IMF cautions against excessive depreciation in Japanese yen

External shocks are partly to blame for Japan’s slow economic growth but so are the country’s incomplete fiscal and structural reforms, which could result in stagnation and doubts about fiscal sustainability, the International Monetary Fund said in its annual assessment of the world’s third largest economy.

“Over the medium-term, weak domestic demand, and incomplete fiscal and structural reforms could result in stagnation, and doubts about fiscal sustainability” added Luc Everaert, Head of the Japan Division in the IMF’s Asia and Pacific Department, added.

In particular, in its annual so-called Article IV consultation document the Fund pointed out the risk that a stagnant economy could set-off an increase in so-called risk premia for the country, which would “induce immediate mark-to-market losses on banks from their significant government bond holdings”.

At least one veteran economist and bond trader was highly sceptical. Bill Hubard, chief economist at Bankor wrote, “unfortunately, as the press note today, PM Abe seems far busier with national stadiums and national security than economic reforms. Moreover, I’ll wager we will never see that spike in sovereign risk premia: the BoJ would buy every JGB in sight before that ever happened, with JPY seeing the sell-off instead.”

Be that as it may, the IMF saw downside risks to economic growth and consumer price inflation running at about 1.5% over the medium-term.

Hence, the Bank of Japan needed to stand ready to ease monetary policy further, the world’s financial watchdog argued.

However, Everaert's team went on to caution that “further fiscal and structural reforms remain imperative to unburden monetary policy and […] this would also help avoid harming direct competitors through excessive yen depreciation.”