The International Monetary Fund (IMF) formally opposed a tax cut on consumption that the Japanese government is pursuing. Citing concerns that it could harm fiscal soundness, the IMF put the brakes on Prime Minister Sanae Takaichi's campaign pledge for a "temporary exemption of the consumption tax on food."
The IMF, in a statement released on the 18th after concluding its annual consultation (Article IV) with Japan, said, "The Japanese authorities should avoid a reduction in the consumption tax." The IMF warned that a consumption tax cut is an "untargeted measure" that would "erode fiscal space and heighten fiscal risks."
The recommendation runs counter to the economic policy being pushed by the Takaichi Cabinet. Prime Minister Takaichi recently led the Liberal Democratic Party to a sweeping victory in the election. Among the key pledges was a plan to suspend the 8% consumption tax on food for two years on a temporary basis. Takaichi has signaled plans to accelerate discussions to make it happen.
The IMF expressed concern that the interest on Government Bonds that Japan must bear is surging. Rahul Anand, the IMF's Japan mission chief, said at a news conference that "debt service expense and welfare expense will continue to increase and ultimately worsen Japan's liability level from where it is now." Anand in particular projected that the cost of funding public liability would double as interest rates rise.
Director General Anand said of the Takaichi government's tax cut plan, "We do not support that approach." Instead, he said, "Targeted support or cash transfers for vulnerable groups are more effective." The logic is that cutting the consumption tax is an inefficient method that benefits even the wealthy. Anand advised, "Japan needs to secure fiscal space to respond to shocks," and to "refrain from short-term fiscal easing policies."
However, on currency policy, it backed the Bank of Japan. The IMF assessed that it is appropriate for the Bank of Japan to raise rates gradually based on data. The IMF projected that the Bank of Japan will raise rates twice this year and once more in 2027, reaching the neutral rate of 1.5% in 2027.
The IMF also mentioned potential volatility in Japan's Government Bonds market. Director General Anand said, "There is still no evidence that foreign investors have pulled back demand for Japanese Government Bonds due to fiscal concerns," but added that market liquidity must be closely monitored as the Bank of Japan reduces its Government Bonds purchases.