Tokyo as a leading global financial center: The vision under the spotlight again

Shirai, Sayuri Working Paper Tokyo as a leading global financial center: The vision under the spotlight again ADBI Working Paper, No. 758 Provided in Cooperation with: Asian Development Bank Institute (ADBI), Tokyo Suggested Citation: Shirai, Sayuri (2017) : Tokyo as a leading global financial center: The vision under the spotlight again, ADBI Working Paper, No. 758, Asian Development Bank Institute (ADBI), Tokyo This Version is available at: https://hdl.handle.net/10419/179214 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-nc-nd/3.0/igo/ ADBI Working Paper Series TOKYO AS A LEADING GLOBAL FINANCIAL CENTER: THE VISION UNDER THE SPOTLIGHT AGAIN Sayuri Shirai No. 758 July 2017 Asian Development Bank Institute The Working Paper series is a continuation of the formerly named Discussion Paper series; the numbering of the papers continued without interruption or change. ADBI’s working papers reflect initial ideas on a topic and are posted online for discussion. ADBI encourages readers to post their comments on the main page for each working paper (given in the citation below). Some working papers may develop into other forms of publication. Suggested citation: Shirai, S. 2017. Tokyo as a Leading Global Financial Center: The Vision Under the Spotlight Again. ADBI Working Paper 758. Tokyo: Asian Development Bank Institute. Available: https://www.adb.org/publications/tokyo-leading-global-financial-center-vision-under-spotlight- again Please contact the authors for information about this paper. Email: ss[email protected], [email protected] Sayuri Shirai is a visiting scholar at the Asian Development Bank Institute and a professor at Keio University. The views expressed in this paper are the views of the author and do not necessarily reflect the views or policies of ADBI, ADB, its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms. Working papers are subject to formal revision and correction before they are finalized and considered published. Asian Development Bank Institute Kasumigaseki Building, 8th Floor 3-2-5 Kasumigaseki, Chiyoda-ku Tokyo 100-6008, Japan Tel: +81-3-3593-5500 Fax: +81-3-3593-5571 URL: www.adbi.org E-mail: [email protected] © 2017 Asian Development Bank Institute ADBI Working Paper 758 S. Shirai Abstract Japan has endeavored to develop its capital Tokyo as one of the top global financial centers for a long time. In 2014, the Tokyo Metropolitan Government presented new initiatives as part of the sustainable economic growth strategies by taking advantage of the global attention given to the 2020 Tokyo Olympic Games. Japan’s advantages are the sheer size of its economy (the third largest in terms of gross domestic product); the status of the Japanese yen as the third international currency after the United States dollar and the euro; and large financial and capital markets with abundant capital. Tokyo has the potential to become a regional financial center that transfers excess capital to emerging Asia given its geographic proximity. So far, this vision has not fully materialized because Japan’s financial investment continues to be destined toward the United States and Europe and in the form of relatively safe debt securities. Moreover, Japan’s capital remains largely risk averse, contributing to lack of diversity in domestic capital markets and limited provision of risk money to the world. This paper takes an overview of Japan’s financial and capital market developments. Keywords: global financial center, international portfolio investment, Exchange-Traded Funds (EFT), and Real Estate Investment Trust (REIT) JEL Classification: E4, F21, G21 ADBI Working Paper 758 S. Shirai Contents 1. INTRODUCTION ......................................................................................................... 1 2. JAPANESE GOVERNMENT’S VISION TO DEVELOP A GLOBAL FINANCIAL CENTER .................................................................................................. 1 2.1 Government’s Aspiration to Internationalize the Yen and Foster Tokyo as a Top Global Financial Center ......................................................... 2 2.2 Prime Minister Abe’s Vision to Make Tokyo a Top Global Financial Center in Asia .................................................................................................. 3 2.3 Tokyo Metropolitan Government’s New Initiatives .......................................... 4 2.4 Assessment on the Progress of Yen’s Internationalization ............................. 4 2.5 Tokyo Financial Center Ranked Fifth since 1997 ............................................ 6 3. JAPAN’s CROSS-BORDER FINANCIAL INVESTMENT AND FINANCIAL INTERGRATION WITH THE WORLD ........................................................................ 7 3.1 Japan’s Financial Assets Concentrated toward Advanced Economies ........... 7 3.2 High Hedging Cost as a Barrier to Rapid External Investment ........................ 8 3.3 Foreign Investors’ Preference for Japan’s Equity over Debt Securities .......... 9 3.4 Japan’s One-Sided FDI Flows ....................................................................... 10 3.5 Assessment of Japan’ Cross-Border Financial Activities .............................. 11 4. JAPAN’s BANKING SECTOR COPING WITH ABUNDANT BANK DEPOSITS ....... 11 4.1 Banking Sector with the Low Loan-Deposit Ratio ......................................... 12 4.2 Long-Standing Limited Credit Demand ......................................................... 13 4.3 Household’s Excessive Reliance on Bank Deposits ..................................... 14 4.4 Cautious Corporate Sector with Ample Deposits and Cash .......................... 17 4.5 Assessment of Banking Sector Activities ...................................................... 18 5. GROWING PUBLIC SECTOR DEBT SECURITIES MARKET ................................. 20 5.1 Overwhelming Size of the JGB Market.......................................................... 20 5.2 Small and Stagnant Private Sector Debt Securities Market .......................... 21 5.3 Growing Amount of JGB Holdings by the BOJ .............................................. 22 5.4 Assessment of the Debt Securities Markets .................................................. 24 6. DEVELOPMENTS OF EQUITY MARKETS AND INVESTMENT TRUSTS .............. 24 6.1 Listed Companies Dominated by Domestic Companies ............................... 24 6.2 Essential Role Played by Foreign Investors in the Equity Market ................. 26 6.3 Stock Price Hike Since Late 2012 ................................................................. 27 6.4 Performance of Investment Trusts: ETFs and REITs .................................... 27 6.5 Assessment of the Equity Market and Investment Trusts ............................. 28 REFERENCES ..................................................................................................................... 30 ADBI Working Paper 758 S. Shirai 1. INTRODUCTION The Japanese government has endeavored to develop its capital Tokyo as one of the major global financial centers for many decades. Japan’s advantages are the sheer size of the Japanese economy (the third largest in terms of gross domestic product) and the status of the Japanese yen as the third international currency after the United States (US) dollar and the euro. Moreover, Japan’s financial and capital markets are large with abundant capital. Thus, Tokyo has the potential to become a regional financial center that transfers excess capital to emerging Asia given its geographic proximity. So far, this vision has not materialized to the extent that had been expected, since Japan’s financial investment continues to be destined toward the US and Europe and has been largely in the form of investment in relatively safe external debt securities. Moreover, Japan’s capital remains risk averse as compared with that of the US and Europe. This appears to have hampered Tokyo in its ambition to become a global financial center due to limited availability of risk money for financing overseas economic and financial activities. As for foreign investors’ financial activities in Japan, they continue to invest actively in Japan’s equity market. Their equity holdings accounted for about 30% based on market value and 27% based on the number of unit shares in fiscal year 2015 (April 2015 to March 2016), rising from 26% and 23%, respectively, in fiscal year 2012. Japan’s equity market has revived somewhat in recent years due to the Abenomics launched in December 2012 after Prime Minister Shinzo Abe came to power and the Quantitative and Qualitative Monetary Easing (QQE) adopted by the Bank of Japan (BOJ) in April 2013 under the newly elected Governor Haruhiko Kuroda. But their longer-run impacts on the functioning of Japan’s financial and capital markets need to be examined. Moreover, lack of diversity in domestic capital markets is another factor that had hampered Tokyo from becoming a global financial center since that attracted limited foreign investors and firms to Japan. This paper takes an overview of Japan’s financial and capital market developments. Section 2 focuses on the Japanese government’s initiatives to develop Tokyo as a global financial center and measures adopted. Section 3 focuses on Japan’s crossborder financial investment activities. Section 4 sheds light on certain features of the banking sector, which is dominant in Japan’s financial markets. Debt securities markets are analyzed in Section 5 and Section 6 highlights the equity market and developments of investment trusts. 2. JAPANESE GOVERNMENT’S VISION TO DEVELOP A GLOBAL FINANCIAL CENTER Japan’s economy is currently the third largest in terms of gross domestic product (GDP) after the US and the People’s Republic of China. Its currency, the Japanese yen, remains the third internationally used currency for foreign exchange trade after the US dollar and the euro. Japan Exchange Group (JPX), which includes the Tokyo Stock Exchange, has the largest stock exchange in Japan and the fourth largest in the world in terms of market capitalization. Moreover, Japan has large financial markets—the amount of total financial assets held by financial intermediaries (covering deposit taking financial institutions, pension funds and insurance firms, and other financial institutions) amounted to about ¥3,303 trillion (or US$30 trillion) in September 2016. According to 1 ADBI Working Paper 758 S. Shirai the BOJ’s estimates and CEIC data, this is the fourth largest in the world, following the US (US$86 trillion) in September 2016, the eurozone (€73 trillion or US$80 trillion) in June 2016, and the People’s Republic of China (CNY236 trillion or US$35 trillion) in September 2016. 2.1 Government’s Aspiration to Internationalize the Yen and Foster Tokyo as a Top Global Financial Center The Japanese government has endeavored to foster Tokyo as a global financial center for many decades. Since the early 1980s, the government has envisaged realizing this vision through internationalizing the yen or increasing usage of the yen in international trade and financial transactions. This vision was put forward in the process of liberalizing the capital account in the 1980s—in addition to the already liberalized current account and the resultant free usage of the yen for international trade and current account transactions. A series of tax measures were taken to make it more attractive for nonresidents to invest in yen-denominated debt securities including Japanese Government Bonds (JGBs) and municipal bonds. Samurai Bonds (yen-denominated bonds issued by nonresidents) and euro-yen-denominated bonds issued by nonresidents were introduced in the 1970s. Subsequently, a wide range of deregulations was adopted to further promote the yen’s internationalization. Those included a further deregulation of euro-yen-denominated bonds issued by nonresidents in 1984; an introduction of euro-yen-denominated bonds issued by residents in 1984; and establishment of the Tokyo offshore market in 1986. In 1996–2001, comprehensive financial and capital market reforms—the so-called “Japanese Financial Big Bang”—were implemented under the then Prime Minister Ryutaro Hashimoto and his ruling Liberal Democratic Party (LDP). This initiative had a clear vision to develop Japan’s financial and capital markets to become comparable to the financial centers in New York and London, and at the same time utilize the huge financial assets of households to energize Japan’s economy and for productive purposes. First, all cross-border transactions were liberalized in 1998 so that the deregulation process related to the yen’s internationalization was completed. Second, it promoted the asset management businesses by introducing various investment trusts and their over-the-counter (OTC) sales by banks and other financial institutions. All the transactions of securities derivatives were liberalized and asset-based securities were introduced. Third, competition was promoted by permitting banks, securities companies, and insurance companies to enter each other’s business fields. A switch from a licensing to a registration system for securities companies was performed with liberalized brokerage commissions. Fourth, the diversity of capital markets was promoted by establishing new markets for start-up firms and introducing electronic trading systems. In response, the Tokyo Stock Exchange established a new market for promising start-ups called “Mothers” (Market of High Growth and Emerging Stocks) in 1999. Finally, regulations to promote transparency and fair-trade were introduced or strengthened. During this period, Thailand, Indonesia, Republic of Korea, and some other Asian economies experienced the Currency and Banking Crisis of 1997. The Japanese government took initiatives by providing financial support and official development assistance to Asia. In the middle of the Thai crisis, moreover, the Japanese government promoted an idea of establishing an Asian Monetary Fund—a regional financing institution that would complement the International Monetary Fund (IMF) activities in Asia in 1997. However, this vision failed to materialize in the face of 2 ADBI Working Paper 758 S. Shirai opposition from the region, the US, and the IMF. Instead, the Asia region decided to develop a regional swap arrangement framework, the so-called “Chiang Mai Initiative” among the Association of Southeast Asian Nations (ASEAN) plus Three (the People’s Republic of China, Japan, and Republic of Korea) in May 2000. Moreover, many Asian governments found it necessary to reduce bank dependence and develop capital markets to prevent another currency and banking crisis. Accordingly, the ASEAN plus Three adopted the Asian Bond Initiative in 2012 to develop local currency-denominated bond markets and facilitate regional bond market integration. The Executive’s Meeting of East Asia and Pacific Central Banks (EMEAP) group—including central banks in the People’s Republic of China, Japan, Republic of Korea, Australia, New Zealand, Thailand, Singapore, etc.—took the initiative to form a jointly-managed fund (Asian Bond Fund [ABF]) utilizing a part of foreign reserves to invest in US dollar-denominated and local currency-denominated bonds issued in Asia. 2.2 Prime Minister Abe’s Vision to Make Tokyo a Top Global Financial Center in Asia In Japan, the view that Japan could play a major role in transferring abundant capital to emerging economies and developing countries in Asia is widely held. Japan could utilize excess capital to promote financial development and finance long-term investment and infrastructure projects needed to sustain economic growth and raise living standards in the region. The LDP has maintained this vision for a long time. The LDP policy manifesto was issued in 2010 when the LDP was an opposition party led by Mr. Sadakazu Tanigaki. The manifesto stressed that it would aim to foster Japan as the leading center of financial and asset management activities in Asia. This would be achieved by fostering competitive financial and capital markets and improving the business environment. Such improvements would enable firms to become more competitive through expanding their economic activities and utilizing households’ financial assets more efficiently. The same vision was repeated in 2012 when the then opposition LDP was led by Mr. Shinzo Abe. After the LDP seized political power following a landslide victory in the general election of December 2012, the 2013 policy manifesto repeated its goal of creating Asia’s leading financial center and added the further goal of Japan becoming the world’s leading financial center within 5 years. To realize this vision, the Japanese government has taken various measures to attract foreign firms and make Japan’s capital markets more attractive. First, the effective corporate tax (including central and local government taxes) was lowered from around 38% to around 35% in fiscal year 2014, further to around 32% in fiscal year 2015, and to 29.97% in fiscal year 2016. Second, the government reformed the basic portfolio of public pension reserve assets (about ¥145 trillion) managed by the Government Pension Investment Fund (GPIF) in October 2014. The target allocation of domestic bonds (mainly comprising JGBs) dropped from 60% to 35% with a change in the permissible range from ±8% to ±10%. Instead, the target allocations for the following assets were increased: for domestic equity from 12% to 25% with a permissible range of ±6% to ±9%, for external equity from 12% to 25% with a permissible range of ±5% to ±8%, for external bonds from 11% to 15% with a permissible range of ±5% to ±4%; and the target allocation for short-term assets was eliminated (it was 5% prior to the reform). 3 ADBI Working Paper 758 S. Shirai Third, the government has attempted to induce individuals to take greater risk to accumulate assets and diversify their financial assets by introducing the Nippon Individual Savings Account (NISA) in 2014—modeled after the Individual Savings Account (ISA) adopted in the United Kingdom. Under the NISA, all dividends and capital gains are tax-free, and individuals aged 20 years or over are currently able to invest up to ¥1.2 million per year. In 2016, the Junior NISA was introduced for individuals under 20 years old by allowing their parents and guardians to open an account for a child and contribute up to ¥800,000 annually on behalf of the child. In 2015, moreover, Prime Minster Abe announced that the Japanese government would provide about US$110 billion over 5 years to support infrastructure projects in Asia. This would be achieved through increasing yen-denominated official development assistance, strengthening financial support for the Asian Development Bank, and promoting Japanese commercial banks and firms to participate in the investment and financing projects operated by the Asian Development Bank and the Japanese government. The 2016 manifesto repeated the same vision to foster Tokyo as Asia’s leading financial center without specifying a timeframe for achieving this. 2.3 Tokyo Metropolitan Government’s New Initiatives Since 2014, the Tokyo Metropolitan Government has been taking its own initiatives to promote Tokyo as an attractive and reliable city at the center of international finance by establishing a task force. This move was inspired by the decision in September 2013 of the International Olympic Committee to select Tokyo as the host city of the 2020 Olympic Games. The Tokyo Metropolitan Government found that it would be a good opportunity to promote Tokyo as a global financial center given that a lot of attention would be paid to Tokyo over this period. The vision is to circulate domestic capital and capital from abroad including New York and London and Asia and invite foreign financial institutions and firms to establish businesses in Tokyo. In the same year, it came up with a report called “Initiatives for the Tokyo Global Financial Center” with detailed proposals including tax incentives, measures to improve the living environment for foreigners, and suggestions for developing a more business-oriented environment. These initiatives are in line with the Japanese government’s efforts to foster Japan as a top global financial center in Asia. 2.4 Assessment on the Progress of Yen’s Internationalization Despite all these government efforts, the yen has not become internationalized as much as the Japanese government wished. The progress can be assessed based on the following four measures: (1) currency composition and location of sales desks with regards to various kinds of foreign exchange trade, (2) currency composition and location of active transactions with regards to OTC interest rate derivatives, (3) invoice currency used for Japan’s exports and imports, (4) currency composition with regards to foreign reserves held by monetary authorities. First, the Triennial Central Bank Survey compiled by the Bank of International Settlements (BIS 2016) indicates that the US dollar, the euro, and the yen were the three top currencies on one side of all foreign exchange trade undertaken from 2000 to 2016. In the latest 2016 report, these currencies accounted for 88%, 31%, and 22% of all trades, respectively—although they dropped from 90%, 38%, and 24%, respectively, in 2001. After the Global Financial Crisis of 2008–2009, the share of the US dollar strengthened moderately from 86% in 2007 to 88% in 2016, maintaining its status as a dominant vehicle currency. The share of the yen also rose moderately from 17% in 4 ADBI Working Paper 758 S. Shirai Japanese firms. Indeed, the presence of Japanese manufacturers including automobile producers is large and noticeable in many Asian economies. The amounts of assets related to outbound FDI to the US and Europe are equally large, accounting for about 35% and about 25% of total outward FDI, respectively. Again, advanced economies are important destinations of Japan’s FDI capital. This is a reflection of the fact that Japan has competitive advantage in producing and exporting high-quality, relatively expensive export products, so these firms tend to increase production in these mature markets. The presence of the Japanese banking sector remained relatively large globally until the first half of the 1990s with the number of overseas branches reaching the peak of 380 in 1996. Since then, the domestic nonperforming loans rose rapidly, and the growing banking sector problems promoted the merger and acquisitions within the sector and a decline in the number of overseas branches (to 92 by 2011). Since 2012, the number of foreign branches began to rise moderately to 102 as of September 2016, reflecting the soundness of the baking sector and the need to develop new business opportunities in other countries in the face of substantially low interest rate and limited credit demand domestically. With regards to external liability related to FDI (accumulated amount of inbound FDI), the amount is relatively small compared with external assets related to FDI and accounts for only 17% of external assets related to FDI. Despite a cut in the corporate tax rate, as mentioned above, the FDI inflow remains limited. Among source regions, Europe is the most active FDI investor in Japan, accounting for about 50% of external liability related to FDI. 3.5 Assessment of Japan’ Cross-Border Financial Activities Tokyo has the potential to become a regional financial center that would transfer excess capital to emerging Asia for productive purposes given its geographic proximity. So far, this vision has not materialized since the major destination of financial investment continues to be biased toward the US and Europe. Japan’s investment in Asia is largely FDI and the size remains limited relative to Japan’s total external assets. Moreover, Japan’s FDI performance can be characterized by a one-way (namely, outbound) flow. A wider gap between FDI-related external assets and FDI-related external liability is indicative of the limited entry of foreign (manufacturing and nonmanufacturing) firms and the limited success of foreign firms operating in Japan. This is different from the US and Europe, where both inbound and outbound FDI are fairly balanced with the rest of the world. Japan’s one-way flow of capital is more evident with regards to FDI as compared with portfolio and other types of investment. Japan’s limited portfolio investment in Asia has remained largely unchanged even after bond markets became more developed in Asia from the 2000s under the Asian Bond Initiative and ABF referred to above. Moreover, Japan’s investors are less willing to take risk compared with those of the US and Europe. This appears to have hampered Tokyo from becoming a center for generating dynamic, innovative, cross-border capital flows in the world. 4. JAPAN’S BANKING SECTOR COPING WITH ABUNDANT BANK DEPOSITS Japan’ financial asset held by financial intermediaries are dominated by deposit taking financial institutions. Deposit taking financial institutions cover domestically licensed banks; foreign banks in Japan; financial institutions for agriculture, forestry and 11 ADBI Working Paper 758 S. Shirai fisheries; financial institutions for small businesses; postal savings (counted as Japan Post Bank from the fourth quarter of 2007); etc. Among deposit taking financial institutions, domestically licensed banks are dominant and account for about 60% of total financial assets. The total asset size held by domestically licensed financial institutions reached about ¥1,876 trillion in September 2016 and ¥1,955 trillion in December 2016 (3.5 times as large as GDP). The presence of the branches of foreign banks remains small as the total financial assets recorded only ¥45 trillion. This section focuses on Japan’s domestically licensed banks that have seen large and growing deposits from households and firms. How to utilize such surplus funds profitably and efficiently has become a challenging task. 4.1 Banking Sector with the Low Loan-Deposit Ratio Domestically licensed banks (mainly, comprising commercial banks) can be decomposed into (1) city banks (comprising large commercial banks such as Mitsubishi UFJ Financial Group, Sumitomo Mitsui Financial Group, and Mizuho Financial Group), (2) regional banks (regional banks and regional banks II), and (3) other smaller banks (and credit unions). City banks account for half of the total financial assets held by domestically licensed banks, in December 2016. Regional banks and other small banks accounted for about 36% and 14%, respectively. Surprisingly, these compositions barely changed from 2000 to 2016. These data indicate that Japan’s banking sector is not very concentrated as compared with other advanced economies. Japan’s banking sector is often considered to be overbanked. According to the Global Financial Development Database compiled by the World Bank, the five-bank asset concentration ratio in Japan rose from 43% in 2000 to 50% in 2007 and further to 60% in 2014 (the latest available figure). As of 2014, Japan’s ratio was higher than that in the US (48%), but was much lower than Germany (99%), the United Kingdom (90%), and France (79%). Thus, the European banking sector is more oligopolistic than the banking sectors in Japan and the US. As in Japan, the ratios increased in the US, Germany, France, and the United Kingdom over the same period. Japan’s banking sector is unique compared with other advanced economies in terms of the abundance of deposits relative to the amount needed for domestic credit. For example, deposits and currency held by Japanese banks accounted for 45% of the total liabilities of all financial intermediaries as of end-June 2016. The ratio is greater than that of the eurozone (34%) and the US (16%) according to a BOJ estimate. According to the Global Financial Development Database, moreover, the ratio of bank deposits to GDP in 2014 (the latest available figure) was 230% in Japan, which was substantially greater than in the US (82%), Germany (78%), and France (77%). In sharp contrast to abundant bank deposits, demand for credit has been limited for a long time in Japan. This is a structural phenomenon, as evidenced by the persistently low and declining bank loans to deposit ratios. The ratio dropped from 66% in January–March 2000 to 53% in October–December 2016 (Figure 2). This reflects that the pace of an increase in bank deposits has been faster than the pace of increase in bank loans. The gap between loans and deposits is mainly filled by JGB holdings. This suggests that abundant capital has not been utilized efficiently for productive purposes in the private sector. 12 ADBI Working Paper 758 S. Shirai Figure 2: Loans, Deposits, and Loans–Deposit Ratio of Depository Corporations (Billion Yen, %) Source: Flow of Funds, Bank of Japan. 4.2 Long-Standing Limited Credit Demand Long-standing limited demand for credit reflects not only the rapid pace of aging in Japan and its declining population, but also the outlook for the shrinking markets of goods and services. The markets for durable consumer goods (such as home electronics and automobiles) already exhibited declining trends after the Global Financial Crisis. This is also due to a declining number of young households and a rising number of elderly single households. The production of durable consumer goods dropped by 15% between 2008 and 2016. Abenomics and QQE helped to increase demand for automobiles with tax advantages and very accommodative financial conditions, but automobile sales levels neither recovered to the level seen before the Global Financial Crisis nor reversed the declining trend. The production level of durable consumer goods dropped further by 9% between 2012 and 2016. In general, credit demand is weaker in local and rural areas than in large cities and relatively prosperous regions. Local and rural areas here refer to almost all regions outside the Tokyo Metropolitan Area, Aichi Prefecture (where Toyota Motor Corporation’s headquarters with large production activities are located), Fukuoka Prefecture (with Fukuoka City, a gateway to Asia and the largest city in Kyushu, Japan’s third biggest island), and Okinawa Prefecture (where population growth and birth rates are the highest in Japan). All these regions have faced a net outflow of population especially of younger working-age people, a rapid pace of aging, and declining business activities. 13 ADBI Working Paper 758 S. Shirai A shift in production location abroad by manufacturers has risen since 2000 and accelerated from 2012. According to the FY 2016 Survey Report on Overseas Business Operations by Japanese Manufacturing Companies compiled by Japan Bank for International Cooperation (JBIC), the share of overseas production in total production rose from 25% in fiscal year 2001 to 30.6% in fiscal year 2007, then fluctuated around this level, before rising to 33% in fiscal year 2012 and further to 38.5% in fiscal year 2016. The increase in overseas production contributed to the weaker economic performance of local and rural areas. A loss of international competitiveness in some manufacturing sectors such as home electronics, personal computers, and other information technology products against other Asian firms has also reduced manufacturing activities in Japan and thus demand for credit. Since 2013, Abenomics and QQE have enabled stagnant loan growth to turn positive. This is a welcome trend, but the current year-on-year loan growth of 2%–3% remains too moderate to offset a decline in the interest rate margins (difference between lending and deposit rates). The interest rate margin fell below 1% in 2012 due to monetary easing by the BOJ under the then Masaaki Shirakawa Governorship. The margin continued to drop under QQE and further after the announcement of a negative interest rate policy in January 2016 (with the effect from mid-February 2016). Deposit growth, rather than slowing, grew even faster than bank loans especially after the negative interest rate policy; thus, the already low loan-deposit ratio dropped even further (Figure 2). The main objective of QQE is to achieve the 2% price stability target by increasing aggregate demand and inflation. One of the important expected transmission channels of monetary easing is to promote portfolio rebalancing of financial institutions from safe assets (i.e., JGBs and TBs) to risk assets (such as bank loans, mergers and acquisitions, FDI, and other securities investment). Together with the banking sector’s provision of innovative financial services, the BOJ has envisaged that firms would be encouraged to shift from holding cash and bank deposits to expanding fixed business investment, mergers and acquisitions domestically and overseas, research and development, FDI, etc. Similarly, the BOJ has envisaged that households’ portfolios would be rebalanced from safe assets (such as cash and bank deposits) to risk assets (such as residential investment, investment in equity investments and investment trusts, etc.). In other words, the unprecedented massive monetary easing intends to energize Japan’s economy by promoting “healthy” risk-taking behavior among firms, households, and financial institutions, which has been lacking since the collapse of the equity and real estate bubbles in the early 1990s. A continuing low and stagnant loan–deposit ratio reveals that QQE has not achieved these objectives so far although it has been successful in lowering lending rates. The limited effectiveness of QQE in terms of stimulating credit demand suggests that abundant deposits and limited credit demand are structural rather than cyclical. 4.3 Household’s Excessive Reliance on Bank Deposits Japan’s banking sector has ample bank deposits held by households and firms. Regarding households, they traditionally prefer banks deposits. Deposits and currency accounted for around 50% of households’ total financial assets from 2000 to 2016 (Figure 3). Such large-scale holdings of deposits are quite remarkable given that the deposit interest rate is very low—it was so even before QQE and has been close to zero percent since the adoption of QQE. 14 ADBI Working Paper 758 S. Shirai Figure 3: Households’ Financial Assets by Type of Assets (Billion Yen) Source: Flow of Funds, Bank of Japan. Thus, it may be difficult to understand, especially for non-Japanese people, why individual investors continue to keep large amounts of money in the form of bank deposits. In the past (mildly) deflationary period, it could be said that households were rational to do so because of the rising real value of bank deposits. But since June 2013 the rate of change in the CPI has been positive and it jumped above 3% during fiscal year 2014 thanks to a consumption tax hike from 5% to 8% (adding about 2 percentage points to inflation) and due to the yen’s depreciation and the resultant increase in import prices. Despite mild inflation, however, Japanese households continue to prefer bank deposits. QQE contributed to raising households’ equity and investment fund share holdings as a share of total financial assets from around 9%–10% in 2008–2012 to 12% in the first half of 2013 and further to 13%–14% from the second half of 2013 to October–December 2016. However, the ratio did not exceed the maximum (17%) reached in June–August 2007 and 15%–16% before the Global Financial Crisis. The moderate increase during 2013–2016 reflects mainly stock price hikes (Figure 1), because the ratio of individuals’ holdings of equity listed on the stock exchanges dropped to 22% in fiscal year 2015 from 29.5% in fiscal year 2011 based on the number of unit shares. Individuals remained net sellers of equity from fiscal year 2009 to fiscal year 2015; many of them took the opportunity to sell equity when prices rose from late 2012. By contrast, households’ holdings of debt securities accounted for only 1%–2% of total financial assets over the same period. Their equity holdings are greater than debt securities holdings partly because a wide range of JGBs and other corporate bonds are available to professional investors as compared with households. Overall, the sheer size of deposits and currency indicate households are highly risk-averse, suggesting 15 ADBI Working Paper 758 S. Shirai continuation of risk averse behavior. This is partly because bank deposits are regarded as safer assets due to the protection of deposits up to ¥10 million per bank per person. The risk adverse behavior of Japan’s households is in contrast with that of households in the US and the eurozone. According to BOJ’s estimates, deposits and currency accounted for 52% of households’ total financial assets in Japan as of end-September 2016 while they accounted for only 14% in the US as of end-September 2016 and 35% in the eurozone as of end-June 2016. Equity holdings and investment trusts accounted for 46% in the US and 25% in the eurozone, while only accounting for 13% in Japan. The high degree of risk aversion in Japan is attributable to limited successful investment experiences since the collapse of stock price and real estate bubbles begun in the early 1990s. Like equity, real estate prices have never recovered the maximum price level achieved in 1991. According to Tochi Data, the national land price reached ¥585,289 per square meter in 1999, dropping to below ¥140,000 per square meter in 2005 and 2012. Between 2012 and 2016, the national land price rose, cumulatively by 14%. Despite the increase, the price remained only 27% of the maximum level reached in 1991. Figure 4: Residential Real Estate Price Development (January 2010 = 100) Source: Japan Real Estate Institute. Figure 4 exhibits residential real estate prices in Tokyo and the Tokyo Metropolitan Area including three neighboring prefectures. Real estate prices began to rise in 2013 after the launch of the Abenomics and QQE and prices in Tokyo approached the levels achieved in early 2000. However, the pace of recovery has been slower in the Tokyo Metropolitan Area than in Tokyo. Some prices in central Tokyo have risen considerably faster due to (a) the expectation of rising real estate prices driven by infrastructure investment related to the 2020 Tokyo Olympic Games, (2) an increase in housing 16 ADBI Working Paper 758 S. Shirai investment for rent mainly for tax saving purposes, and (3) increased demand for highquality apartments. Rather than being a response to growing demand for rental housing caused by a greater number of tenants, higher investments in housing for rent were made by individuals who own land since inheritance and property taxes could be reduced on the portion of land utilized for apartments or housing for rent. 4.4 Cautious Corporate Sector with Ample Deposits and Cash Like households, Japanese firms are known to be highly risk averse, as demonstrated by their large holdings of deposits and currency. The amount of deposits and currency held by banks remained stable at around ¥180 trillion in 2000–2010, but began to rise from 2011 and rose at an accelerated pace from 2013 owing to an increase in corporate profits. In 2016, the amount of deposits and currency exceeded ¥240 trillion—about one fourth of firms’ financial assets and about 45% of GDP in 2016 (Figure 5). This reflects firms’ choice to accumulate profits in the form of retained earnings rather than allocating them to expanding business fixed investment, mergers and acquisitions, research and development, foreign portfolio investment, and outbound FDI. Corporate profits rose rapidly in 2013 and companies maintained high profit levels in 2014–2016. This high profitability was attributable to various favorable factors: (1) the yen’s substantial depreciation from end-December 2012 and the resultant increase in the yen value of overseas profits, (2) large public investment in 2013, (3) a series of cuts in the corporate tax rate from 2014, (4) higher tourist arrivals driven by the yen’s depreciation and a deregulation of tourist visa issuance since 2013, (5) a sharp decline in commodity prices and imported materials in 2014–2016, and (5) an increase in foreign demand since 2015. Figure 5: Firms’ Holdings of Deposits and Currency (Billion Yen, % of Total Financial Assets) Source: Bank of Japan, Flow of Funds. 17 ADBI Working Paper 758 S. Shirai In 2013–2016, firms increased their nonresidential fixed investment. However, the amount of increase was moderate and remained well below cash flows or change in deposits and currency. Since 2013, firms have been expanding outbound FDI with the amount of assets growing from ¥72 trillion in the first quarter of 2013 to ¥123 trillion in the fourth quarter of 2016. The increase was moderate and foreign assets related to FDI accounted for only half of deposits and currency in 2016. Similarly, firms in the US also increased their holdings of deposits due to an increase in profits over time and achieved about US$1 trillion in December 2016. However, the amount is relatively small compared with Japan, accounting for only 5% of total financial assets and 5% of GDP. In addition, US firms actively engaged in outbound FDI so that the amount of foreign assets related to FDI recorded US$5 trillion, which is about 5 times as large as deposits. Firms’ nonresidential fixed investment exceeded cash flows or change in deposits. 4.5 Assessment of Banking Sector Activities Among advanced economies, financial markets in Japan and the eurozone are bank-dominated. The amount of financial assets held by deposit-taking financial institutions accounted for about 60% of total financial assets held by financial intermediaries in Japan and about 50% of total financial assets held by financial intermediaries in the eurozone. By contrast, financial markets in the US are marketbased, with financial assets held by these institutions accounting for only 20% of total financial assets. The financial markets in the US are dominated by a wide range of nonbank financial institutions or entities—including securities dealers and brokers; the MMFs, FTFs, GSEs, financial companies, Real Estate Investment Trusts (REITs), etc. The amount of total financial assets held by these institutions accounted for about 46% of total financial assets held by financial intermediaries. Given abundant deposits and the public’s preference for bank deposits, Japan’s banking sector is likely to remain dominant among financial institutions in the financial and capital markets for the foreseeable future. The banking sector has been struggling with its long-standing problem of how to utilize abundant deposits given the limited demand for credit. Firms maintained financial surpluses or excess savings (greater savings relative to nonresidential fixed investment) before and after the Global Financial Crisis. An increase in corporate profits since 2013 has further increased corporate holdings of deposits and currency, thereby expanding the financial surplus and excess saving in 2015 and 2016 (Figure 6). As for households, their financial surplus has declined since 2013 and at present is nearly zero because the rapid pace of aging and the declining working-age population reduced saving. This means that financial deficits or excess investment of the Japanese government are financed solely by the corporate sector; no longer by the household sector. In such an environment, it is not easy for the banking sector to find new firms and existing borrowers who wish to engage in new economic activities and are thus short of capital. Tighter financial regulations also make commercial banks more cautious in extending credit to unknown clients without track records or collateral. 18 ADBI Working Paper 758 S. Shirai Figure 6: Financial Surplus and Deficit by Sector Source: Flow of Funds, Bank of Japan. Moreover, small and medium-sized enterprises have traditionally obtained funding from credit unions that have deeper knowledge of the regions and individual firms through long-term relationships. Through such relationships, they take greater credit risk than other banks. Given an increase in abundant deposits, both credit unions and larger regional banks are eager to provide credit to viable client enterprises including small and medium-sized enterprises. As a result, competition has become intensified. Since 2014, the Financial Services Agency has encouraged commercial banks to provide asset-based lending (ABL) rather than traditional lending based on collateral using land and personal guarantee—for the purpose of promoting new lending to small and medium-sized enterprises. Such ABL refers to loans collateralized by movable property (such as inventories) and accounts receivable. This ABL helps commercial banks to deepen their understanding of the actual conditions of their clients’ enterprises. Meanwhile, the BOJ has been providing 4-year lending (currently at zero percent interest rate) since 2011 to commercial banks in accordance with their actual lending and investment performance toward strengthening the foundations for economic growth—including commercial banks’ ABL. While such initiatives have contributed to new types of lending activities by commercial banks, their impacts on total credit demand as well as active use of ABL have been limited. The BOJ’s outstanding loans linked to ABL (and equity investment) recorded ¥60 trillion and applied to only 14 financial institutions as of end-May 2017. In a longer run perspective, the abundance of bank deposits is expected to decline gradually, especially in small cities and rural areas. This is not only because the number of elderly people is growing, but also because bank deposits inherited from the older generations are likely to be transferred to and concentrated in large cities where the younger generations tend to live and work. This suggests that an increase in joint business activities or mergers and acquisitions among banks and credit unions in small cities and rural areas is expected as a way to reduce operating costs and raise profitability. 19 ADBI Working Paper 758 S. Shirai 5. GROWING PUBLIC SECTOR DEBT SECURITIES MARKET Japan’s capital markets (debt securities and equity) are much smaller than its banking sector. Nevertheless, the size of the debt securities market has been growing rapidly because of an increase in the issuance of Japanese Government Bonds (JGBs). This section focuses on public and private sector debt securities markets as well as the BOJ’s asset purchase programs that have significantly influenced the markets. 5.1 Overwhelming Size of the JGB Market The capital markets comprised the debt securities market and the equity market. The total size of the debt securities market recorded about ¥1,263 trillion in December 2016 and accounted for 235% of GDP. This size is greater than that of the equity market (equity market capitalization accounted for about 100% of GDP), which is a reflection of the sheer size of the general government’s mounting debt. Privates sector debt securities (those issued by financial institutions and nonfinancial enterprises) amounted to only ¥114 trillion and accounted for just 21% of GDP, which is well below the size of the equity market. In the debt securities market, the general government (central government, local governments, public corporations) is the dominant issuer. General government debt securities comprise (1) central government securities (ordinal bonds), (2) Treasury Discount Bills (TBs), (3) municipal bonds, and (4) other securities issued by public corporations. The total size of debt securities issued by the general government doubled between 2000 and 2016—rising from ¥490 trillion in December 2000 to ¥720 trillion in December 2007 and further to ¥1,046 trillion (about 195% of GDP) in December 2016. The ordinal bonds (¥854 trillion) and TBs (¥117 trillion) dominate the general government debt securities market and accounted for 93% of the total general government debt securities outstanding in December 2016. The market size of municipal bonds remains small. It should be noted that JGBs include ordinary bonds and Fiscal Investment and Loan Program (FILP) bonds. However, they are separately reported as ordinary bonds are included in the general government account and the FILP bonds are included in the public enterprises account. Nevertheless, they are classified collectively and issued together as same JGBs. FILP bonds are loan funds that require redemption, while ordinary bonds are grant funds that do not require a repayment obligation since taxes are the main fiscal sources. In December 2016, the FILP bonds recorded about ¥104 trillion (or about 19% of GDP) so that the amount of JGBs outstanding issued amounted to ¥958 trillion. While the amount of outstanding general government debt securities issued is huge, general government financial assets are relatively large and recorded ¥558 trillion (104% of GDP). Taking the difference between total financial liability and total financial asset generates a net financial liability of ¥690 trillion (128% of GDP) and is much smaller than total (or gross) financial liability of ¥1,245 trillion (233% of GDP). Total financial assets include the assets held by the social security funds including the GPIF (about ¥245 trillion). The GPIF and other public pension funds are invested mainly among (domestic) debt securities, equity and investment fund shares, and external debt securities, more or less in line with the GPIF portfolio guideline mentioned above. Even though the net financial liability is much smaller than the gross financial liability, it should be remembered that financial assets managed by the social security funds are 20 ADBI Working Paper 758 S. Shirai 6.3 Stock Price Hike Since Late 2012 Stock prices have risen since late 2012 reflecting high corporate profits and other favorable factors mentioned above. Moreover, the BOJ has been purchasing directly the EFTs that track major stock price indices such as Nikkei 225, TOPIX, and JPX Nikkei Index 400. This has certainly contributed to higher stock prices by reducing the downside risk and thereby reassuring investors, as pointed out below. The BOJ’s largescale purchases of JGBs also contributed to raising stock prices through a decline in long-term interest rates—through portfolio rebalancing, the exchange rate, and asset price channels. A further rise in stock prices is expected by many equity investors. This is partly because current equity prices—as measured by the price earnings ratio—are no longer undervalued, but not necessarily overpriced. Moreover, many investors anticipate higher stock prices in Japan due to a further increase in interest rate differentials between the US and Japan. This would be driven by expected economic stimulus packages to be implemented under Donald Trump’s presidency and resultant higher interest rates. Foreign investors also hold the view that the BOJ’s massive asset purchases with yield curve control would continue and contribute to maintaining the interest differentials by holding down Japan’s yields. Since major listed companies are manufacturers in Japan, a depreciation of the yen contributes to raising the yen value of corporate profits and hence stock prices. 6.4 Performance of Investment Trusts: ETFs and REITs Japan’s total net assets of investment trusts recorded US$1.4 trillion in December 2016—the eighth largest in the world according to data released by the Investment Trusts Association. The total net assets of investment trusts in the US overwhelmed other countries due to their sheer size (18.8 trillion US dollars). Luxemburg (US$3.9 trillion) is ranked second and Ireland (US$2.2 trillion) is ranked third. Out of Japan’s net assets in investment trusts, about 60% are allocated to publicly offered investment trusts and the rest to privately placed investment trusts. The net assets of publicly offered investment trusts have grown rapidly since 2013 and reached about ¥100 trillion in March 2017—the highest level registered since 1998 when data started becoming available—¥86 trillion of which were stock investment trusts (including ETFs worth about ¥23 trillion), accounting for about 90% of the net assets of publicly offered investment trusts. The net assets of publicly offered stock investments are largely denominated in the yen. The market share of yen-denominated assets rose from 43% in 2009 to 67% in March 2017 (of which net assets excluding ETFs rose from 40% to 54% over the same period). This was a result of a rapid increase in investment in Japanese equities since 2013. The expansion of the ETF market is remarkable. Japan’s ETFs are largely stock ETFs and all are of the stock index type. The net assets of ETFs were small before the Global Financial Crisis, reaching a maximum of about ¥4 trillion in 2006, followed by a decline in 2007–2009. From 2013 they rose rapidly, from ¥4.2 trillion in 2012 to ¥8 trillion in 2013 and further to ¥23 trillion in March 2017. The BOJ’s expansion of ETF purchases clearly energized this market. The BOJ introduced a program to purchase ETFs tracking the Nikkei 225 and TOPIX as part of a Comprehensive Monetary Easing (CME) package led by the then Governor Shirakawa in October 2010. Initially, the maximum amount of holdings was set at ¥450 billion with a deadline of end-December 2011. The maximum amount was subsequently expanded 27 ADBI Working Paper 758 S. Shirai in March 2011 to ¥900 billion and the deadline extended to end-June 2012, and further expanded in August 2011 to ¥1.4 trillion with the deadline extended to end-December 2012. In April 2013, QQE expanded the amount of the ETF purchase by setting an annual pace of about ¥1 trillion, which was an acceleration of the BOJ’s purchase pace. The annual pace was expanded to about ¥3 trillion in October 2015 and further to about ¥6 trillion in July 2016. ETFs tracking the JPX Nikkei 400 were added to the program in March 2016. The BOJ’s holdings of ETFs recorded about ¥14 trillion in May 2017 and accounted for over 60% of the total net assets of ETFs. The BOJ became a dominant player in the ETF market. The number of ETFs rose steadily and rapidly from 16 in 2007 to 156 in March 2017. Since the growth rate of the number of ETFs is greater than the growth rate of the net assets, the size of net assets per fund stagnated. With regards to listed REITs, the market has faced a similar rising trend to that of the ETFs since 2013. Several factors contributed to this trend: BOJ’s purchases of REITs as pointed out below, low interest rate environment, and the speculation on higher real estate prices driven by the 2020 Tokyo Olympic Game, etc. The net assets of listed REITs recorded about ¥4 trillion in 2009 and remained at that level until 2011. The net assets then rose rapidly from 4.6 trillion in 2012 to ¥8.5 trillion in February 2017 (the market value of REITs rose from ¥4 trillion to ¥12 trillion over the same period). The number of REITs was 42 in 2007–2009, followed by a decline in 2010– 2011. The number of REITs subsequently rose from 37 in 2012 to 58 in February 2017. However, the TOSHO REIT index (the index of the REITs listed on the Tokyo Stock Exchange) saw an end to its rising trend in early 2015 and has since fluctuated between 1,700 and 1,900 points. As with the ETFs, the BOJ’s action contributed to expanding the REIT market rapidly. The BOJ introduced the REIT purchase program in October 2010 under its CME package by initially setting the maximum amount of holdings at around ¥50 billion with a deadline of end-December 2011. The BOJ also introduced several self-imposed conditions on ETF purchase: (1) a minimum credit rating requirement (AA or higher), (2) a purchase limit (5% of the amount outstanding issued), and (3) ETFs whose purchase and sale have been transacted “on a financial instruments exchange 200 days or more per annum with a total trading value of 20 billion yen or more per annum”. This purchase limit was then raised to ¥100 billion in March 2011 with the deadline extended to end-June 2012 and further raised to ¥110 billion in August 2011 with a deadline of end-December 2012. Subsequently, QQE introduced an annual pace of ETF purchases of about ¥30 billion, followed by a rise to about ¥90 billion in October 2015. As the BOJ’s holdings rose, the BOJ found it difficult to continue the ETF purchases due to its violation of the self-imposed 5% limit for some REITs. The limit was raised, therefore, from 5% to 10% in January 2016. As of May 2017, the BOJ’s holdings of ETFs stood at ¥390 billion. 6.5 Assessment of the Equity Market and Investment Trusts The BOJ considers its purchases of ETFs and REITs to be part of its monetary easing policy for the purpose of raising aggregate demand and inflation—not to keep the market price artificially high. Together with the yen’s sharp depreciation and rising corporate profits, the ETF purchases contributed to raising Japan’s stock prices. With the REIT market, the real estate market has also grown in the Tokyo Metropolitan Area and other large cities, leading to greater transaction volumes. 28 ADBI Working Paper 758 S. Shirai These movements promoted portfolio rebalancing for some investors and financial institutions. Many existing investors benefited from capital gains and raised the valuation of their financial assets. Although these favorable market developments have increased the confidence of existing investors and large listed firms, they have not managed to change the risk averse behavior of households, firms, and financial institutions in general, and have not resulted in a large number of new individual investors. Many remain cautious, as pointed out above. Moreover, the impact of the BOJ’s actions on these markets is large since the market participants have been conducting transactions by taking into account the BOJ’s actions – even though the amounts of purchases are well below the daily transaction volumes. The BOJ is widely viewed as tending to purchase ETFs and REITs when their prices fall. This has given a sense of security to investors by reducing downside risk as well as generating transactions that attempt to anticipate the BOJ’s moves. Some equity market participants view that a further increase in the BOJ’s ETF purchases may lead to a situation where market prices of individual companies do not necessarily reflect firms’ specific information and fundamentals. Meanwhile, many individual investors and some market participants in the REIT (and real estate) markets hold the view that these markets are likely to remain active and favorable at least until the 2020 Olympic Games due to an expected increase in construction activities (such as for sport facilities, hotels, and restaurants)—even if the BOJ reduces the amount of REIT purchases. An important issue in the future, therefore, will be how the markets will respond to change in the BOJ’s policy, which is likely to move toward normalization or a more sustainable framework in the foreseeable future. 29 ADBI Working Paper 758 S. Shirai REFERENCES Bank for International Settlements. 2016. 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