The International Monetary Fund said Thursday the coronavirus pandemic is unlikely to have "significant scarring effects" on Japan, but the world's third-largest economy needs to work on post-pandemic policies to ensure sustainable growth despite its rapidly aging and shrinking population.
Following consultations with the Japanese government on economic developments and policies, the IMF also said the country's tax revenues as a percentage of gross domestic product are low relative to the Group of Seven industrialized nations, leaving room for "increased revenue mobilization" such as through consumption tax rate hikes.
The Washington-based institution holds regular consultations with member countries, usually annually. The pandemic, however, has caused a delay in the schedule, making the latest assessment report on Japan the first since February 2020.
In the report describing the preliminary findings, the IMF estimated that Japan's growth will accelerate to 3.3 percent in 2022 following a 1.6 percent rise, on the back of continued strong fiscal support, a high COVID-19 vaccination rate, and the easing of pandemic-related global supply constraints. The economy suffered a 4.5 percent contraction in 2020.
While the current surge of the highly transmissible Omicron variant in Japan could slow the growth momentum in the first quarter of 2022, a "strong rebound" is expected in the second quarter as the wave dissipates, the IMF said.
But it also warned of the "unusual uncertainty around the pandemic," touching on a possible delay in the recovery of services consumption if strict containment measures become necessary in response to an overwhelmed health sector amid the spread of Omicron.
While acknowledging the need for fiscal policy support in the near term to prevent permanent economic damage from the pandemic, the IMF said a stimulus package announced by the Japanese government in November could have been "better targeted" such as by lowering the income threshold for cash transfers to child-rearing households.
In the medium to long term, Japan's aging and declining population will continue to weigh on the economy, the IMF said, forecasting real GDP growth to converge with its potential of 0.5 percent.
Ranil Salgado, assistant director of the IMF's Asia and Pacific Department who led the IMF's mission to Japan, said a "possible shrinking labor force and low productivity growth are two of the main challenges faced by the Japanese economy over the longer term."
The exceptional fiscal support and the sharp output drop during the pandemic raised Japan's debt-to-GDP ratio from 236 percent in 2019 to 259 percent in 2021.
While debt rollover and issuance risks are "contained" in the near term, helped by a large domestic savings base and other factors, debt sustainability risks will rise as demographic trends weigh on the medium and long term, with healthcare and long-term care spending expected to continue rising, the IMF said.
To raise revenues, the IMF laid out options to explore including raising the current 10 percent consumption tax rate, without specifying the exact level, and strengthening property taxation through the removal of preferential treatment of residential land.
Inflationary pressure, meanwhile, is expected to rise gradually in line with domestic demand, but medium-term inflation is projected to remain well below the Bank of Japan's 2 percent target, according to the IMF.
"In this regard, we strongly support the Bank of Japan's commitment to accommodative monetary policy until inflation is durably above target," Salgado said.
While other advanced economies are experiencing higher inflation and monetary tightening is expected or already under way, the IMF official said monetary policy divergence will likely have limited effects on Japan's recovery, while interest rate differentials could weaken the yen further.
A weaker yen would be a boon for export-oriented firms, as their overseas profits would gain a boost when repatriated.
At the same time, a sharp tightening of global financial conditions could lead to "heightened risk aversion" and trigger an appreciation of the yen, which is perceived as a safe-haven, the official added.