The International Monetary Fund on Friday backed the massive monetary easing program launched by the Bank of Japan in April and said the economic recovery is gaining traction.
While applauding the government's ambitious growth strategy outlined by Prime Minister Shinzo Abe, dubbed "Abenomics", the IMF said Japan needs to adopt a complete package of fiscal and growth reforms to achieve its present policy targets. The lender also noted that Abe's new policy framework is bearing fruit.
Commenting on the exchange rate, the IMF said that the recent depreciation of the yen is not problematic. "So long as monetary easing pursues domestic goals, and is accompanied by comprehensive fiscal and structural reforms," the Fund said.
It also noted that compared to the average level in 2012, the yen has depreciated by about 20 percent in real effective terms by April 2013 as a result of aggressive monetary easing, higher energy imports, reduced safe-haven effects, and the expected widening of interest rate differentials with the U.S.
IMF projects GDP growth of 1.6 percent for 2013. The Fund said in the report that it expects activity to become increasingly private-demand driven, led by a recovery of exports and investment and a front-loading of domestic demand ahead of the 2014 consumption tax increase.
Because of the rising impetus of private demand, growth in 2014 will slow but only moderately to 1.4 percent despite fiscal consolidation resulting from the planned consumption tax increase and the unwinding of reconstruction spending, the report added.
IMF expects headline CPI to rise 0.1 percent this year and 1.3 percent in 2014, nearing BoJ's target of 2 percent. A report from the Statistics Bureau today showed that the all-items index fell 0.7 percent in the year through April and the core CPI fell 0.4 percent.
The report noted that though the near-term recovery and the pass-through from the yen depreciation to domestic prices will create inflationary pressure, the effects are likely to be small. Apart from this, Japan needs credible medium-term fiscal and growth reforms to achieve the goal, it said.
IMF commended the BoJ's efforts to contain excessive volatility in the government bond market, but said the bank faced uncertainty in weighing the relative effects of the purchases and the prospect of higher inflation down the road.
Separately, BoJ Deputy Governor Hiroshi Nakaso said the latest steps taken by the BoJ "will lead to the stable formation of long-term interest rates by suppressing excessive rise in interest rates and heightened volatility."
On Thursday, the BoJ said it will increase the frequency of Japanese government bond purchases 8 to 10 times per month and may increase it further as needed.
Nakaso said positive moves have started to take place in the economy, driven by the Bank's quantitative and qualitative monetary easing. "Positive economic activity and a change in expectations will induce an improvement in the real economy and a rise in the expected rate of inflation, paving the way to the achievement of the 2 percent price stability target."
The policymaker noted that to continue with the easing measures, it needs to be recognized by the public that the bank's purchase of JGBs is carried out solely to achieve the price stability target and not to finance the fiscal deficit.
"To that end, it is critical to maintain fiscal credibility," he said. "We strongly expect the government to move on that front," Nakaso added.
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