The International Monetary Fund (IMF) has strongly advised Japan to refrain from reducing its consumption tax, citing concerns that such a move would diminish fiscal space and exacerbate existing fiscal risks. Concurrently, the IMF urged the Bank of Japan to continue its gradual interest rate hikes to normalize monetary policy, emphasizing the importance of the central bank’s independence.
The IMF’s recommendations come at a critical juncture for Japan, with Prime Minister Sanae Takaichi‘s administration considering a temporary suspension of the sales tax on food. The Fund cautioned that while targeted measures for vulnerable households are acceptable, a broad sales tax cut would be an untargeted approach that could worsen the nation’s fiscal health. Japan’s public debt is already the highest among major economies, and the IMF projects that interest payments could double between 2025 and 2031 due to rollovers at higher yields.
The IMF commended the Bank of Japan’s (BOJ) decision to exit its massive stimulus program and implement gradual rate hikes. The organization believes these actions are appropriate for controlling inflation, which has exceeded the BOJ’s 2% target for nearly four years. The IMF anticipates that the policy rate could reach a neutral stance by 2027 if the withdrawal of monetary accommodation continues as planned. They stressed the importance of the BOJ’s continued independence and credibility in anchoring inflation expectations.
With a significant portion of Japan’s spending funded by debt, and with the BOJ gradually reducing its bond holdings, the IMF highlighted the need for careful monitoring of market liquidity. The Fund suggested that the BOJ should be prepared to conduct “exceptional targeted interventions,” such as emergency bond-buying operations, if heightened volatility threatens liquidity. The IMF also welcomed Japan’s commitment to a flexible exchange rate regime, viewing it as a tool to absorb external shocks and support price stability.
The IMF noted that risks to Japan’s economic outlook are tilted to the downside. Key domestic risks include weak consumption if real wage growth fails to turn positive. Externally, renewed strains in Japan-China relations were also cited as a potential concern. The organization recommended that any fiscal support measures should be budget-neutral, temporary, and narrowly targeted to specific groups most affected by rising costs or external shocks.