(EnergyAsia, June 21 2012, Thursday) — The Japanese economy is experiencing a solid recovery from the effects of the March 2011 earthquake-tsunami tragedy, but the European debt crisis is likely to dampen demand for the country’s exports, and weigh on business sentiment, said the International Monetary Fund (IMF).

The fund’s First Deputy Managing Director, David Lipton, said reconstruction spending and stronger private consumption will enable the world’s third largest economy to grow by 2% this year and 1.75% in 2013.

Mr Lipton and an IMF team gave this assessment after visiting Japan for its annual economic health check.
Japan’s headline inflation remains near zero percent, but the exchange rate has appreciated over the last year, partly because of inflows of capital seeking a safe haven. IMF economists believe the Japanese yen is moderately overvalued from a medium-term perspective.
For the long term, the team said Japan faces “many longstanding challenges” including tackling its high public debt, low growth and deflation.

To make “meaningful” progress in tackling these issues, Mr Lipton said Japan needed to “move forcefully on many fronts to take advantage of synergies between policies. This includes a combination of fiscal, structural, and monetary policies.”

The Japanese government must immediately focus on its “deep-rooted fiscal problems.”

Over the last 20 years, the country’s net public debt has increased tenfold, fuelled by a rapid rise in social security spending. The IMF believes that tax and social security reforms are crucial to demonstrate a commitment to fiscal reform and sustain investor confidence.

Mr Lipton said: “Our estimates suggest that Japan will need to achieve an overall fiscal consolidation of about 10% of GDP over the next decade.” This will require a “bold and comprehensive” package of structural reform to help reduce the public debt-to-GDP ratio, as well as raise potential growth.

The IMF said reforms should focus on the most important constraints to growth including the aging labor force, low female labor force participation, domestic sector regulations and the limited availability of risk capital.

It has called for additional easing to increase the likelihood of achieving the 1% inflation goal by 2014 under the IMF staff’s baseline scenario that could help reduce lending rates further, and raise inflation expectations.