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Group 4 Japan

Group 4 Japan

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Country Analysis

GROUP 4 Sridhar Vardharajan(09020241047) Vishal Singla(09020241048) Aastha Kalra(09020241049) Abhisake Sharma(09020241050) Amit Kumar(09020241051) Rishi Saraf(09020241068)



Initiation of Japan in to the global economy Japan was inducted in to the global economy around the 16th century, when European traders started trading with Japan on their high quality iron ore equipments. Japan was perceived as one of the more developed Asian economies at the beginning of the last century. But the actual opening up of the economy occurred when the Tokugawa Shogunate opened the country to Western commerce and influence around 1854. Subsequently the Meiji government heralded the Meiji Restoration era which saw the emergence of Japan as a global militaristic as well as an economic power. The outbreak of World War I proved a boon to the country which it leveraged to establish itself as a global power in the absence of its European competitors. After which, large emphasis was given to develop its military capabilities and increase its geographical influence. World War II left the Japanese economy in tatters and the once great empire was wracked by a. Shortages b. Inflation c. Currency Devaluation Post War Japan and the Japanese Economic Miracle One of the strongest points about the Japanese culture has been its attitude towards which is marked by Confucianism, where the loyalty towards the country has been given more significance than benevolence of the country towards its citizen. Another significant contribution was thatLeadership stemmed from the government and businesses looked towards the government for guidance. Japanese government has exerted a great degree of interventionism in the development of its businesses. Some of the other reasons for the Japanese economic miracle include a. High level and quality of investment b. As a later entrant to modernization, was able to avoid certain errors perpetrated by other economies c. Japanese Labor Force is very skilled and disciplined. d. High Productivity Growth was achieved due to the high skilled labor force and economic policies taken by the government Twin Asset Bubble: Post WW II, Japan employed policies which encouraged people to save their income. This led to an increase in the bank deposits, which a. In turn it made loans and credit easier to obtain b. Japan was running trade surpluses and Yen appreciated against foreign currencies c. Local companies could invest in capital resources more easily than their competitors This easy money readily available for investment led to rife speculation a. Nikkei stock exchange hits an all time high (38915.87)

b. Real estate prices hits unheard figures, some as high as $1 million per sq mt. in Tokyo This bubble in both real estate and stock markets saw a huge crash around the early 1990s. This has been followed by a continuous slump, prompting the last decade of the previous century to be known as Japan s Lost decade. Politics in Japan There has been a huge upheaval in Japanese politics, with the country seeing seen 5 prime ministers in the last 5 years and 14 prime minister in the last 20 years. The country has been facing a number of problems including a. Bulging budget deficits b. Deflation and stagflation c. An ailing social security system Many governments have been toppled due to its failure to pass important reforms through the Diet ; which is the country s Bicameral legislature. The country has seen a Twisted Parliament currently existing in the country which is preventing many much needed reforms from being enforced. The Liberal Democratic Party (LDP) which has been in power for majority of the last century recognized its authority to govern by adopting policies designed to ensure high economic growth. The party tied its fortunes to power by expanding the national economic pie, rather than trying to take larger slices for itself or for its support base from a pie of fixed economic size. Such policies, in times of economic fortunes, would lead to the expansion of the national economic pie due to its ability to rake in higher revenues for the government. But at times of economic hardships; continuation of such policies requires aligning towards deficit financing by issuing more and more debt. In Japan deficit budgets have become the norm irrespective of whether the economy is in good shape or in doldrums often as a result of political maneuvering over fiscal sustainability. There has been also indications from various agencies like Standards & Poor s, that the country is facing the risk of lowering of its credit rating. A lower credit rating would raise the borrowing costs, adding to the country s budget woes. This is again being attributed to the Twisted parliament existent in Japan, which is preventing the government from reining the debt; which currently is twice the nation s GDP. Apart from the Woes the country faces; it still ranks 5th out of 41 countries in the Asia Pacific regions in the 2010 index of economic freedom and ranks 19th overall. The overall freedom to start and close a business is well protected under Japan s regulatory environment. Starting a business takes 23 days compared to the world average of 35 days and obtaining a business license takes less than the world average of 18 procedures and 218 days Each country shows different development stages in the bond market. In Japan, experience shows that the government bonds are sold mainly to the banking sector in the early stages of the development of the bond market. However, in year 2006, all these syndicated sales were abolished. Currently all the Government bonds are sold through market auctions. There are no forced sales to the financial institutions. Some Asian countries are in the process of starting the government bond market, as Japan started in 1965. Many lessons could be learned from the experiences of those overseas. In

Japan, the Government bonds whose maturity was 10 years were the major product issued by the MOF in the 1970s and 1980s. In the beginning stage of the setting up of the Government bond market, 10 year Government bonds were mainly sold to the financial institutions.

From 1990s, the MOF started to sell various kinds of government bonds to the market, namely, short-term, medium-term and long-term. Short-term Government bonds are treasury bills which are redeemed within one year and they are discounted bonds. Medium-term Government bonds such as 5 years are mainly sold to banks. Commercial banks in Japan prefer to hold 4-5 years Government bonds, since the average maturity of deposits is less than 5 years. The Government bonds can be sold not only to financial institutions but also to private individuals as the market develops. Postal savings in Japan played an important role during the process of economic development. The Government can sell individually targeted Government bonds to households. The terms of individually targeted Government bonds are 5 years (fixed interest rate) and 10 years (variable interest rate). These Government bonds are sold through private financial institutions and post offices. There are many lessons to be learned from Japan s experiences as is shown below.

The development of the bond market in Japan can be seen with the growth of Japan s government bond (JGB) market. JGBs, which the Government issues for financing purposes play the central role in Japan's financial and securities markets as a financial instrument traded on the market with high levels of credit and liquidity Thus, JGBs yields are regarded as benchmarks of the bond market in Japan.

The Japanese economy has developed continuously since the 1950s. There have been several fluctuations with the Japanese economy, affected in particular by two major oil crises in 1974 and 1979. Despite these crises, the Japanese economy did remarkably well until 1989 when the bubble burst. Since the 1990s, the Japanese budget deficit has been increasing rapidly for a number of reasons:

long-term recession and the decline of tax revenue; various tax rate reductions introduced in late 1990s; failure of the Keynesian Policy which relies on public work to enhance economic recovery immediately after the collapse of the bubbles in 1991; (iv) an increase in welfare spending such as medical spending due to the aging population. Thus, the budget deficit climbed to higher than 170% of GDP from 70% in 1993, comparable to the level seen in other OECD nations.

(i) (ii) (iii)

General government dependency for government bonds

Social welfare represents the biggest part of the general government budget, at about 25%. It represented only 7.7% in 1950 and 13.7% in 1955. However, the aging population forced government to spend much more money on medical care etc. Figure 2 compares the aging population (the share of population who are more than 65 years old). Japan is the most rapidly aging society among the OECD countries. There are three major taxes in Japan, namely, (i) (ii) (iii) Income tax, Corporate tax, Consumption tax. Population aging in Japan in comparison to other countries

Total tax revenue peaked in 1991when the bubble economy burst. Income tax started to decline rapidly after 1991. The Corporate tax also started to decline due to recession. In 1988, consumption tax increased from 3% to 5%, however the consumption tax revenue has not shown much change since 1999 due to long- term economic recess. Increasing government expenditure together with gradual decline in tax revenue brought high dependency on Government Bonds as shown in Figure 3. In 2003 and 2004, the Government Bonds dependency ratio to total spending went up to 44%.
Government bond dependency ratio

With the budget deficit increasing, issues of JGBs has increased, especially in recent years, JGBs have been issued on a large scale, bringing the outstanding debt to enormous amounts. The Major development process of the government bond markets in Japan since the 1960s can be summarized as the following. The Deficit financing bond was issued for the first time after World War II in 1965. In the 1960s, government bonds were sold to financial institutions (syndicated underwriting). Furthermore, JGBs were purchased by the Bank of Japan one year after issue; the maturity of JGBs was 1year in 1960s and 1970s in the sense that the JGB could be purchased after being held by the financial institutions for one year if required, despite the face maturity being 10 years. In 1966, JGB underwriting by the Trust Fund Bureau (MOF) had started. The main sources of the Trust Fund Bureau fund came from postal savings, post life insurance and Government pension fund reserves. High household savings were kept mainly in private financial institutions as deposits or government postal savings. Postal savings in Japan offered a unique financial product which private banks were not allowed to issue. Namely, 10 year deposits (Teigaku Deposits) whose interest rates were fixed for 10 years and could be withdrawn any time after 6 months. Since Japanese postal savings were entrusted to the Ministry of Finance for 7 years for fixed interest rates, postal savings could provide a fixed interest product on a long-term basis. At this time Private banks offered only 1year deposits. Postal savings attracted numerous customers.

In 1974, the first oil crisis forced the Japanese government to issue more government bonds. The Japanese economy suffered a lot by sudden rise of oil price by OPEC. Almost all oil in Japan is imported from overseas. The price of oil increased to three times that in 1973. A high dependence on oil from abroad made the Japanese economy quite vulnerable to oil shock. Many industries use oil as their energy source and export oriented Japanese industries were faced with high production costs caused by the sudden increase in oil price. The Japanese real economic growth went negative (-0.5%) for the first time since World War II due to a decline in exports, private investment and consumption. High economic growth stopped. In order to mitigate the sudden oil shock and declining private demands, the Japanese government introduced the Keynesian fiscal policy by stimulating the Japanese economy. Public works were implemented. Negative real economic growth brought a decline in tax revenues so that the Government had to rely on issuing Government bonds. The Government s dependency on Government bonds increased as shown in Figure 1. All these Government bonds were sold to financial institutions. Syndicated groups of financial institutions, which consist of private banks, insurance companies and securities companies, purchased these Government bonds. However, huge issues of JGBs made it difficult for financial institutions to keep holding all the JGBs. In 1977, trading of JGBs, which were held by financial institutions, initiated in the market. 1982 saw the launch of 15 year floating rate JGBs which were offered privately. This was the first time that the JGB was issued not just for 10 year maturity, but maturity.

In 1983, banks started to sell Government bonds through their branch offices to individual investors. JGBs were kept at financial institutions, however huge issues of JGBs made it difficult to keep them all at their branch accounts. The Ministry of Finance decided to sell the JGBs to individuals through the branch offices of financial institutions. In 1984, banks were allowed to deal in Government bonds, local Government bonds and Government guaranteed bonds despite the opposition of securities firms in the past. Securities firms were only allowed to deal in Government bonds in the past and they dominated in the bond market. Thus, they were reluctant for private banks to start

de ve e ds I 1988 e d ling of JGB for public offering by pos offices s rted. In 1989 partial competitive auction of 10-year Government bonds was introduced. In 1990 Expansion of the ratio of competitive auction on 10 -year Government bonds from 40 to 60 was implemented. In 1991 the same-day publication of auction results of 10year Government bonds started. 1994 saw the launch of public offering auctions of 6 -year JGBs. In 1996 quarterly auction of 20-year JGBs started. 1999 saw the launch of public offering auction of 1-year Treasury bills (TBs and launch of public offering auctions of 30-year JGBs. In 2000 public offering auction of 15-year floating-rate JGBs were launched. In 2005 increase in the competitive auction of 10-year JGBs (from 85 to 90 . In 2006 the syndicated underwriting was completely abolished and all the JGB issues were traded on the financial market. 

In contrast to the continuous growth of the Government bond market, the corporate bond market has not been developed. In 1905, issues of non -collateral corporate bonds law were implemented and new issues of corporate bonds were increased. However, huge issues of corporate bonds created defaults of bonds. In 1935, quality enhancing of the bond market started. Regulation of the new issues of corporate bonds, such as proper conditions and collateral based conditions continued until the 1990s. Thus, the corporate bond market was not developed in Japan. Furthermore, Japanese Government banks provided long-term loans to corporations in the past which contributed less dependency on corporate bonds by firms. Table 1denotes the amount of trade in the bond market in Japan. The majority of the bond market is the Government bond and the share of the corporate bond is relatively small. 


s of J p n s Go
! ! $ $ !& # ! %

The JGB issue numbers have been on the increase in recent years. While the JGB issue amount often refers to that of new financial resource bonds (construction bonds + special deficit financing bonds , securities issued by the central Government also include refunding bonds and fiscal loan bonds. 

As we reviewed in the previous section, the total issue amount of these Government bonds was increasing at a dramatic pace particularly in the recent years. Although the issue amount of new financial resource bonds had been hovering between ¥30 and ¥40 trillion since F 1998, it reduced to under ¥30 trillion in F 2006. However the total issue amount of JGBs, including refunding bonds, increased from ¥70 trillion to over ¥80 trillion from F 1998 to F 2000. Furthermore, launch of fiscal loan bonds in F 200 1pushed it to over ¥130 trillion, and since then
' ' ' ' '

! $ !# "




n t bondsin recent years


£    © 

£ ¦  £ ¨£§ ©

 © ¦¥ £¢ ¤£¢   ¡

it has been continuously increasing. In FY2006, however, the total amount was at the same level as in FY 2005, approximately ¥165 trillion.

B. Variety of Japanese Government bonds to satisfy demand from the market (1) Types of JGBs classified by method of issuance There are six categories of JGBs currently issued: (i) Short term (6-month and 1-year Treasury Bills); (ii) medium term (2-year and 5-year Bonds); (iii) long term (10-year Bonds); (iv) super long term (15-year floating rate, 20-year, 30-year Bonds and 40-year bonds); (v) JGBs for individual investors (5 -year and 10-year); and (vi) inflation-indexed bonds (10-year). As Table 3 shows, the long-term JGBs (10 years or more), the benchmark of the market, account for more than 50% of all JGBs outstanding. Various types of JGBs
Maturity Type of issue Min. face value unit Issuance method BOJ switch Auction method Non price Competitive Auction Transfer Reoentfrequency of issue Postal Savings (OTC sale) Postal Savings (OTC sale) Piiee competitive auction Non-price Competitive Auction Not restricted Bimonthly (odd months) Inflation-Indexed bonds 10-year Short-term (Ms) month, 1-year Discount bonds *10,000,000 Public offering h;tedium-term 2-year, 5-year *50.000 Public offering Long-term 10-year Coupon-hearing bonds *50.000 Public offeiing Super-long-term 15-year floatin;f-rate" *100.000 Public offering

Price-cmpetitive auction ; Price-competitive auction : Pride-competitive auction Non price Competitive Auction I Restricted'' Monthly each Non-Competr4eAuction Non-Competitive Auction Non-price Not restricted Monthly each Super-long-term Non-price Compet Not i~estiieted Monthly

JGBs for Individual InveUtors 30-year 10-year sting-rate.

Maturity Type of issue Min. faca value unit Issuance method


5 year fixed rite Coupon-beating bonds *50,000 Puhlie offering Fiscal Lawn Bonds Publicoffeiing Yield-ompetitiveauction ; Dutch-style auction' Non-price Competrtiye Auction II Not restricted Restrkted'~ Handling of public offering _ Public offering Yield-competitive auction: Dutch-stole auction ti Non-price Competitive Auction II Restricted'= *50.000 *10,000 *100.000

Auctionrnethod Non-price Competitive Auction Transfer

Price-eompetrtiye auetion Conventional-style auction Non-price Competitive Auction I Not restricted



Recent frequency of issue




Bimonthly ieven monthsi

a) Discount bonds The short-term JGBs are all discount bonds, meaning that they are issued at the price lower than the face value. No interest payments are made, but at maturity the principal amounts are redeemed at face value. For example, if the maturity of the bond is 100 yen and it were sold at 95 yen, the interest payment at the maturity becomes 5 yen which is equivalent of the interest rate of 5.2% (=5/95).

b) Fixed-rate coupon bonds All medium- (2-year and 5-year bonds), long-( 10-year bonds), super-long-term bonds (20year, and 30-year bonds (except for the 15-year floating-rate bonds)) and JGBs for individual investors (5-year) are the bonds with fixed-rate coupons. Figure 4 shows the fluctuations of 10-year JGB yield in the market. The interest rate on 10-year JGBs is determined by the market when it is issued. With fixed-rate coupon-bearing bonds, the interest calculated by th e coupon rate determined at the time of issuance is paid on a semiannual basis until the security matures and the principal is redeemed at face value. Figure 4. JGB yield curves


c) Floating rate bonds The 15-year floating-rate bonds and the JGBs for individual investors (10-year) feature their coupon rate that varies according to certain rules. The inflation-indexed bonds is a security of which the principal amount is linked to the consumer price index (CPI). Thus, although their coupon-rate is fixed, the interest payment also fluctuates. d) Abolished bonds In the past, there used to be some other types of JGBs. However, after the August 1988 issue of 3-year fixed rate bonds, the September 2000 issue of 5-year discount bonds, the February 2001issue of 4-year fixed-rate bonds, the March 2001issue of 6-year fixed-rate bonds, and the November 2002 issue of 3-year discount bonds, these bonds have been stopped being issued due to lack of demand from the market. e) JGB for individual investors . Individual investors, compared with financial institutions, now account for a much smaller share in JGB holdings. However, they tend to be relatively stable and long -term bondholders. Thus, it should make the market stable and enable us to finance more smoothly to diversify the bondholder composition further, with particular emphasis on individuals. For these reasons, the Ministry launched in March 2003 the bonds specifically designed for individual investors. Furthermore, in January 2006, we started to issue a new model of JGBs for individual investors, 5-year fixed-rate bonds. Following is the overview of two types. JGBs for individual investors are issued on a quarterly basis most likely on the 15th day of April, July, October and January and the flotation term starts during the first half of March, June, September and December. It is available at financial institutions, such as security companies, 12

banks and post offices. Along with other conventional JGBs, it is issued and fully managed paperless in exclusive accounts for JGBs at financial institutions or post offices.

Table 4. JGB for individual investors

f) Inflation-indexed bonds Inflation-indexed bonds, introduced in March 2004, are the securities in which principal amounts vary as they are linked to the consumer price index -i.e., CPI excluding fresh food. While this new instrument meets the needs of investors who want to avert inflationary risks, it can also serve as a means of observing the expected inflation rate on the market. In the cas e of conventional fixed-rate coupon-bearing JGBs, the principal at the time of issuance remains unchanged until redemption, and the interest amount remains the same for biannual interest payment. In contrast, in the case of inflation -indexed bonds, the pri ncipal amount varies as it is linked to the CPI. So if the CPI increases after issue, the principal amount also increases according to the rate of inflation, and vice versa, and at maturity these bonds are redeemed at the adjusted principal amount (hereina fter called "inflation-adjusted principal amount"). Interest amount is calculated by multiplying the inflation -adjusted principal amount at the time of interest payment by the pre-fixed coupon rate, so it also changes according to the rate of inflation. The inflation-adjusted principal amount is calculated by multiplying face value by indexation coefficient. Indexation coefficient, which indicates the level of fluctuation from the time of issuance, is calculated by dividing the Ref index for the day by the Ref index at the time of issuance (specifically, the 10th day of the issue month). 13

Samurai Bonds: A Samurai bond is a bond sold in Japan by an outside source. It is denominated in Japanese currency, the yen, and governed by Japanese law. Samurai bonds ha becoming ve increasingly popular over the last 50 years. One purpose of a Samurai bond is the accumulation of capital from investors in Japan. Japanese capital appears to be very attractive to corporations and governments worldwide, especially during a period of economic instability. Recent issuers of Samurai bonds include the Royal Bank of Canada, the Republic of Indonesia, and the Philippines. The recent bond issue by the Philippines provides a useful example of the concept. The Philippine government is in debt, partly because attempts to issue bonds in its own pesos are failing. Samurai bonds are valuable for the Philippines because they increase available capital and financial security; they are attractive to Japanese investors because they pay higher dividends than local bonds. A Samurai bond can also be used to decrease risks associated with exchange rates in foreign currency. If a company has Japanese operations that it needs to finance with yen, it may wish to acquire the yen directly in Japan rather than relying on continual exchange from dollars or some other currency. Even a company with no direct need for yen might issue a Samurai bond to take advantage of a favorable exchange rate. The Japanese government has created an institution called the Mark Access Support Facility et (MASF) to help Asian governments with poor credit ratings to issue Samurai bonds. The MASF guarantees Samurai bonds issued by these countries up to 500 billion yen. It is hoped that these guarantees will encourage investment and help the Asian economy at large. Shogun Bonds: A Shogun bond, sometimes called a geisha bond, is similar to a Samurai bond, but not denominated in yen. This type of bond is rarer than a Samurai bond. Another variety is a bond that is denominated in yen but issued outside of Japan. These Euroyen bonds are found most commonly in London. This type of bond is subject to fewer regulations than bonds issued in Japan. Uridashi bonds, like Shogun bonds, are denominated in foreign currency. These are sold to smaller investors in Japan. They are attractive because they typically provide higher interest rates than Japanese government bonds. Parallels to the Samurai bond can be found throughout the world's markets. Foreign companies can get Yankee bonds in the United States, Bulldog bonds in London, Kangaroo bonds in Australia, and Matrioshka bonds in Russia 5. DEBT MANAGEMENT POLICIES In recent years, JGBs have been issued on a large scale, bringing the outstanding debt to enormous amounts. As a result, debt management policies have become increasingly significant in order to secure smooth and stable financing and to minimize medium and 14

long-term financing costs against such a backdrop. This section outlines the debt management policies and gives an overview of each policy. The debt management policies are the collective term that includes various policies in areas that range from Government bond issuance to distribution and redemption. Given the severe fiscal situation, large-scale JGB issuance will continue. It is thus essential that the Ministry of Finance (MOF , as the debt-issuing authority, implements its debt management policies in accordance with the aim of securing stable and low-cost financing which are the foundations for smooth fiscal management.

When implementing debt management policies in the future, it is important to address the following points Securing stable financing in the age of large-scale JGB issuance Maintaining and increasing the JGB market liquidity and Appropriately managing a large amount of outstanding JGBs.
0 0 )

To secure smooth and stable financing; and To minimize medium and long-term financing costs. Every year in late December, the issuing authorities announce an issuance plan for the coming fiscal year, covering the issue amount by types of maturity, the total issue amount, etc.

In designing these issuance plans, the authorities listen to opinions from market participants and attempt on this basis to maintain an appropriate balance among different maturity zones short-, medium-, long-, and super-long-term while taking into account correlations between financing costs and risks associated with interest rates and refunding, in addition to the future redemption profile. As the fiscal year proceeds, we listen to investors to enable us to respond to market needs and trends, for example, by increasing the issue amount of maturity zones according to investor's demand. In addition, the authorities attempt to ensure the predictability of the market in our day-today management of the JGBs. 15


Debt management policies have two major objectives

Balance of Payment , Japan
‡ Japan's current account surplus decreased in 2009 for the second consecutive year to 13.3 trillion yen, down from 16.4 trillion yen in 2008, mainly due to a decrease in the income surplus. The capital and financial account deficit (net outflow) decreased to 12.7 trillion yen in 2009, down from 18.4 trillion yen in 2008. Reserve assets continued to increase, rising by 2.5 trillion yen in 2009 compared to an increase of 3.2 trillion yen in 2008.In balance of payments statistics, the following relationship holds true at all times: Current account + capital and financial account + changes in reserve assets + errors and omissions = 0. Japan's balance of payments shows that the current account surplus earned is mirrored by reverse flows abroad in the form of a capital and financial account deficit (outflows) and an increase in reserve assets.








Current Account






Exports and Imports by currency settlement





Outward direct investment by residents decreased significantly, registering a net outflow of 7.0 trillion yen from 13.2 trillion yen in 2008, when it hit a record high.  lack of large-scale transactions  a plunge in reinvested earnings reflecting the deteriorating business performance of overseas subsidiaries. Inward direct investment by nonresidents also decreased significantly, registering a net inflow of 1.1 trillion yen, down from 2.5 trillion yen in the previous year.  foreign companies clearly refrained from making direct investments due to the global economic slowdown Outward portfolio investment recorded an increase in net purchases (outflows) to 16.3 trillion yen in 2009 from 14.0 trillion yen in 2008. Inward portfolio investment recorded a decrease in net sales (outflows) to 4.8 trillion yen in 2009 from 10.3 trillion yen in 2008. As a result, there continued to be a large net outflow of portfolio investment amounting to 21.1 trillion yen compared with 24.3 trillion yen in the previous year.






Net purchases (outflows) of equity securities decreased to 3.0 trillion yen , down from 6.4 trillion yen , due to a decrease in purchases of foreign equity securities by public and private pension funds through banks' trust accounts.

Forecast of economic activity by sector
‡ Since autumn 2008, faced with major declines in demand, companies have reduced the number of their personnel, and this has resulted in a marked deterioration in conditions in the employment environment. Although the feeling among corporations that they have an excess of personnel is being relieved by progress toward employment adjustments, it is still strong, and corporations are maintaining a cautious stance toward hiring new personnel. For this reason, the unemployment rate is believed likely to remain at a high level. As a result of the implementation of economic policies that incorporate measures to promote the purchases of eco-friendly products, consumer spending, principally for durable goods, is continuing to increase. Although consumer spending may decline temporarily in the latter half of fiscal 2010, as the effects of economic policies run their course, consumption is expected to improve in fiscal 2011 as the income environment improves, influenced by the payment of the full amount of government child allowances and other factors.


Forecasts for Prices and Financial Markets
‡ The sharp declines experienced previously in the prices of raw materials, especially crude oil and metals, have ended, and prices of these commodities are rising again, thus boosting some prices. However, in the medium term, considerations of supply capacity and expansion in demand in China and other newly emerging economies suggest that inflationary pressures upstream and deflationary pressures on industrial and other final products downstream will persist. Among domestic corporate prices, the prices of petroleum products and other items that are influenced by international commodity market prices have begun to rise, but prices of other materials are continuing to show weakness, and prices of machinery are declining. Although the trends toward firming and increases in these prices may continue going forward, the pace of increase is expected to be moderate because of the weak recovery momentum in the domestic economy and other factors. The outlook is for the decline in consumer prices to bottom out after the beginning of fiscal 2011, but in the interim it may continue to decline because of the strong downward pressure on sales prices to final consumers.



Regarding monetary policy, the lifting of quantitative easing in March 2006 set in motion the process of normalizing monetary policy to raise interest rates in Japan from their excessively low levels. However, as a result of the turbulence in financial markets triggered by the subprime loan crisis and the recognition of the risk of a downturn in the domestic and overseas economies, in fall 2008 and onward, measures were implemented to ease monetary policy. In October 2009, temporary measures to ease monetary policy were retracted, while in December 2009, strong policies were adopted to ease monetary policy again based on the stance of not tolerating declines in consumer prices. For the time being, the Bank of Japan is expected to continue its stance of easing monetary policy. Since a strong momentum in the economy is lacking, and short-term interest rates are remaining stable at low levels, long-term interest rates are also expected to remain low.


Trends in Overseas Economies
‡ The world economy is continuing to show signs of improvement. In the October-toDecember quarter of 2009, the United States and the countries of Europe continued to report positive growth (compared with the previous quarter), and growth in China accelerated to double-digit levels for the first time in 18 months. The outlook is for recovery in the world economy to continue in 2010. Consumer spending in the United States is showing clear improvement, and, in China, even though there is concern about a tightening of monetary policy, there is a strong possibility that high growth rates will continue. However, improvement in employment conditions in Europe may be delayed, and the outlook is for a slow pace of recovery because of the deterioration in the financial positions of certain countries. As the world economy recovers, Japan¶s exports are increasing. By region, although Japan¶s exports to the United States and Europe are rising gradually, exports to countries in Asia are expanding at a brisk pace. These exports to the rest of Asia are expected to be a driving force, and the outlook is for exports to continue on a rising trend going forward. The surplus generated in the international income account by Japan¶s net overseas assets will be influenced to some extent by world economic conditions but is expected to remain steady. As the recovery in the trade surplus continues to be moderate, the surplus in the income account is likely to come to occupy a larger share of the current account surplus.






Demography: Economic Impacts of Population Aging in Japan
Given the demographic outlook and reasonable economic parameters, the general long-term picture is one of slowing per capita growth, a declining national saving rate, rising social contribution rates (subject to the assumption of no change in labor force participation rates or the calculation of pension, health, and long-term care benefits), and reduction in net foreign assets. While disposable income of both the elderly and the working-age population are expected to rise (i.e., living standards will continue to improve), it will translate into an eventual long-term decline in the living standards of the young relative to those of the elderly

Japan positioning : Availability of latest technologies vs Venture Capital Availability


Japan had a lost decade. The reason is that the authorities began to work on the banking sector problem seriously and decisively only after the country suffered from a systemic banking crisis in 1997 1998.

Causes of the Banking Crisis: Bursting of the Bubble
One of the direct causes of the banking crisis in Japan was the bursting of the asset price bubble in the period from the late 1980s to the early 1990s. After the 1985 Plaza Accord, Japan pursued expansionary fiscal and monetary policies to counter fears of recession brought aboutby the sharp appreciation of the yen. At the same time, a strong yen created a confidence and optimism in the future of the Japanese economy. This belief supported by abundant liquidity and self-fulfilling expectations of ever rising prices of stocks and land led to asset price bubbles. Stock and land prices peaked in December 1989 and March 1991, respectively. There were basically three causes of the banking sector crisis in the 1990s: 1. Bank loans were overextended particularly in risky areas with inadequate supervision and regulation over banks during the bubble period. Specifically, loan portfolios were concentrated in property-related businesses such as construction, real estate, and nonbank financial services. As most of these loans were collateralized by land whose values plummeted after the bubble burst, and cash flows were inadequate to repay the loans, these became nonperforming. 2. Banks were allowed to hold common stock on their balance sheet and had accumulated sizable unrealized capital gains, boosting their capital base. The bursting of the stock price bubble reduced these unrealized capital gains and eroded the value of capital reserves of many banks. The decline of their capital base damaged banks ability to extend loans and take risks. In fact, the amount of bank loans outstanding declined from the peak in 1997 until the mid-2000s, despite government efforts to avoid a credit crunch, partly due to weak demand from industry for funds. 3. The economic slowdown and price deflation in the 1990s also led to the growing levels of NPLs, especially in the late 1990s and the early 2000s.

Lost Years (1991±1997)

y y y

The initial policy adopted by the Ministry of Finance (MOF) was intended to protect ailing banks through regulatory forbearance and other forms of support, while gaining time for a hoped for recovery of economic growth and asset prices. The failure of Toho Sogo Bank in 1991 was the first bank failure in the postwar period in Japan. In 1994 and 1995, failures of small financial institutions accelerated. In 1995 1996, the government injected JPY680 billion to deal with jusen, specialized, nonbank housing loan companies. This policy was unpopular politically, and the government was heavily criticized for bailing out the nonbank financial institutions. As nonbank mortgage finance companies, jusen were less strictly regulated, and thus more aggressive in their lending to real estate-related small businesses than larger commercial banks during the bubble period. 26







The unpopularity of jusen intervention discouraged the MOF from pursuing policies to use public funds to address bank balance sheet problems. The government did make efforts to contain the emerging difficulty in the banking sector without using public funds. In June 1996, the deposit insurance system was strengthened through a major amendment of the Deposit Insurance Law including a temporary suspension of limits on deposit protection at first, until March 2001, then extended to 2002, and after another amendment in 2002, eventually until March 2005 (thereby introducing a blanket guarantee of bank deposits), and an increase in the insurance premium from 0.012% to 0.084% of total deposits outstanding. These efforts were mainly targeted at problems of credit cooperatives rather than for major banks. Economic growth had slowed down sharply in 1992 1994 following the bursting of the asset price bubble. Growth began to resume in 1995 1997, but the adoption of tight fiscal policy and the outbreak of the Asian financial crisis sent the economy back to recession. This fueled the banking crisis in Japan, which became acute in late 1997, affecting large financial institutions and major banks. Stagnant economic conditions and falling asset prices intensified market pressures, leading to the 1997 1998 systemic banking crisis. In the fall of 1997, Yamaichi Securities, one of the four largest security houses, collapsed and a medium-sized one, Sanyo Securities, also failed. These security houses were not able to obtain short-term funding in the Japanese interbank market due to their heightened risks as judged by market participants. Hokkaido Takushoku Bank, a city bank, became unable to raise funds in the interbank market and had to announce its discontinuation of business operations in November 1997. Subsequently, the premium for offshore foreign-currency interbank loans extended to Japanese banks by foreign banks, called the Japan premium , surged from the fall of 1997 through the spring of 1999.




The government announced in December 1997 that up to JPY30 trillion of public funds would be made available to the Deposit Insurance Corporation of Japan (DICJ) by March 1998 comprised of JPY13 trillion to bolster bank balance sheets and JPY17 trillion to strengthen the deposit insurance system. Public funds were augmented to a total of JPY60 trillion more than 12% of gross domestic product (GDP) at DICJ for financial support for banks in October 1998. Public funds totaling JPY1.8 trillion were injected to the 21 major banks in March 1998 to help banks meet the required capital adequacy standards. Nevertheless, the government had to intervene in two major banks, the Long-Term Credit Bank of Japan (LTCB) and Nippon Credit Bank (NCB) which were temporarily nationalized in October and December 1998, respectively. Both banks had problems with mismanagement in their loan portfolio during the bubble period and thereafter. Their shares were acquired by DICJ with zero value and, after the restructuring of their assets, they were put on sale to the private sector. It turned out that JPY1.8 trillion was not enough to fully recapitalize the ailing banking system. As a result, JPY7.5 trillion more of public funds were injected into 15 banks in March 1999. The second recapitalization operation encouraged private sector-driven capitalization and thus improved banks capital adequacy ratios and addressed bank NPL problems. By the 27



spring of 1999, banking sector stability was largely restored and the Japan premium narrowed substantially. The bank regulatory agency, together with the Bank of Japan, identified the total amount of NPLs of all banks to be JPY34 trillion, including JPY22 trillion for major banks, as of March 1999. However, these inspections were based solely on banks own assessments of NPL classifications and levels, and doubts about the reliability of these figures were rampant. There were large discrepancies between inspectors calculations of NPL levels and bank selfassessments. In 2000 and 2001, the government calculations indicated that banks underreported NPLs by 25% to 37%, and underestimated needed provisions and write -offs by 30% to 50%. This implied that at the time of bank recapitalization in 1998 and 1999, the exact scale of capital shortage was not accurately recognized by the authorities.

Recovery Phase (2002±2005)
y y




In 2001 the Financial Services Agency (FSA), established in 2000, 6 launched a special inspection of bank loans for the second half of fiscal year 2001. Large scale reclassification of loans to 149 companies; a quarter of the ³normal´ or ³need attention´ loans examined were reclassified to bad loans ²³bankrupt´ or ³in danger of bankruptcy´ loans. The increased regulatory pressure led to a dramatic change i n loan classifications by the banks in 2002, with the value of NPLs of all banks rising by more than 25% from JPY33.6 trillion at fiscal year -end 2000 to JPY43.2 trillion at fiscal year -end 2001. The FSA conducted a second round of special inspections in 2 003 that covered loans to 167 borrowers ²of which 142 had been examined in the first round of special inspections in fiscal year 2001 ²at 11 major banks that totaled JPY14.4 trillion. As a result of the stringent FSA inspection of bank loan quality, an enha nced and extensive policy package, Program for Financial Revival (PFR), was introduced in October 2002. PFR was intended to accelerate bank loan restructuring through a decisive three-pronged strategy: 1. Reduce the amount of equities held by banks to a leve l equal to 100% of Tier 1 capital by September 2006. 2. Strengthen the classifying of and provisioning for nonperforming loans through measures such as new inspections of major banks, harmonization of loan classification for large borrowers across banks, and disclosure of the gap between major banks¶ self -assessment of problem loans and FSA assessments. 3. Remove 50% of banks¶ new NPLs within one year and 80% within two years, with a target of halving the ratio of major banks¶ NPLs by March 2005 from the 8.4% March 2002 level. (No quantitative target was set for regional banks.) y As a result, loan classification and loan loss provisioning were strengthened, beginning with the fiscal year 2003 measures to improve the classification of loans to large businesses. y As a part of comprehensive efforts to revitalize the banking system and the economy, the government established a new asset management company, the Industrial Revitalization 28





Corporation of Japan (IRCJ) in April 2003. The objective of IRCJ was designed to promote the restructuring of relatively large and troubled, but viable, firms by purchasing their loans from secondary banks, leaving the main bank and IRCJ as the only major creditors. IRCJ was expected to promote structural reform of the Japanese economy by enabling troubled large firms to revive. Another policy to restore bank balance sheets to health, introduced as part of PFR, was to force all banks to reduce their holdings of equities to a level equal to 100% of its Tier-1 capital by September 2006. For the enforcement of this policy, the government set up a new institution, Banks Shareholdings Purchase Corporation (BSPC), in January 2002 to buy the stocks held by banks. BSPC purchased about JPY1.6 trillion of stocks from banks by 2006. The Bank of Japan also purchased stocks from banks, as part of quantitative easing under the zero interest rate policy, and the total amount bought by the Bank of Japan reached approximately JPY2 trillion between 2002 and 2004. With the mix of the policy measures to resolve the banking sector problems, the NPL ratio for the major banks went down to 2.9% by March 2005, at which point the government announced that the prolonged NPL problems had ended. Japan s economy returned to a full-fledged recovery path supported by global economic expansion starting in 2004. Japanese banks incurred cumulative losses inclusive of net costs of provisions for loans and direct write-offs of some JPY96 trillion between fiscal year 1992 and fiscal year 2004.

Delay in Decision Making
Delay in taking decisive action due to following reasons: 1. Expectation that a resumption of economic growth would restore the financial health of banks. Land prices were also expected to bottom out soon and resume rising again. The asset price bubble experienced in the late 1980s was the first in post-war Japanese history, and thus it took time to even recognize the situation as a bubble. It was only after the economy faced a systemic banking crisis in 1997 1998 that the authorities began to take decisive measures. 2. No domestic pressure and no external pressure. 3. Imperfections in accounting and disclosure standards, which enabled financial institutions to avoid recognizing loan losses. 4. Lack of legal framework to resolve troubled, large financial institutions, which fuelled their delay in adequately addressing problems at these institutions. In order to ensure the timely resolution of troubled financial institutions, it is crucial that the authorities possess a legal framework for resolution, specified operational procedures, and sufficient funds to cover capital shortages. It was only in 1998, after a series of failures of large financial institutions, that the full-fledged safety net framework was put in place.


Lessons Learnt
1. Prompt action to gauge the exact amount of loan losses is a critical initial step 2. A government recapitalization operation that involves taxpayer funds is the most direct policy measure to contain the acute phase of market turmoil 3. Removal of impaired assets from banks balance sheets is essential to the restoration of bank health. 4. Economic stagnation can cause new NPLs to emerge rapidly, and deplete bank capital.


anging anking environment

Limitations of the corporate-lending-centric business model Plagued by nonperforming loans (NPL) amid Japan s decade-long,post-bubble economic slump from the early 1990s, Japanese banks resorted to mergers, publicly funded recapitalizations, and costcutting. They eventually regained financial health once their NPL ratios began to decline from 2002. Even today, however, Japanese banks remain beset by a challenging earnings environment. Their current challenges stem from a slowdown in growth in corporate lending, which accounts for the bulk of their earnings, and an ongoing decline in their collective loan-to-deposit ratio. One factor behind these trends is that Japanese companies deleveraged and restructured their balance sheets as the Japanese economy s growth prospects diminished under the weight of its protracted malaise. Another contributing factor is that companies have diversified their modes of fundraising, most notably by increasing issuance of commercial paper, bonds, and private-placement bonds. In comparison to major foreign banks, Japanese banks have historically had relatively undiversified profit structures, more heavily weighted toward corporate lending. They consequently faced pressure to diversify their earnings through such means as increasing fee and commission revenues and deriving more profits from retail in addition to corporate customers.


Interest Rate trends

Major Happenings in the Banking sector
Once the Japanese government embarked on progressive deregulation, restrictions on banks product offerings were drastically eased from late 1990s. Banks are now able to sell investment trusts, insurance as a soliciting agent, and equities and bonds as an introducing broker.

Today banks, insurers, and securities brokerages are all able to sell banking, insurance, and securities products in one capacity or another (i.e., principal, agent, introducing broker).Other than the above deregulation, the Japanese government has changed regulations which influence financial institutions. Major changes are implementing paperless securities certificates which will enhance operational efficiency for financial institutions, strengthening compliance for customer protection, and introducing new taxation system which provides simpler filing procedure of final tax return from stocks and other investment products to tax payers.


Investment products share of household financial assets has been growing, albeit partly in response to market factors. Between 2002 and 2007, investment products (i.e., investment trusts, JGBs, equities) share of household financial assets increased from 13 to 18 , while savings deposits share decreased from 54 to 51 . Banks are playing a major role in selling investment products to the public. They are actively marketing investment trusts and annuities, among other products, capi talizing on their large customer bases and branch networks. Over the decade since banks began selling investment trusts, investment trusts aggregate assets have doubled. Investment trust units sold by banks account for half of current investment trust assets. Banks are key intermediaries in households ongoing asset reallocation from savings to investment products. Japanese banks have undertaken various initiatives to strengthen their retail businesses. Meanwhile, Japanese consumers have started to recogn the necessity of investments as they reallocate assets ize from savings to investment products.
2 2 2 2


10 Advantages of Investing in Japan
1. Japan - A Market of Enormous Potential Š Japan is an enormous market, one of the world s largest in terms of economic scale. Š Japan s regions also offer an attractive market and extensive business opportunities.

2. Sophisticated Consumers with High Purchasing Power and Discerning Tastes Š Japan is often seen as a superb test market for the introduction of new gl obal products and services. Š Japan s figures for final household consumption expenditure are among the highest for the major developed nations. The level of discretionary expenditure is high and consumer demand is substantial, with a significant share of ex penditure occurring in the areas of education and entertainment, transport, and communications. Š Japan s 120 million citizens hold personal financial assets of approxi -mately 1,500 trillion yen, adding up to considerable potential buying power.


3. Promising Markets and Industries Š Brief introduction to four sectors which are seen to have signifi -cant potential for future growth, and which have attracted considerable interest from companies in Japan and overseas. a. Information and communication technolog y (ICT) is an area in which Japan, backed by its world leading technological capability, is strong in all stages of


the product development process, from R&D to design and production. The scale of the market is enormous, and it is growing steadily. b. MEDICAL & HEALTH CARE-the market for care, nursing and welfare-re-lated services is also expected to grow steadily. c. AUTOMOTIVE PARTS- Japan s automotive industry is a global leader in terms of number of units manufactured and marketed, percentage of the world market, technology implemented, etc. Japan also offers foreign companies the chance to collaborate with these Japanese companies, which can lead to further expansion of their business overseas and provide considerable opportunities for in -novation. d. ENVIRONMENT Japan s environment-related market has been expanding rapidly since the mid-1990s. There has been considerable growth in environmen -tally friendly products and services in response both to the establish -ment of environmental laws and to an increasing co ncern towards global warming and other environmental problems. 4. Home of the World s Top Companies Š Japan is home to many of the world s top companies. These companies have established bases throughout the world and continue to expand their procurement, production and sales networks Š Advanced technologies originating in Japan have spread around the globe, and Japan s technological sophistication and innovativeness are admired throughout the world.

5. SMEs Possess Unique Technologies Š Japan hosts a large number of small and medium-sized enterprises (SMEs) which, while perhaps small in scale, are tremendously innovative. Š Many of these SMEs work in areas of basic production that support the international competitiveness of major companies, supplying, for example, equipment and parts that rely on high-precision machining technologies. Š Other SMEs may possess unique technologies, enabling them to occupy niches that major companies find difficult to enter.

Š For foreign companies seeking to enter the Japanese market, partnerships with companies of this type have numerous merits, including offering them the ability to develop products that fit the market, to boost their technological capacity, and to open up markets and sales channels. 6. Innovation Ushering in the Future Š Japan s expenditure on R&D as a percentage of GDP is the highest of any advanced nation Š Amid the ongoing globalization of business activities, efforts to create new products and services and increase added value through business alliances that transcend the borders between nations and the boundaries between different industries will be vital to business enterprises. With its world -leading technologies and commitment to R&D, Japan possesses the ideal conditions to be a center of innovation.

7. A Gateway to the Asian Market Š As the East Asian market grows rapidly, the economic integration between countries in the region continues to strengthen. The sustained high growth of the region is increasing its influence on the world economy Š Japan is becoming ever more important for companies from around the world as a location for regional headquarters and R&D bases to support their push into Asia. Š Due to the rapid economic growth of East Asia, the region s share of the world GDP has expanded significantly, where Japan continues to have a strong presence.


8. Foreign Companies Expanding Business in Japan Š Japan is a business destination that off ers abundant potential for foreign enterprises to increase their profit. Š The number of firms seeking to expand their businesses in Japan with a long -term investment strategy is steadily increasing. Š The value of foreign direct investment in Japan has grown steadily in recent years, and a large number of foreign companies have successfully entered the Japanese market.

9. Mature Investment Infrastructure Š Japan s industrial structure and business environment are similar to those of Europe and the US, and this makes it simpler for foreign companies to establish themselves here and to expand their businesses within the country than it is in other Asian countries. Š The Japanese government is also making considerable efforts to improve the investment environment. Š FDI is flowing into Japan faster than ever before, and the number of M&As is also increasing rapidly. Japan offers a mature and stable business environment that makes it ideal as a base for global business.


10. A Secure, Comfortable Living Enviro nment Š Japan possesses all the elements required for a comfortable life, including stable infrastructure, clean and safe urban environments, and efficient social systems. Š Japan welcomes its guests with a secure and comfortable life-style, rich with the potential to enjoy the diversity and beauty of nature in all its seasonal changes. Š Food in Japan is also relatively inexpensive when compared with prices in major cities around the world, and it is easy to find imported food -stuffs and daily items. Š Japan boasts a public infrastructure and a level of public safety and order that are unparalleled in most of Asia. The nation also provides an outstanding living environment from the perspectives of health care, education and leisure.

4 phases of Japan economy
1. Post-war reconstruction Š After World War II, the Japanese economy struggled to recover. the Japanese government adopted the priority production system, focusing on the production of steel and coal, expecting spillover effects on other sectors of the economy Š Three major structural reforms that is, the dissolution of "Zaibatsu," or financial conglomerates, reform of agricultural lands, and labor reform - these policies paved the way for the high economic growth that followed. 2. High growth Š During the period from 1956 to 1972, the economy grew on average 9.3 percent in real terms. These years are called the "high growth period. Š Exports also increased at faster paces, thanks to the modernization of production equipment and cost reduction by new tech nologies.

3. Stable economic growth Š In the early 1970s, the era of high economic growth ended, due to two external shocks - the Nixon Shock and the first oil crisis - and the era of stable economic growth of around 5% started. Š Nixon Shock - On August 15, 1971, US President Nixon unilaterally declared the end of the fixed exchange rate system, even though major economies had been consulting with each other to deal with the imbalances among the countries. This is called the "Nixon Shock." Š First Oil Crisis - In October 1973, the Middle East War led to the first oil crisis. Even before the oil crisis, Japan was suffering from two -digit inflation due to the over heating of the economy. Š The sharp rise in oil prices came on top of it, resulting in a serious inf lation of over 20% for the first time since the war. The oil crisis caused panic in the society, as Japan's dependency ratio on oil at that time was by far the highest in history. 4. The post-bubble Š Asian currency crisis - It broke out in Thailand in July 1997. In an effort to solve the Thai crisis, the IMF provided US$ 4 billion, with Asian countries providing US$ 11 billion, including US$ 4 billion from Japan. Nonetheless, the crisis spread to other Asian countries, including Indonesia, Korea, Malaysia, and the Philippines. Š Japan made the largest contributions in the world in support of Asia's economic recovery, including US$ 30 billion under the New Miyazawa Initiative Š Domestic Financial Crisis - Japan was hit by a serious domestic financial crisis. Fou r major financial institutions went bankruptcy within just one month toward the end of 1997 and economy plunged. Š In 1998, the economy recorded negative growth for the second time after the war.

Potential contribution of Japan to Asian recovery Š Japan has undoubtedly made a crucial contribution in economic recovery in East Asia as well as in the world economy as a whole. It has so far adopted various measures, including fiscal and monetary stimuli to revive economic growth. Š Since the outbreak of the crisis in East Asia, Japan has provided some $40 billion of financing to the region, including $28 billion long -term financing. Much of the latter has been chanelled through the IMF and has been used as part of bailout operations Š It calls on the Export- Import Bank of Japan to guarantee the debts of Asian corporations and banks, to offer subsidies on interest payments, to buy Asian government bonds to provide countries with more foreign currency, and to provide additional yen- denominated loans.


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