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Japanese Capital Flows: Nature, volume, and direction

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
September 1988
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Akira Ariyoshi

Japan’s role in global capital flows has increased dramatically in the last few years. Its cumulative current account surplus reached $280 billion during 1983-87, making it the largest net supplier of foreign savings in the world. Gross long-term capital outflows from Japan over the same period exceeded the cumulative surplus by $145 billion, the balance being financed mostly by short-term capital inflows (Table 1). Thus, Japan as a major financial center acts as an intermediary for the transfer of international capital, and its influence on the global allocation of capital extends beyond its current account surplus.

Table 1.Japanese capital flows, 1983-871

(In billions of US dollars)

19831984198519861987
Net long-term flows of Japanese capital−32.46−56.78−81 82−132.10−133.43
of which
Direct investment3.615966.4514.4819.49
Trade credits− 2.59−4.94−2 82− 1.840.61
Loans8.4211.9210.439.2816.70
Securities16.0230.8059.77101.9887.80
Net long-term flows of foreign capital14.767.1217.270.63−3.70
Net long-term flows17.70−49.65−65.54−131.46−137.13
Net short-term flows−3.5513.3011.7956.9095.65
Net flows−21.25− 36.35−52.75− 74.56−41.48
Memorandum item: increase in official reserves1 231.820.2015.7339.24
Total capital flows plus increase in reserves22.4838.1752.9590.2980.72
Sources: Bank of Japan Balance of Payments Monthly and IMF staff estimates.

Minus signs show net outflows of capital from Japan. Components may not add up to totals because of rounding.

Sources: Bank of Japan Balance of Payments Monthly and IMF staff estimates.

Minus signs show net outflows of capital from Japan. Components may not add up to totals because of rounding.

The liberalization of financial markets and “cross-border” (i.e., international) flows in recent years has contributed to the surge in capital flows from Japan. The progress in financial deregulation in Japan means that economic factors and financial conditions, rather than quantitative controls, predominantly determine the pattern of capital flows (see “The Changing Japanese Financial System,” by Shinji Takagi, Finance and Development, March 1988). The factors that affect capital flows are varied and differ with the type of flow and the agents concerned.

Recent developments in Japan’s capital flows are characterized by:

  • a massive increase in long-term capital outflows financed by short-term inflows, as indicated above;

  • a concentration of long-term outflows in bonds;

  • a sharp increase in overseas direct investment;

  • a substantial growth of short-term banking flows; and

  • the net sales of shares by foreign investors that have offset large issues of external bonds by Japanese borrowers.

Forms of investment

Japan’s savings rate has been one of the highest among the industrial countries. Furthermore, since the early eighties domestic savings exceeded domestic investment. This excess savings, reflected in Japan’s large payment surpluses, was invested abroad principally by the private sector—the primary source of savings in Japan. The private sector held about 90 percent of Japan’s total external assets and liabilities at the end of 1986. Though the saving is largely by the household sector, individuals or households generally do not directly invest their savings abroad; such investments are largely handled through intermediaries, such as private financial institutions and nonfinancial corporations. Life insurance firms and pension funds are the two major institutional investors. Other groups of institutional investors with significant holdings of foreign assets include non-life insurance companies, the Government Postal Life Insurance Fund, and banks. Nonfinancial corporations include manufacturing and trading companies. The principal forms of investment that have shown substantial increases recently are direct investment and long-term securities.

Direct investment. Japan’s direct investment abroad has shown a significant increase during 1984-87. Direct investment has increased principally in banking and insurance, manufacturing, and the real estate sector; the share of the primary sector has diminished considerably. Such investment has been largely in the industrial countries; investment in developing countries, by contrast, has increased only moderately.

Rising protectionist pressures and the appreciation of the yen have induced exporting manufacturing firms to produce locally in some industrial countries. Voluntary export restraints (VERs) on automobiles since 1981, for example, provided major incentives for Japanese automobile makers to set up production facilities in the United States. Virtually all Japanese automobile manufacturers have decided to establish production plants in the United States by 1990. Circumvention of protectionist measures was also a major factor in the construction of production facilities in Europe by Japanese consumer electronics companies.

Long-term securities. The dominant form of investment, however, has been long-term securities. Net purchases of foreign securities by Japanese residents since 1985 have even exceeded Japan’s current account surplus. Financial institutions own close to two thirds of all foreign securities. Among the financial institutions, the principal investors in foreign securities have been life insurance firms and trust banks (as administrators of pension funds).

Commercial banks held more than ¥ 11 trillion in foreign securities at end-1987. However, the sharp increase in foreign securities of these banks was financed almost entirely by short-term foreign currency borrowings, resulting in a substantial deterioration in their net short-term positions.

A relatively small but growing portion of securities investment has been in equities. Purchases of equities rose significantly in the first three quarters of 1987, reflecting both a diversification away from bonds and a buoyant US stock market.

Other outflows. Other outflows include trade credits extended through nonbanks and official channels. Long-term trade credits are extended to developing countries to finance their imports. These credits have suffered since 1982, reflecting the debt-servicing difficulties and import contraction in some developing countries.

Flows to LDCs

In recent years Japanese financial institutions have played an important role in providing external resources to the developing countries. They have participated in debt restructurings, contributed to new money packages (new loans by groups of banks to countries that have lost spontaneous access to external financial resources) and have continued with spontaneous lending to those countries not experiencing debt-servicing difficulties, especially in Asia. The Japanese authorities also have helped increase financial flows to developing countries by providing greater public resources as well as by promoting private financial flows.

In 1986, the net flow of funds from Japan to developing countries amounted to almost $15 billion, accounting for one sixth of the total net capital outflow. Net flows to developing countries during the past decade have remained relatively stable in relation to GNP (Table 2), despite substantial swings in the current account position which has ranged from a deficit of one percent of GNP to a surplus of four percent. This suggests no significant correlation between the net flow to developing countries and Japan’s current account balance.

Table 2.Capital flows to developing countries, 1980-87

(In billions of US dollars)

8081828384858687
Official development assistance
Bilateral2.02.22.42.42.42.63.85.2
Multilateral1.30.90.71.31.91.21.82.2
Subtotal3.33.23.03.84.33.85.67.4
ODA as percentage of
GNP0.320.280.280.320.340.290.290.31
Other Official Flows11.53.02.92.00.7−0.3−0.7
Private flows2.06.03.02.16.78.19.9
Total6.812.28.97.611.711.614.8
Total flows as
percentage of GNP0.661.080.840.680.930.870.75
Source: Ministry of Finance, Monthly Finance Review.Note: Components may not add up to totals because of rounding.

Other official flows consist of official export credits, finance for direct investment, and multilateral agencies.

Source: Ministry of Finance, Monthly Finance Review.Note: Components may not add up to totals because of rounding.

Other official flows consist of official export credits, finance for direct investment, and multilateral agencies.

Official development assistance. Japan’s ODA increased from $3.3 billion in 1980 to $3.8 billion in 1985. This increase was guided by a medium-term target set in 1981 to double the net disbursements of ODA in US dollar terms during 1981-85 over its level of the previous five years. The cumulative net disbursements of $18 billion during 1981-85 fell somewhat short of the target. In 1986, ODA flows in US dollar terms increased by almost 50 percent to 5.6 billion; they rose by a further 32 percent in 1987 to $7.5 billion. This increase reflected the sharp appreciation of the Japanese yen vis-a-vis the US dollar over those two years. The ratio of ODA flows to GNP in 1986 also increased from 0.29 percent in 1985 to 0.31 percent in 1987.

About two thirds of Japanese ODA flows are on a bilateral basis. Within bilateral assistance, the share of grants has risen, from about one fourth to one half, with a corresponding decline in loans. As a result, the grant element of Japan’s ODA increased from about 70 percent in 1975 to about 80 percent in 1986. Nevertheless, Japan’s ODA still remains less concessionary than that of most other industrial countries because of its relatively high component of loans.

Asian countries are by far the largest recipients of bilateral Japanese ODA, with a share of about two thirds. The shares of Central and South America, Africa, and the Middle East are each about 10 percent. Official policy increasingly favors pure grants for Sub-Saharan Africa—over 15 percent of total grant aid went to this region in 1986.

Private flows. Private Japanese capital flows to developing countries have increased from over $2 billion in 1983 to close to $10 billion in 1986. Private flows have a varied composition and each type of flow has behaved differently in recent years. Private export credits recorded, on average, a net reflow reflecting the withdrawal of official export credit insurance for a number of developing countries facing debt servicing difficulties. Direct investment revived in recent years from a depressed state in 1982-83, reaching nearly $3 billion in 1986. The earlier drop reflected the general deterioration in the international investment climate. Direct investment in Asia surged as exports from Asian countries, particularly to the United States, increased.

Bilateral credits, which include bank loans and bond issues, increased greatly in 1984-86. The principal borrowers for both bank loans and bond issues in Japan were Asian countries that had not experienced debt-servicing difficulties. Multilateral agencies have steadily increased their funding from the Japanese market, averaging over $2 billion per year during 1984-86. Grants by private voluntary agencies are of relatively minor importance in total private flows.

Promoting flows to LDCs

Though Japan’s current account surplus and long-term capital outflow have increased substantially since 1981, both as a proportion of GNP as well as in absolute amounts, the bulk of capital outflows has gone to industrial countries. Flows to developing countries have not increased proportionately. Official development assistance has remained more or less constant at about 0.3 percent of GNP (Table 2), falling short of the average rate of 0.35 percent for the industrial countries as a group. The Japanese authorities have adopted special measures to increase both official and private flows to the developing countries. These initiatives would help recycle Japan’s current account surplus in a way that would benefit the developing countries, and also allow Japan to assume an international role that is commensurate with its economic size.

Medium-term ODA target. In September 1985, Japan established a medium-term target for ODA disbursements for 1986-92, involving $40 billion in net disbursements, and a doubling of the annual level of ODA to $7.6 billion in 1992. Subsequently, the authorities announced, in June 1988, a revised target to disburse $50 billion during 1986-92. This is double the amount extended in the previous five years, 1983-87.

The authorities have declared their commitment to the world’s poorest countries, including those in the Sub-Saharan region. In May 1987, they announced their intention to provide $500 million in grants to those countries. The authorities have also emphasized the provision of technical aid to developing countries, to assist technology transfer in order to establish the foundations for sustained growth.

In December 1987, the Japanese authorities indicated that they would contribute some SDR 300 million toward the enhanced structural adjustment facility (ESAF) of the IMF. They will also provide SDR 2 billion to the IMF, in loans at commercial terms to help finance the facility.

Furthermore, in June 1988, the authorities announced that expanded relief measures will apply to concessionary loans (amounting to about $5.5 billion) extended to least less developed countries (LLDCs) during the past ten years.

Other official flows. The Japanese authorities have also introduced measures to increase other official flows, mainly by increasing direct loans by the Export-Import Bank of Japan (EXIM) to foreign governments and public institutions. These loans provide foreign governments and public financial institutions with funds for use in projects that are not tied to specific imports from Japan. The loans are quick-disbursing with very long maturities, and are made at or slightly below market interest rates.

Other official efforts to increase the flow of funds to developing countries included the establishment of the Japan Special Fund QSF) in the World Bank. Under this arrangement, finalized in 1987, the Japanese Government will make available ¥ 330 billion, of which ¥ 30 billion is on a grant basis, to finance certain programs and projects supported by the World Bank during 1987-89. The funds will be used for technical assistance to developing countries in connection with Bank-supported projects and programs, including sectoral and structural adjustment loans; cofinancing of Bank-supported loans, rehabilitation loans, and technical assistance loans; and cofinancing of Bank-supported emergency assistance loans. The Japanese Government also entered into an arrangement to lend SDR

3 billion to the IMF at market interest rates with disbursements over a four-year period through May 1991. In addition, the Government agreed to grant $4 billion to the International Development Association and the Asian Development Fund. These official Japanese contributions to multilateral institutions amount to about $10 billion in total.

$20 billion recycling plan

Japan also announced, in May 1987, a $20 billion package to increase the flow of financial resources to developing countries. The package, covering a three-year period, includes $8 billion from the Japan Special Fund to the Asian Development Bank and the Inter-American Development Bank, as well as through additional capital contributions to multilateral development banks; $9 billion through parallel or cofinancing of multilateral development lendings by the Overseas Economic Cooperation Fund, EXIM, and commercial banks; and $3 billion from an expansion of EXIM’s untied loans and cofinancing with commercial banks. Together with the earlier flows of $10 billion, the authorities envisage some $30 billion in additional funding to the developing countries over the three-year period 1987-89.

Promoting private flows

In addition to providing increased flows of official funds, measures have been taken to stimulate private flows to developing countries. Indeed, since the financial surplus is in the private sector, the Japanese authorities see a significant role for the private sector in increasing the flow of funds to developing countries. Financial deregulation over the past several years has greatly improved the access to Japan’s capital markets by those developing countries that have good credit ratings. Multilateral development institutions also benefited from the easing of regulations concerning bond issues.

The Government has also taken measures to promote direct investment in developing countries. In June 1987, Japan ratified the convention that established the Multilateral Investment Guarantee Agency, the first industrial country to do so.

The Japanese authorities see potential for further encouraging the flow of funds to developing countries through the multilateral institutions. At the 1987 IMF-World Bank Annual Meetings, they suggested the possibility of an international scheme to insure the noncommercial credit risk of private loans to developing countries. They also support the role of the International Finance Corporation in establishing investment funds for developing countries and in arranging debt-equity swaps.

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