Japan Urged to Address Fiscal Risks Amid Spending Pressures
Japan faces an urgent need to improve its fiscal health as it grapples with natural disasters and rising social security costs, according to the International Monetary Fund (IMF).
In a recent interview, Nada Choueiri, the IMF's Japan mission chief, warned that the country's fiscal space is limited, making it vulnerable to shocks. She emphasized the need for proactive planning to accommodate future spending needs without increasing deficits.
The IMF's concerns arise amid Japan's increasing expenditures on defense, birthrate promotion, and other initiatives. These expenses are compounded by rising interest rates stemming from the Bank of Japan's recent rate hikes. Japan already holds the highest public debt among developed nations.
The IMF's Article IV report, released on Friday, projects a slight widening of Japan's primary deficit to 2.2% of GDP in 2025, up from 2.1% in 2024. "This is a small deterioration, but it's the wrong direction," said Choueiri. "The deficit needs to decrease over the medium term to ensure fiscal sustainability."
According to a finance ministry estimate, Japan's debt servicing costs are expected to surge by 25% by fiscal year 2028, assuming a 3% economic growth and 2% inflation. The IMF forecasts public debt to reach 232.7% of GDP this year.
"The government needs to prepare for rising yields today to avoid unexpected consequences in the future," said Choueiri, although she acknowledged the gradual pace of rate hikes mitigates immediate risks.
Meanwhile, the ruling minority government's weakened position has emboldened opposition parties to demand increased spending. The ongoing parliamentary debates include proposals to raise the ceiling on tax-free income.
"We are closely monitoring the parliamentary negotiations," said Gita Gopinath, the IMF's first deputy managing director. "We strongly advise Japan to initiate fiscal consolidation now."
Prime Minister Shigeru Ishiba's government has approved a ¥13.9 trillion supplementary budget for economic stimulus, and a record ¥115.5 trillion initial budget for the fiscal year starting in April.
"We hope the parliamentary discussions will lead to a fiscal position that begins the consolidation process," said Gopinath.
On monetary policy, Choueiri expressed support for the Bank of Japan's gradual normalization of interest rates, emphasizing flexibility and data dependency. The IMF expects rates to rise steadily toward a neutral rate of around 1.5% by 2027.
Recent data suggests that Japan's economy may be transitioning to a sustainable inflationary equilibrium, according to the IMF report. Choueiri expressed confidence in Japan's ability to achieve stable inflation over the medium term, citing strengthening inflation expectations, consumption growth, and demand-driven price pressures.
However, she cautioned that the BOJ should remain vigilant and adaptable in adjusting the size and timing of rate increases, considering uncertainties in the global economy, including potential tariff announcements from the US.