Japan near-term economic outlook better

The near-term outlook for Japan's economy is improving although an ageing population and slow underlying economic growth pose medium-run dangers, the International Monetary Fund said.

In its report prepared July 29 and released overnight (NZ time), the IMF also welcomed a plan to privatise Japan's postal system -- an effort defeated in parliament earlier in the day, prompting Prime Minister Junichiro Koizumi to call a snap election.

The fund said Japan's economy has performed well so far this year, with recent indicators of retail sales, investment plans and employment growth heralding further expansion ahead. However, mild downward pressure on prices has persisted.

"The financial system has been stabilised, the corporate sector is more resilient, labour markets have become more dynamic and fiscal consolidation is under way. As a result, the economy appears better positioned to sustain an expansion," the fund's executive directors said.

The IMF forecast growth of 1.8 per cent in Japan's economy in 2005 and a decline of 0.4 per cent in the consumer price index. Japan's economy grew 2.6 per cent last year on a seasonally adjusted basis while consumer prices were flat.

The fund saw Japan's unemployment rate falling to an average of 4.4 per cent in 2005 from 4.7 per cent in 2004.

"Nonetheless, directors noted that low trend growth and rising demographic pressures pose risks to medium-term prospects," the IMF said, urging Japanese authorities to step up fiscal and structural reform.

"Directors acknowledged that implementing such reforms will be difficult, but emphasised that they would strengthen the domestic economy and, together with concerted policy efforts in other countries to address external imbalances, contribute to making the global economy more resilient," the fund said.

Better balance in the world economy would cut the risk of a "disorderly adjustment" in currency markets, the IMF said.

Japan intends to achieve primary budget balance, excluding social security, by early in the next decade.

"A number of directors agreed that a steady and gradual reduction in the deficit is appropriate, to minimise any negative impact on the still-nascent economic recovery," the IMF said.

"Many other directors, however, observed that a larger adjustment may be required to stabilise the debt, especially if real interest rates rise more than expected in the future." A bigger debt reduction would require tough steps on both the revenue and spending side, but the directors said these should be manageable given the Japanese economy's improved tone.

The fund said the Bank of Japan must stay focused on vanquishing deflation, welcoming its pledge to remain accommodative until actual and expected prices rise.

Directors were divided over the usefulness of a formal inflation target.

"Some directors supported the announcement of a quantified inflation objective to stabilise inflation expectations once deflation is incontestably defeated," the IMF said.

"Others noted that, in the current situation, the benefits of announcing an inflation target might be limited, in light of the uncertainties about the effectiveness of the monetary policy transmission mechanism," it added.

There were similar divisions about the merit of currency intervention, which Japan has not engaged in since early 2004.

Some directors said intervention could be a last resort if the yen rose high enough to threaten the economy while most others said the economy was in better shape to handle a stronger currency, which can make it tougher for a country's exporters to compete.

These directors, the IMF said, "cautioned that intervention should only be used under extraordinary circumstances."

- REUTERS