Japan may face deflation through 2011: IMF

WASHINGTON (AFP) – The International Monetary Fund on Wednesday said that Japan would likely wrestle with deflation through 2011 as it struggles to recover from severe recession.
 
“Inflation is projected to remain negative until 2011,” the IMF said in a report.

The IMF sees prices falling 1.1 percent this year, 0.8 percent in 2010 and 0.4 percent in 2011.

The world’s second-largest economy has benefited from authorities’ “well-calibrated response” to the worst recession in decades, said the report on a consultation with Japanese authorities that ended on July 6.

But the IMF directors said authorities will need to ratchet up the battle against recession if downside risks turn out to be real.

A week ago the Washington-based institution raised its outlook for Japan to gross domestic product growth of 1.7 percent in 2010, after a 0.6 percent contraction this year.

Concerns have been growing about the prospect of another bout of deflation in Asia’s largest economy.

Japan was stuck in a deflationary spiral for years after an economic bubble burst in the early 1990s, prompting consumers to postpone spending in the hope of further price drops, further deepening the slump.

The IMF said the outlook for the export-dependent economy was “exceptionally uncertain.”

“A sustained recovery will likely emerge during the course of 2010 but will hinge critically on improvement in overseas lending conditions and trade,” said the report on the so-called Article IV consultation.

But, the IMF warned, “notwithstanding recent signs of stabilization, risks are tilted to the downside due to a deteriorating labor market, still-tight financial conditions, and lingering uncertainties about global growth.”

Japanese authorities should continue to bolster the financial system, particularly by boosting bank profitability and capital and paring risks from their equity holdings.

“At the same time, promoting restructuring of viable but distressed firms could help the economy adjust to the downturn,” it said.

“Going forward, most directors supported additional credit easing measures should downside risks materialize or financial stresses resurface, while minimizing risks to the Bank of Japan?s balance sheet,” the IMF said.

The IMF outlook was in line with those of the Bank of Japan.

The central bank on Wednesday revised downward growth forecasts, to a 3.4 percent contraction in the financial year to March 2010, and growth of 1.0 percent in the next financial year.

“The current financial and economic situation is still severe, but we’ve seen clear signs of an improvement,” central bank governor Masaaki Shirakawa told a news conference.

Shirakawa declined to outline a possible “exit strategy” from the bank’s emergency pump-priming measures.

The IMF report noted that the Bank of Japan has “sufficient instruments” to conduct an orderly exit.

“The challenge will be to assess the appropriate timing and to clearly communicate the exit strategy to guide expectations,” it said.

“A few directors suggested that clarifying the horizon over which inflation is expected to return toward the Bank of Japan?s understanding of price stability could anchor expectations.”