The International Monetary Fund (IMF) has urged Japan to take immediate action to improve its fiscal health, particularly as the country faces increasing risks from natural disasters and rising social security costs. Nada Choueiri, the IMF’s mission chief for Japan, warned that Japan has limited fiscal flexibility to respond to future shocks and emphasized the need for strategic planning to manage its fiscal spending without further expanding its deficit.
Japan is currently ramping up spending to address a variety of national priorities, including national defense and initiatives to raise the birthrate. However, these efforts come at a time when the country is already grappling with the largest public debt burden among developed nations, compounded by rising financing costs due to the Bank of Japan’s recent rate hikes.
In its Article IV report, the IMF noted that Japan’s deficit is expected to slightly widen to 2.2% of GDP in 2025, from 2.1% in the previous year. This small increase is still considered problematic, with Choueiri urging that the deficit should be on a downward trajectory to ensure long-term fiscal sustainability.
Japan’s debt servicing costs are projected to rise by 25% by fiscal year 2028, a significant concern given that the country’s public debt is already forecast to reach 232.7% of GDP this year. Choueiri emphasized the importance of preparing for future interest rate increases now, to avoid negative surprises in the coming years.
The Japanese government, led by Prime Minister Shigeru Ishiba’s minority coalition, is facing political pressure to increase spending across multiple policy areas. This includes debates in the Diet on raising the ceiling for tax-free income. Meanwhile, the government has passed an extra budget of ¥13.9 trillion ($91.3 billion) to fund its latest economic stimulus package and approved a record ¥115.5 trillion initial budget for the fiscal year starting in April.
On monetary policy, Choueiri supported the Bank of Japan’s gradual approach to normalizing interest rates, noting the importance of flexibility and data dependency. The IMF expects the BOJ to raise rates gradually toward a neutral rate of around 1.5% by the end of 2027. The BOJ recently implemented its third rate hike since March 2024, bringing the policy rate to 0.5%, the highest level since 2008, with further rate increases likely.
While the IMF expressed confidence that Japan is on the right path toward achieving sustainable 2% inflation, Choueiri cautioned that the BOJ must remain flexible and responsive to global uncertainties, particularly given the potential impacts of trade policy shifts from the U.S. under President Donald Trump. Japan’s highly integrated role in the global economy means it must carefully monitor any announcements that could affect its economic outlook.
Choueiri’s comments reflect growing concerns about Japan’s fiscal trajectory and the challenges it faces in balancing domestic needs with the need for sustainable long-term growth.
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