FAQ for
Ginî piggu: Manhôru no naka no ningyo (1988) (V) More at IMDbPro »

The ending hints that the events of the film were real, but ultimately leaves it up to the viewers imagination. The three main interpretations are that;

A) The mermaid was a figment of the artists imagination, due to his declining mental health, and the scale at the end has no real significance to the final scene or alternatively there may have been a real mermaid that he encountered as a child and he found the scale, which triggered memories which he used to create a fantasy world to cope with the reality of what he had done to his wife (which would explain the scene after the credits where something moves in the sewer, hinting that the mermaid does exist)

AND

B) The mermaid was the artists' wife, who had died while pregnant and the child had died too, hence the fetus found in the pile of gore that was the mermaid.

OR

C)The mermaid was real, and her transformation at the end was some kind of illusion

The sewer (and everything in it) is a disfigured and dying version of everything good in his life before the split with his wife. All the flashbacks in the film are likewise done though bright, colourful paintings, a contrast from how his work looks now.

Throughout the film, whenever the artist is overcome with sorrow, his eyes glaze over and he tries to cope with his feelings through his paintings, as he appears unable to otherwise. Before he starts stabbing his mermaid, his eyes glaze over once again, but he has already finished his perfect painting, and with no outlet for his anguish, becomes enraged and psychotic.