IMF warns: Japan needs to immediately cut its deficit to repair its fiscal trajectory.

Notice, the International Monetary Fund has stated that with the increasing risk of natural disasters and continuous rise in social security costs, Japan must take immediate action to improve its fiscal situation. IMF Japan mission chief Nada Choueiri 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 the space to meet fiscal expenditure needs without increasing the deficit." As the IMF issued its warning, Japan is increasing spending to meet a range of needs from strengthening defense to boosting birth rates. Meanwhile, due to the Bank of Japan's interest rate hike last year, its financing costs are slowly rising. Japan's public debt burden is already the highest among developed countries. In its fourth report released on Friday, the organization stated that there is a "significant" risk of further widening the deficit for the minority government led by Prime Minister Shizo Abe. The organization predicts that by 2025, Japan's basic deficit will slightly increase to 2.2% of GDP, compared to 2.1% last year. "Although the situation has slightly deteriorated, it is still heading in the wrong direction," Choueiri said. "The medium-term deficit needs to be declining to ensure the sustainability of the fiscal account." The Japanese Ministry of Finance estimated last month that assuming an annual economic growth rate of 3% and an inflation rate of 2%, by the fiscal year 2028, Japan's debt servicing costs are expected to increase by 25% compared to next year. According to the report released on Friday, the IMF forecasts that Japan's public debt size will reach 232.7% of GDP this year. Choueiri stated, "The government needs to prepare for rising yields now, because you don't want negative surprises four or five years from now," pointing out that gradual interest rate hikes can mitigate current risks. At the same time, the weakening of the ruling minority government has given the opposition the courage to push for increased spending in multiple policy areas, including ongoing parliamentary debates involving raising the limit on tax-exempt income. IMF First Deputy Managing Director Gita Gopinath said in a news conference on Friday, "Parliament is in close deliberation, and we look forward to actual measures. But we strongly recommend Japan to start fiscal consolidation now, which is very important." The Shizo Abe government passed an additional budget of 13.9 trillion yen (US$913 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 parliamentary discussions will indicate the beginning of the integration process of the fiscal situation." Regarding monetary policy, Choueiri supported the Bank of Japan's gradual normalization of interest rates, emphasizing the importance of flexibility and data dependence. She stated that the IMF still expects rates to gradually rise to around 1.5% by the end of 2027. The Bank of Japan raised interest rates for the third time since March 2024 last month, raising the policy rate to 0.5%, the highest level since 2008. Bank of Japan Governor Haruhiko Kuroda said at a news conference after the decision that there is still room for further rate hikes and that the bank is still far from the neutral rate. The IMF stated in the report that after nearly 30 years of near-zero inflation, there are signs that the Japanese economy can move towards a new balance in a sustainable manner. Choueiri said that she is increasingly confident that Japan will achieve stable inflation in the medium term, citing recent signs of strengthening inflation expectations and price pressures driven by consumer demand. "These are indications of recovery that make us believe we are moving towards our sustainable 2% inflation target." However, she warned that given factors such as global economic uncertainty, the Bank of Japan should maintain caution and flexibility in 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 drag down global trade. So far, the U.S. has not indicated any tariff actions against Japan ahead of the meeting between Shizo Abe and Trump later on Friday. "We will continue to watch and monitor these announcements," Choueiri said. "As Japan is highly integrated with the global economy, we need to pay attention to how any announcement will impact its economy."