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IMF to BOJ: You are too optimistic on Japan

Bank of Japan headquarters in Tokyo
Yuriko Nakao | Bloomberg | Getty Images
Bank of Japan headquarters in Tokyo

The International Monetary Fund warned the Bank of Japan will take longer than it expects to hit its inflation target even with more monetary easing, and said "bolder" structural reforms are required to shake off an entrenched deflationary mindset.

In a statement after "Article 4" consultations with Japanese policymakers released on Friday, the IMF urged Prime Minister Shinzo Abe to speed up fiscal reform and not rely on "overly optimistic" estimates in fixing the country's finances.

The value of the yen on a real, effective basis has broadly stabilised after weakening somewhat during the second half of 2014, it said.

"Without bolder structural reforms and credible fiscal consolidation, domestic demand could remain sluggish, and any further monetary easing could lead to overreliance on the depreciation of the yen," the IMF said.

Since deploying "quantitative and qualitative easing" (QQE) in April 2013 and expanding it in October last year, the BOJ has stood pat on policy on the view the economy will recover enough to nudge inflation to its 2 percent target.

But inflation ground to a halt on falling oil costs and soft consumption, keeping alive expectations of more easing later this year.

The IMF said that while there is not much slack left in the economy, lower energy costs and "deep entrenchment" of the deflationary mindset were keeping inflation subdued.

Inflation expectations have been broadly flat at around 1 percent in recent months, suggesting the "regime shift" desired by the BOJ has not yet materialized, it said.

"The monetary transmission is weak so that even with further easing, reaching 2 percent inflation in a stable manner is likely to take longer than envisaged by the BOJ," the IMF said.

The comments contrast with the BOJ's view that the flood of money it is pumping will spur inflation expectations and encourage households to boost spending.

'Incomplete reforms'

Having pushed back the timing for hitting its price target last month, the BOJ now expects inflation to hit 2 percent by around September next year, a forecast analysts still see as too optimistic.

Given the delay in lifting inflation, the BOJ must stand ready for further easing such as through steps like increasing asset buying, targeting assets with longer durations and cutting a 0.1 percent floor set on market rates, it said.

The IMF warned that the biggest risks for Japan came from weak domestic demand and "incomplete" fiscal policy and growth strategies.

Abe will release a fiscal consolidation plan next month with the goal of returning to a primary surplus in fiscal 2020 and then lowering the debt-GDP ratio, which is among the worst for advanced economies.

The economic assumptions behind the government's fiscal policy have been "overly optimistic" and risk hurting market trust in Japan's resolve to fix its finances, the IMF said.

"A concrete and credible medium-term plan would remove uncertainties about fiscal intentions, which could be hampering domestic demand, and help to respond to downside risks," it said.