The Bank of Japan should stick with its expanded quantitative easing to achieve its inflation target, but this may not be enough to foster sustainable economic growth unless it is coupled with structural reforms, the OECD said on Tuesday.
Japan's government should stay with its plan to double the sales tax to 10 percent, compile a detailed plan to return to primary budget surplus in 2020 and boost revenue from other taxes, the Organisation for Economic Co-operation and Development said.
The size of fiscal consolidation needed means Japan does face the risk of a spike in interest rates that would hurt the financial system due to its large exposure to Japanese government bonds, the Paris-based think tank said. "The new quantitative and qualitative monetary easing should be implemented to meet the new 2 percent price stability target, although this may not be enough," the OECD said in its economic survey of Japan.
"Pushing ahead with structural reform on a broad front is equally imperative to achieve sustained growth." The BoJ earlier this month committed to open-ended asset buying to nearly double the monetary base to 270 trillion yen ($2.72 trillion) by the end of 2014 to end 15 years of deflation and achieve its 2 percent inflation target in two years.
At a news conference, OECD officials said they were uncertain when Japan would meet its inflation target but that they were willing to give the BoJ some leeway as long as prices are approaching the target. "We don't know how quickly it will take for inflation to come back," said Randall Jones, a senior economist at the OECD.
Haruhiko Kuroda, the BoJ's new governor, has dubbed the policy quantitative and qualitative easing, because the BoJ is greatly increasing the size of asset purchases and changing the composition by focusing on longer-term government debt. Japan's consumer prices are still showing small annual declines, and many private-sector economists doubt the BoJ can meet its price target by 2015.
The OECD forecast that Japan's core-core consumer prices, which exclude fresh food and energy, will rise around 0.5 percent in the fourth quarter of 2014 from the same period a year earlier. It is important for Japan to end deflation because this lowers nominal gross domestic product (GDP), which worsens Japan's debt-to-GDP ratio, the OECD said. Japan's debt burden is already the worst among major economies at more than twice the size of its $5 trillion economy.
In order to repair public finances, the government should not use multiple tax rates when raising the sales tax, the OECD said. Some lawmakers have argued that the government should exempt food and other items from sales tax hikes. Should doubts about fiscal discipline emerge, Japan's financial sector would be vulnerable as government debt accounts for about a fifth of all bank assets, the OECD said.