to 0.7 percent in FY2019 [Footnote 1]. Notwithstanding shocks from bad weather and natural disasters, the economy is expected to grow moderately in FY2018 reflecting buoyant domestic and external demand. Growth in FY2019 also would be moderate due to the scheduled consumption tax hike in October 2019, and spillovers impacts from the U.S.-China trade conflicts.

Consumer Price Index (CPI) inflation – excluding fresh food – is expected to rise moderately to 0.9 percent in FY2018 and 1 percent in FY2019. Given lagged adjustments in wages and goods prices amid low inflation expectations of around 1 percent, it is unlikely that inflation will reach the Bank of Japan’s 2-percent target in the near- to medium-term.

The external position remains strong given the significant current account surplus, supported by large primary income inflows. Meanwhile, capital outflows continue to be driven by residents’ outward investments in search of higher returns amid the sizable current account surplus.

The overall financial condition remains accommodative amid very low interest rates. However, the prolonged low interest rate environment and intensified competition among financial institutions continue to depress net interest margins, thereby exerting downward pressure on the banking sector’s core profitability.

Fiscal consolidation has lagged behind schedule and fiscal policy has remained expansionary. Nonetheless, the overall fiscal deficit has been reduced slightly, reflecting strong tax revenue collection owing to robust economic growth and lower interest expense. However, the target to achieve a primary surplus of the central and local governments has now been shifted beyond FY2020 to FY2025.

Downside risks to the near-term outlook have intensified, mainly due to external risk factors. These include a further escalation of the U.S.-China trade conflicts and a sharper-than-expected economic slowdown in major trading partners. Domestically, the scheduled consumption tax hike in October 2019 may cause demand fluctuation, while mitigating measures will be implemented. Structural challenges include demographic headwinds from population aging, weakening of fiscal discipline, and prolonged easing of the monetary policy.

In this context, fiscal policy should prioritize restoring fiscal sustainability, while addressing the short-term negative impact from the scheduled consumption tax hike. A comprehensive and consistent medium-term fiscal consolidation plan should be formulated, based on realistic macroeconomic scenarios with a strong commitment to cope with structural challenges.

The current accommodative monetary policy could be maintained for an extended period. However, the policy should be constantly reviewed and recalibrated to address critical issues such as the achievability of the 2-percent-inflation target and its adverse side-effects on financial markets and financial institutions. The authorities should also enhance its supervision of risk-taking behaviors and the potential build-up of credit risks by financial institutions in light of growing loans against a backdrop of narrowed interest margins.

Structural reforms focused on tackling demographic challenges should be enhanced and implemented in a credible and bold manner. The authorities’ proactive approach toward ‘Human Resource Development’ and ‘Supply System Innovation’ is commendable. Embracing foreign workers will also contribute to enhancing the growth potential of the economy and facilitate the demographic transition. Continued efforts in support of trade multilateralism will contribute to sustaining the growth momentum by expanding markets.

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[Footnote 1] In the baseline projection, the effect of temporary offsetting measures including temporary fiscal stimulus (worth JPY2 trillion) is not considered. If these measures are successfully implemented, they may pose upside risks to the growth outlook in FY2019.

About AMRO and AMRO’s Annual Consultation Report:

The ASEAN+3 Macroeconomic Research Office (AMRO) is an international organization established to contribute towards securing macroeconomic and financial stability of the ASEAN+3 region, which include 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 the implementation of the regional financial arrangement, the Chiang Mai Initiative Multilateralisation (CMIM), and provide technical assistance to the members.

The Annual Consultation Report was prepared in fulfilment 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.