Japan's Fiscal Responsibility and Monetary Policy

By Leika Kihara

TOKYO (Reuters) – Japan must fund any additional spending plans within its budget rather than issuing more debt, the International Monetary Fund (IMF) stated on Friday. The IMF urged the government to improve fiscal discipline as the central bank prepares to raise interest rates.

"Given the fact that monetary policy normalization is happening, it puts the onus on the fiscal side to actually embark on consolidation, which is, in my opinion, long overdue," said Krishna Srinivasan, director of the IMF's Asia and Pacific Department, in an interview with Reuters.

Japanese Prime Minister Shigeru Ishiba has committed to creating a large-scale spending package to alleviate the impact of rising living costs on households. However, he has yet to comment on funding sources for this spending.

"Any kind of support you're providing should be a lot more targeted, and any kind of new initiative should be financed within the budget," Srinivasan advised. "You should not be increasing more debt to provide for any new initiative."

On the topic of monetary policy, Srinivasan recommended that the Bank of Japan (BOJ) raise interest rates in a "gradual" and "data-dependent" manner due to both upside and downside inflation risks.

The BOJ maintained ultra-low interest rates on Thursday but indicated that risks surrounding the U.S. economy are somewhat easing, signaling readiness to raise rates again.

BOJ Governor Kazuo Ueda has stated that the central bank will continue to raise interest rates, currently at 0.25%, if Japan progresses towards its 2% inflation target.

"I think the BOJ is doing the right thing. It's doing everything possible to ensure inflation and inflation expectations are anchored at 2% over the policy horizon," remarked Srinivasan.

A prolonged period of ultra-low rates in Japan has contributed to the recent depreciation of the yen. This currency weakness is adversely affecting retailers and households by increasing the cost of imported fuels and raw materials.

Japanese authorities have described the yen's recent movements as "one-sided" and sharp, issuing warnings to investors against further downward pressure on the currency.

Srinivasan noted that currency markets could face volatility amid significant uncertainties regarding the economic prospects of Japan and the United States, along with factors that might amplify movements, such as an unwinding of yen carry traders.

"But broadly speaking, I think they're fully committed to the flexible exchange rate regime," he added, referring to Japanese authorities' approach to yen fluctuations.

Japan's public debt, which is double the size of its economy, is the largest among major countries, largely due to extensive past spending packages and increasing social welfare costs stemming from a rapidly aging population.