IMF - International Monetary Fund
IMF - International Monetary Fund
02/17/2026 | Press release | Distributed by Public on 02/17/2026 17:47
February 17, 2026Japan: Staff Concluding Statement of the 2026 Article IV Mission
Japan: Staff Concluding Statement of the 2026 Article IV Mission
February 17, 2026
A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or 'mission'), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF's Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.Washington, DC[1] - The Japanese economy has displayed impressive resilience in the face of global shocks and is experiencing a sustained period of output growing above potential. Domestic demand has been robust and unemployment remains low. After three decades of near-zero inflation, prices have been growing faster than the BOJ's 2-percent target for three and a half years. While nominal wages are rising at a historic pace, there are persistent concerns about the cost of living as high inflation erodes household purchasing power. Japan continues to face challenges from its aging population and high public debt. With the output gap positive and inflation expected to converge to target from above, fiscal and monetary policies should be calibrated to sustain price and output stability, while rebuilding fiscal buffers. Reforms to the labor market are needed to ensure that labor market tightness translates into sustained real wage gains.
RECENT DEVELOPMENTS, OUTLOOK, AND RISKS
Growth has been resilient, recovering to exceed potential in the first half of 2025, but has started to moderate. Despite elevated uncertainty and the introduction of U.S. tariffs, domestic demand has remained firm, with business investment and consumption strong. Inflation was stronger than expected in 2025, boosted by soaring rice prices, and inflationary pressures have broadened across products. Services inflation has been more moderate, while yen depreciation has had a limited impact on headline inflation, with import prices declining on average in 2025. Medium-term inflation expectations have been rising and are gradually realigning with the BOJ's target. Labor market tightness is supporting higher nominal wage growth than has been seen in decades, but real wages have continued to contract as headline price increases outpace wage gains.
Economic activity is projected to remain strong in 2026, but to moderate due to weaker external demand. Private investment is expected to strengthen further despite gradual tightening of financial conditions, while private consumption will be supported by a gradual rise in real wages as inflation eases and labor shortages persist. The fiscal stance is expected to turn expansionary in 2026, based on staff's working assumption that past practice on supplementary budgets will continue. Above-potential growth in 2025-26 is leading to a positive output gap that is projected to close by end-2027 as monetary and fiscal policies become neutral. Inflation is expected to moderate in 2026 and converge toward the BOJ's target in 2027, reflecting easing global oil and food prices, stabilization in domestic rice prices, and the impact of fiscal policy measures to contain prices. Core inflation is expected to remain more persistent than previously anticipated, partly reflecting the more accommodative fiscal policy stance now projected by staff.
The current account surplus is projected to remain strong in 2026, driven primarily by an income balance surplus earned from Japan's large stock of net foreign assets. It is expected to moderate somewhat over the medium term as the rate of return on external assets normalizes. Staff project Japan's commitment to invest $550 billion in the U.S. economy to boost outward investment and bilateral trade. As the scale of outward investment to the United States expands, it may crowd out investment in other regions to some extent. The external position is assessed on a preliminary basis as broadly in line with the level implied by medium-term fundamentals and desirable policies.
Financial conditions in Japan are broadly neutral, supported by still-ample liquidity, compressed credit spreads, and generally favorable market functioning. Equity prices rose sharply in 2025, on the back of strong corporate earnings and successful corporate governance reforms. Sovereign bond yields have climbed rapidly, driven by higher expected policy rates and term premia, with the latter reflecting heightened geopolitical tensions, perceptions of domestic political uncertainty and higher fiscal risk. The yen-dollar exchange rate had generally tracked the US-Japan yield differential in recent years, but has consistently decoupled since mid-2025. Observed positions in the yen futures market have been associated with yen movements that are not accounted for by yield differentials.
Japan's open capital account, large stock of outstanding government debt securities, and sizable net international investment position create interlinkages with global financial markets, providing a transmission channel for JGB market conditions to spill over to markets abroad, just as shocks emanating from the United States and Euro Area affect conditions in Japanese markets. Clear communication and prudent policy settings-calibrated to achieve domestic stability, as below-can mitigate adverse asset price reactions and outward spillovers.
Risks to the outlook are tilted to the downside. Deepening geoeconomic fragmentation and rising trade restrictions-including recent strains in Japan-China relations-could further disrupt supply chains and dampen business sentiment. An abrupt deterioration of financial conditions could weaken confidence and domestic demand. Domestically, the main risk remains weak consumption if real wage growth fails to turn positive.
Risks to inflation are balanced. On the downside, weaker-than-expected wage growth could weigh on price momentum and revert recent gains in re-aligning inflation expectations with target. On the upside, more expansionary fiscal policy could boost demand pressures and core inflation, and recurrent forecast errors-where headline inflation has remained more resilient than expected-suggest a risk that the inflationary process may be becoming more persistent.
ECONOMIC POLICIES
Monetary and Exchange Rate Policies
The BOJ is appropriately withdrawing monetary accommodation, and gradual hikes should continue to move the policy rate toward neutral. The current policy rate remains below staff's estimate for the neutral rate, which is subject to significant uncertainty given Japan's prolonged period of policy rates at or near the effective lower bound. Staff welcome the BOJ's recent policy rate decisions over the past year, including pausing rate hikes as the impact of external shocks was ascertained, and resuming in December as the Japanese economy showed resilience and there was growing evidence that inflation will stabilize at the BOJ's target. As the baseline projection continues to materialize, withdrawal of policy accommodation should continue so that the policy rate reaches a neutral stance in 2027. A gradual pace of normalization remains appropriate to support the re-anchoring of inflation expectations at target, since expectations are shaped by Japan's long history of low inflation. The BOJ's continued independence and credibility will help keep inflation expectations well anchored. A flexible and data-dependent approach remains appropriate in light of heightened uncertainty about external conditions, the neutral rate, and the transmission of monetary policy.
BOJ balance sheet reduction continues to progress smoothly. The pace of balance sheet adjustment strikes an appropriate balance between improved market functioning and mitigating the risks of disruption given the BOJ's outsized participation in the JGB market. In the context of its regular reviews, the BoJ should stand ready to modify the pace and maturity profile of its outright purchase schedule if financial conditions become inconsistent with the desired monetary policy stance. Going forward, it will be important for the BOJ to articulate its approach for the long-run size and composition of its balance sheet.
The authorities' continued commitment to a flexible exchange rate regime is welcome. Exchange rate flexibility should continue to help absorb external shocks and support monetary policy's focus on price stability. At the same time, it will also help maintain an external position in line with fundamentals.
Fiscal Policy
Japan's post-pandemic fiscal consolidation has been underpinned by strong revenue performance and, more importantly, spending restraint. The primary deficit of general government for 2025 is estimated to have been smaller than it was in 2019 before the pandemic, and among the smallest in the G7. Revenue strength was supported by buoyant tax collections amid solid nominal wage gains and strong corporate profitability. Expenditure growth remained moderate, constrained in part by supply bottlenecks in the construction sector but also thanks to the gradual withdrawal of pandemic-related support. In December 2025, the authorities approved a sizeable supplementary budget containing several measures to address the rising cost of living. Nominal growth that exceeds the effective interest rate will help reduce the public debt-to-GDP ratio. However, gross debt will remain elevated-the highest among major economies-and is expected to rise as spending pressures build.
Near-term fiscal policy should refrain from further loosening, preserving recent gains in fiscal consolidation. With the economy operating above potential, a more neutral fiscal stance is recommended in the near term to avoid reinforcing cyclical pressures. While Japan has some fiscal space, fiscal restraint is warranted to prevent the erosion of buffers and to preserve the capacity to respond to shocks-it would also contribute to stable JGB market conditions. The authorities should avoid reducing the consumption tax, an untargeted measure that would erode fiscal space and add to fiscal risks. Support for vulnerable households and firms most affected by rising costs of living or large external shocks should be budget neutral, temporary, and targeted to these groups. The authorities are discussing a two-year suspension of the consumption tax on food and beverages, along with sources of financing that would prevent the need for additional JGB issuance. Limiting the consumption tax cut to essential goods and ensuring it is temporary would help contain fiscal costs. Given scarce public resources, a system of refundable tax credits, which the authorities are discussing introducing after the two-year suspension, if well-designed, could provide better-targeted support to the most vulnerable Japanese households.
Over the long term, the primary deficit of general government is projected to grow and spending pressures to increase, leading to an increase in debt. Interest payments are projected to rise as debt is rolled over at higher yields, doubling from 2025 to 2031. Health and long-term care spending is projected to rise, reflecting advances in medical technology, rising long-term care costs, and demographic pressures from an aging population. High and persistent debt levels, together with a deteriorating fiscal balance, leave Japan's economy exposed to a range of shocks.
Staff recommend growth-friendly fiscal adjustment starting in 2026 to offset spending pressures, rebuild fiscal buffers, and keep the debt-to-GDP ratio on a firm downward path. Expenditure rationalization should improve efficiency and preserve high-quality investments in human and physical capital. Current spending remains elevated compared to pre-pandemic levels, highlighting the need to eliminate poorly targeted subsidies, including energy subsidies.
A credible medium-term fiscal framework is needed and should include a clearly defined fiscal anchor, establishing a strong link between annual budgets and medium-term planning, and ensuring that fiscal decisions are guided by the anchor. The use of supplementary budgets should be restricted to responding to large, unexpected shocks that overwhelm automatic stabilizers, which would also avoid providing unwarranted stimulus in normal times and help avoid sharp JGB market movements. Enhancing fiscal frameworks at the subnational level remains a priority, as local governments account for a large share of general government spending and play a key role in implementing discretionary fiscal measures. Improving the governance of state funds is also essential to safeguard expenditure control and budget discipline.
Financial Stability
Japan's financial system remains broadly resilient, supported by robust capital and liquidity positions across the banking and insurance sectors. Gradual policy rate hikes have lifted net interest margins, supporting profitability. Capital buffers remain solid for both internationally active and domestic banks. Major banks continue to manage interest rate risks proactively through portfolio rebalancing and diversified funding sources. The insurance sector is similarly well capitalized and profitable, with higher domestic rates improving investment margins and valuation effects remaining in aggregate manageable despite market volatility.
Overall systemic risk has not materially changed from the 2025 Article IV consultation, though its sources have shifted. A tightening in global financial conditions could trigger further increases in JGB yields or corrections in elevated asset prices, leading to valuation losses and higher funding costs that could strain some financial institutions and corporates. Structural vulnerabilities identified in the 2024 FSAP persist, including sizeable mark-to-market securities across bank and insurer balance sheets, FX and cross-currency funding exposures, and pockets of vulnerability in commercial real estate. While insurers are well capitalized, a faster-than-expected rise in yields could lead to the realization of valuation losses on asset holdings and increase liquidity needs. Regional banks remain broadly resilient but are more vulnerable than major banks, reflecting more limited shock-absorbing capacity, larger unrealized securities losses, structurally weak local credit demand, and demographic headwinds.
Strengthening systemic risk monitoring, the macroprudential framework, the financial safety net, and the oversight of the financial sector remain essential to bolster resilience and mitigate risks in the financial system, following up on key recommendations in the 2024 FSAP. In addition, given significant FX exposures and increasing interconnectedness between foreign NBFIs and the Japanese financial sector, it is crucial to close remaining data gaps-especially regarding FX derivative positions and investment activities of leveraged foreign investors.
Close monitoring of JGB market liquidity and investor positioning is needed, given increased volatility in yields and a shifting demand across investors as the BOJ reduces the size of its balance sheet. With duration gaps largely narrowing in preparation for new solvency rules, life insurers have scaled back purchases of super-long JGBs. Foreign investors are playing a growing role in the JGB market, contributing to better market functioning, but may be making it more sensitive to fiscal news and global developments. If heightened volatility undermines market liquidity, the BOJ should be prepared to make exceptional targeted interventions-such as temporary JGB purchases-which should be clearly communicated to avoid weakening market functioning. Flexibility should be maintained to further rebalance JGB issuance toward shorter maturities if demand at the long end weakens further.
Structural Policies
Real wage growth, which is critical for supporting domestic consumption, has been elusive despite rising labor shortages. Since 1996, the gap between productivity and wages has widened substantially. Stabilizing this divergence will require labor market reforms to increase worker mobility. Low mobility results in a lack of competition among firms for skills, few outside options for workers, and hence lowers worker bargaining power. Shifting to job-based employment and merit-based pay will help to boost mobility, improve productivity, and support wage growth. There is early evidence that labor mobility is starting to pick up in recent years, driven by younger workers.
In the face of demographic headwinds, potential growth could be supported by removing policy distortions that limit labor supply. For instance, the exemption from social security contributions lead female workers to limit their hours worked to remain eligible. Additionally, expanding health and pension contributions to those working 20 hours a week could have had the unintended consequence of limiting part-time hours worked.
Active labor market policies will need to support workers' mobility to tackle job displacement from AI while leveraging AI's productivity potential. Effective and inclusive mobility could be supported by subsidized training programs to reskill and upskill the workforce.
There has been a global resurgence of industrial policies and Japan has also stepped up their use, notably to promote investment in semiconductors and to encourage the green transformation. Any use of such IPs should be time-bound with clear sunset clauses and subject to a thorough cost-benefit analysis. To minimize distortions, IPs should remain narrowly targeted to specific objectives where externalities or market failures prevent effective market solutions.
The IMF team would like to thank the authorities and other interlocutors in Japan for the frank and open discussions.
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Japan: Selected Economic Indicators, 2022-27
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[1] An IMF mission, led by Rahul Anand and including Yan Carrière-Swallow, Andrea Deghi, Rahul Giri, Parisa Kamali, Shujaat Ali Khan, Akihiro Matsuura, Haruki Seitani, and Ken Teoh, conducted meetings in Japan during January 22-February 5, 2026. The mission met with senior officials at the Ministry of Finance, Bank of Japan, and other ministries and government agencies, along with representatives of labor unions, the business community, financial sector, and academics.
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