IMF urges Japan: should avoid cutting consumption tax to avoid exacerbating fiscal risks.

As Japanese Prime Minister Takashimaya Sanae prepares to accelerate discussions about the possible suspension of the food consumption tax, the International Monetary Fund (IMF) has stated that Japan should avoid lowering the consumption tax to prevent exacerbating fiscal risks. In its latest concluding statement released on Wednesday, the IMF stated, "Japanese authorities should avoid reducing the consumption tax, as it is an untargeted measure that could erode fiscal space and increase fiscal risks." The IMF also predicted that by 2031, interest payments on Japan's public debt will double from 2025 as a result of needing to refinance maturing debt at higher yields. The IMF warned, "High and sustained debt levels, coupled with deteriorating fiscal conditions, are exposing the Japanese economy to a range of shocks." The IMF's forecast aligns with estimates from the Japanese government. Japanese authorities project that by the fiscal year 2029, the country's interest payments will double from the current year to 21.6 trillion yen, assuming a nominal annual economic growth rate of 3%. Officials also anticipate that debt service costs will rise from 28.2 trillion yen to approximately 41.3 trillion yen during this period. The IMF's recommendations come as Takashimaya Sanae is preparing to accelerate discussions on whether to suspend the two-year food consumption tax. Takashimaya Sanae had previously pledged to expedite this discussion, ultimately leading the Liberal Democratic Party to a historic election victory. Following the election, Takashimaya Sanae stated that the plan would not require additional borrowing to offset the projected annual loss of 5 trillion yen (US$47 billion) in revenues. The IMF acknowledges that limiting the tax suspension to food and keeping it temporary will help mitigate fiscal impacts. However, the IMF believes that more effective price support measures should be budget-neutral, time-bound, and targeted at vulnerable households and businesses. In terms of broader fiscal policy, the IMF urges Japan to adopt a credible medium-term framework with clear fiscal objectives. Takashimaya Sanae stated that her government will focus on reducing the country's debt-to-GDP ratio to effectively achieve the long-term goal of achieving a primary budget surplus a more challenging standard. Furthermore, the IMF calls on the government to control additional budgets to reduce the risk of sudden fluctuations in the Japanese government bond market. Japanese government bonds faced pressure in the first few months after Takashimaya Sanae took office in October last year, as investors feared that her expansionary policies could worsen fiscal issues. A sell-off in January led to long-term Japanese government bond yields exceeding 4%. The Japanese government bond market has been relatively calm after the election, as Takashimaya Sanae has reassured investors multiple times that her policies will remain prudent. Regarding monetary policy, the IMF stated that the Bank of Japan should continue to progress with policy normalization, expecting interest rates to rise to a neutral level of 1.5% by 2027. Most economists expect the Bank of Japan to maintain the benchmark interest rate at 0.75% at its next policy meeting on March 19, with many expecting a rate hike next month. The IMF "welcomes" the actions taken by the Bank of Japan over the past year, noting that after pausing rate hikes during global uncertainty, it resumed tightening policies in December as confidence in inflation outlook gradually returned. The IMF expects that Japan's key price indicators will reach the Bank of Japan's 2% target by 2027, although pressure on prices will ease when the effects of food and energy temporarily subside in 2026. Recent data shows that key inflation indicators have remained above 2% for four consecutive years until 2025, and data to be released next week is expected to show a slowdown in January's inflation growth to this threshold. The IMF also stated that the Bank of Japan's independence and credibility are crucial to maintaining stable inflation expectations. Additionally, the IMF welcomes Japan's continued commitment to a flexible exchange rate regime. This comment comes after finance officials warned of recent sharp fluctuations in the yen, with reports mentioning that interventions in January led the yen to appreciate from 159 to 152 against the US dollar within hours. The IMF stated, "Exchange rate flexibility should continue to help absorb external shocks and support monetary policy focus on price stability." It is worth noting that IMF representative Rahul Anand stated on Wednesday that the IMF does not hold a view on the appropriate level of the yen, as the value of the yen is determined by market forces. He stated during an online press conference, "In an open economy with capital accounts, the value of the yen is subject to fluctuations. Japanese authorities are committed to maintaining a flexible exchange rate system." "Therefore, the price or value of the yen is determined by market forces...we believe there is no such thing as a 'correct' level for the yen." When asked under what conditions Japan might intervene in the currency market to support the yen, Rahul Anand stated, "We cannot speculate on the authorities' future actions."