IMF warns: Japan needs to cut deficits immediately to restore fiscal path

The Zhitong Finance APP noted that the International Monetary Fund (IMF) stated that Japan must take immediate action to improve its fiscal situation as the risks of natural disasters increase and social security costs continue to rise.

Nada Choueiri, head of the IMF's Japan division, warned in an interview in Tokyo on Thursday, "Japan currently has limited space to respond to shocks." She added, "Japan now needs to plan how to find space to meet fiscal spending needs without increasing the deficit."

As the IMF issued its warning, Japan is increasing spending to meet a range of demands, from strengthening national defense to boosting birth rates. Meanwhile, financing costs are slowly rising due to the Bank of Japan's interest rate hikes last year. Japan's public debt burden is already the highest among developed countries.

In a report released on Friday, the organization stated that given the political pressures faced by Prime Minister Shigeru Ishiba's minority government, the risk of Japan's deficit further expanding is "high." The organization predicts that by 2025, Japan's primary deficit will slightly widen to 2.2% of GDP, up from 2.1% last year.

"Although the situation has slightly worsened, it is still in the wrong direction," Choueiri said. "In the medium term, the deficit needs to trend downward to ensure the sustainability of fiscal accounts."

Japan's Ministry of Finance estimated last month that assuming an annual economic growth rate of 3% and an inflation rate of 2%, Japan's debt repayment costs are expected to increase by 25% by fiscal year 2028 compared to next year. According to Friday's report, the IMF predicts that this year Japan's public debt will reach 232.7% of GDP.

Choueiri stated, "The government now needs to prepare for rising yields, as you do not want negative surprises four or five years down the line," while noting that gradual interest rate hikes can alleviate immediate risks.

Meanwhile, the weakening status of the ruling minority government has emboldened opposition parties to push for increased spending in several policy areas, including ongoing parliamentary debates regarding raising the tax-exempt income threshold.

IMF First Deputy Managing Director Gita Gopinath stated at a press conference on Friday, "The parliament is in close consultation, and we will wait to see actual measures. But we strongly advise Japan to start fiscal consolidation now, which is very important."

Shigeru Ishiba's government passed an additional budget of 13.9 trillion yen (approximately $91.3 billion) to fund the country's latest economic stimulus plan, and the cabinet also approved a record initial budget of 115.5 trillion yen for the fiscal year starting in April.

Gopinath said, "We hope the outcome of the parliamentary discussions will indicate that the fiscal situation has begun to show signs of consolidation."

Regarding monetary policy, Choueiri expressed support for the Bank of Japan's gradual normalization of interest rates and emphasized the importance of flexibility and data dependence. She stated that the IMF still expects interest rates to gradually rise to around 1.5% neutral rate by the end of 2027 The Bank of Japan raised its policy interest rate to 0.5% last month, marking the third increase since March 2024 and the highest level since 2008. Bank of Japan Governor Kazuo Ueda stated at a press conference following the decision that further rate hikes are possible and that the bank is still some distance from a neutral interest rate.

The IMF reported that after experiencing nearly zero inflation for 30 years, there are signs that the Japanese economy is moving towards a new balance in a sustainable manner.

Choueiri expressed her increasing belief that Japan will achieve stable inflation in the medium term, citing recent signs of rising inflation expectations, consumption growth, and demand-driven price pressures. "These are all signs of recovery that reinforce our confidence that we are moving towards a sustainable 2% inflation target."

However, the official warned that given factors such as global economic uncertainty, the Bank of Japan should remain cautious and flexible regarding the scale and timing of interest rate hikes. A key issue is the series of tariff-related measures announced by U.S. President Trump, which could weigh on global trade. So far, the U.S. has not indicated any tariff actions against Japan ahead of Shigeru Ishiba's first meeting with Trump later on Friday.

"We will continue to observe and pay attention to these announcements," Choueiri stated. "Given Japan's high integration with the global economy, we need to monitor how any announcements will impact its economy."