(Provisional Translation)
Outline for Fundamental Reform of the Fiscal Investment and Loan Program
(Summary of Discussion at the Sub-committee of the Fund Operation Council)
November 1997
1. Introduction
The Sub-committee of the Fund Operation Council carried out a further review following the chairman's remarks compiled last July. The sub-committee's views and opinions concerning fundamental reform of the Fiscal Investment and Loan Program (FILP) are summarized as follows.
2. Roles That the FILP Has Performed Up to Now and Its Current Problems
(1) The FILP has contributed to Japan's economic development as a means to make efficient use of domestic savings for the improvement of the social infrastructure and other fiscal objectives.
(2) Due to an improvement in the private sector's ability, in keeping with a comprehensive maturing of the economy and improvement of market mechanisms, it is necessary to review the role of the government and to carry out a fundamental review of the FILP system.
The functions that the FILP should fulfill can be summarized as follows:
(a) to provide social infrastructure and other public goods,
(b) to counter externalities, and
(c) to supplement the capital market by supplying long-term fixed-rate funds.
(3) The present FILP system, the main element of which is integrated management of public funds, is criticized for the following problems:
(a) Source of funds: expansion of the scale of the FILP caused by passive fund collection and problems in setting of interest rates; and
(b) Use of funds: problems of softening fiscal constraints and problems accompanying long-term and fixed interest rates.
These problems cannot be solved through a partial review of the FILP, and a fundamental reform of the comprehensive system and operation of the FILP is necessary.
3. Basic Idea and Direction of Reform
(1) The basic role and necessity of the FILP, which is to provide interest-bearing funds efficiently to appropriate fields in fiscal policy, will remain in the future, but its specific role should shift as social and economic conditions change.
Future funding and projects of the FILP should be strictly restrained through a careful examination of the range of the public sector in responding to social needs. Consequently, reduction in the scale of the FILP should be aggressively pursued through strictly adhering to the principle of supplementing private-sector businesses, carefully examining candidate projects to secure interest payment and redemption, and sufficiently comparing costs with benefits.
(2) In order to accomplish thorough reform with respect to the FILP objective areas and projects, it is also necessary to reconsider the current system of passive fund collection and the uniform management and allocation of funds.
At that time, the following rationales should be met:
(a) to actively raise only the necessary amount of money;
(b) to raise funds in the most efficient way that precisely matches market conditions; and
(c) to appropriately manage interest rate risk of the Trust Fund Bureau.
4. Review of Objective Areas and Projects
(1) Objective areas of the FILP are categorized as follows:
(a) housing;
(b) small and medium-size enterprises;
(c) agriculture, forestry, and fisheries;
(d) social infrastructure;
(e) the environment;
(f) industry and technology;
(g) overseas cooperation; and
(h) regional areas.
Each area must be reviewed on a continuous basis. (Refer to the main text for details on individual areas.)
Towards the 21st century, we need to take notice of the existence of such areas as medical and welfare services and education where the FILP is expected to be utilized in order to meet the trend towards fewer children and an aging society.
A series of Cabinet decisions on the reduction and rationalization of public corporations determined this year should be esteemed and steps should be made in the formulation of the FILP.
(2) With respect to policy finance, while the role and function of private financial institutions have been expanding in keeping with the progress on reform of the financial system, continuous review should be carried out according to the principle of supplementing private-sector businesses: i.e., to exclude lending to those areas the necessity of which has decreased or to those that can be dealt with sufficiently by private financial institutions.
In the future, each government-sponsored financial institution should endeavor to reduce the scale of policy finance by making effective use of guarantees and moving toward securitization of its loan assets.
5. Introduction and Sophistication of Cost Analysis Methods
(1) In managing the FILP, it is necessary to examine projects and to form policy judgement by quantifying the project's cost, in terms of a projected amount of future tax funds needed, and by publicly disclosing information on the project from the viewpoint of disclosure of information regarding the national burdens and securing fiscal soundness.
(2) The 1990 Federal Credit Reform Act of the United States makes it mandatory to disclose cost projections on finance and guarantee to each federal agency beginning with the 1992 budget. While many problems, including those stemming from data restriction, still persist, it is understood that this will lead to fiscal soundness and to further disclosure of information on national burdens.
(3) In Japan, in adopting projects, each FILP institution would be expected to make a projection on the cash flow of future fiscal costs, such as interest subsidies, in the subsequent years, and to evaluate the discounted present value of such costs. These should serve as a basis for cost analysis that provides quantitative analysis of potential future tax burdens in advance. Therefore, it is important to introduce such a system, starting where possible, and to phase it in.
6. Promoting Harmonization with Market Principles
(1) While it is one of the key features of the FILP to supply long-term and fixed-rate funds that are scarce in the capital markets, it should also be noted that the current system of interest rate determination has resulted in insufficient cost-of-funds awareness among some FILP recipients because it applies a uniform interest rate regardless of the duration of loans. It is therefore recommended that the interest rate on a loan be determined according to the duration of the loan based on the prevailing yield-curve in the market, and that the duration of loans to a FILP recipient be determined based on the case-flow characteristics of the projects to be financed.
(2) After reform, it will be necessary to raise funds under conditions precisely matching the market.
7. Fund Raising
(1) Under the present compulsory deposit system of postal savings and pension reserves, the amount of funds to be allocated and funds actually collected are determined independently of each other, but it has been criticized that the latter may unduly influence the former so that market principles and fiscal discipline have not always performed their function sufficiently. In order to enforce fiscal discipline at the fund allocation stage, fiscal discipline at the fund raising stage is important. Accordingly, the present compulsory deposit system of postal savings and pension reserves should be abolished, and a new system of fund raising appropriate for the future FILP should be introduced.
(2) As for the method of future fund raising for the FILP, the sub-committee considered the following methods:
(a) FILP agency bonds (public corporation bonds without government guarantee)
(b) Government-guaranteed bonds (public corporation bonds with government guarantee)
(c) FILP bonds (bonds issued collectively on the government credit based on market principles)
The merits and demerits for each method have been examined as follows.
(3) Sub-committee members had lively discussions around the two schools of thoughts on future fund raising for the FILP; One viewed the FILP agency bonds as the primary means and the other the FILP bonds.
The difference between these views stemmed largely from the difference between the sense of value of each individual member: in reviewing objective areas and projects of the FILP, one placed more faith on market principles and the other on political decisions through the democratic process. Therefore, the gap could not be easily narrowed.
(a) Those in favor of FILP agency bonds argued as follows:
In theory, the democratic process is expected to perform a strict check on various projects of public corporations. However, in practice, it is often difficult to expect the democratic process to carry out that check. Therefore, reform of public corporations should be pushed through by forcing public corporations to issue FILP agency bonds. By the issue of FILP agency bonds, these agencies would receive market evaluation of their financial conditions and have incentives to increase the efficiency of their management. Furthermore, agencies whose management is still inefficient would be weeded out. In this sense, public corporations themselves should raise funds in the market through the issuance of FILP agency bonds without both government guarantees and "implicit government guarantees."
(b) On the other hand, those in favor of FILP bonds argued as follows:
In essence, objective areas and projects of the FILP should be reviewed each year and determined by a political decision through the democratic process. The market is in no position to make a democratic decision in its place. Therefore, once the democratic process determines that certain projects of public corporations are necessary, it is the government's responsibility to endeavor to minimize the public burden by financing these projects at the least expensive funds. In this sense, fund raising for vitally important policy areas should be carried out through FILP bonds, which is the instrument for collectively raising funds through credit of the government based on market principles.
Although the difference between these two views persisted, the view that only one method should be applied gradually diminished as discussions deepened in the sub-committee. Thus, most of the members agreed that both FILP agency bonds and FILP bonds should be adopted.
(4) Based on the discussions summarized above, the sub-committee has arrived at a broad consensus on the following regarding the reform in the fund raising for the FILP.
(a) The competent authorities and agencies should examine whether these agencies can issue FILP agency bonds within the amount needed to implement relevant projects. In doing so, it is important to take note that the issuance should not increase the fiscal burden.
However, it is unsuitable to easily issue FILP agency bonds based on "implicit government guarantees." Therefore, the government should improve the environment for proper market evaluation by (1) providing a legal scheme for bankruptcy for the agencies that issue FILP agency bonds; (2) cutting low priority subsidies; and (3) promoting further disclosure.
FILP agencies are encouraged to consider issuing so-called "specific-revenue bonds" or "asset back bonds."
(b) For an agency that cannot raise sufficient funds from the market to fulfill its needs or an agency for which the cost of the issuance would become too expensive, the government should provide funds in a stable manner, as long as the policies of that agency are determined necessary. In such a case, in order to minimize the public burden, it is necessary for the government to actively decide the amount of funds to be raised and their terms, and to introduce FILP bonds that collectively raise funds based on market principles through the credit of the government. The introduction of FILP bonds is an important method for the future FILP fund raising to be in greater harmony with market principles.
With respect to FILP bonds, the government should implement further studies on legal aspects, etc. In such a case, in order not to issue excessive FILP bonds and not to inflate the scale of the FILP, the amount of FILP bond issues for each fiscal year should be made subject to a resolution by the Diet. In addition, it is very important to seriously consider measures for appropriate restraint for the amount of FILP bond issues.
(c) With respect to government-guaranteed bonds, the government should grant the guarantee in such cases where the guarantee is deemed absolutely necessary, so that an individual agency cannot easily raise extra funds based on government guarantee.
Government guarantee may be transitionally granted to agencies that are taking steps to issue FILP agency bonds without the guarantee but that are facing difficulty in immediate issue without the guarantee. In such a case, the government guarantee may be granted after strict examinations and the guarantee should no longer be granted once these agencies become capable of issuing bonds without the guarantee.
Furthermore, after strict examination, government guarantee may be granted to agencies that face difficulty in issuing FILP agency bonds without the guarantee in the following cases: in a case of the issuance of the bonds for fund raising until payment of money is borne by beneficiaries; or in a case of limited issuance of government-guaranteed bonds due to the necessity of ALM (Asset Liability Management) as supplementary fund raising.
(5) In order to abolish the present compulsory deposit of postal savings and pension reserves, FILP bonds are also needed as a secure means of raising funds to finance the redemption of deposits at maturity, while maintaining the loans outstanding at the time of the abolition until the due date.
Characteristically, the FILP has an extremely large loan balance. Thus, in reforming the system, appropriate transitional measures need to be taken to warrant smooth implementation and at the same time to avoid any financial risk for ALM of the Trust Fund Bureau.
8. Ideal Means of Self Management (Portfolio Investment)
(1) With respect to the management of postal savings and pension reserves after the abolition of compulsory deposit, a system that would result in a burden for taxpayers is inadmissible. As long as postal savings and pension reserves remain public, the responsibility of the management should be kept visible and the safeness and soundness of management should be adhered to as the fundamental principle.
Furthermore, self management should be consistent with market principles and should sufficiently take into account its influence on capital markets.
If public funds such as postal savings are supplied to public corporations without passing through markets, the funds would become similar to a pre-reform FILP, only worse, if anything. Consequently, this should not be allowed.
(2) To prevent any national burden as a result of a failure of management, postal savings should be managed through a system where the result of failure would be borne entirely within the business of postal savings that is self-sufficient.
(3) With respect to management of pension reserves, if expected operational earnings are not gained or losses are incurred, pension subscribers are compelled to bear the burden by the reduction of payments or by increase of premiums. Therefore, management risks should not be undertaken without prudent consideration.
9. Towards Continuous Reforms of the FILP
(1) Social and economic conditions surrounding the FILP will continue to change, even after a fundamental reform is carried out in accordance with the above-mentioned draft. Therefore, it is important to continue reform.
(2) In the future, it will be necessary to create a way to maintain the financial discipline of public corporations so that the necessity and role of the future FILP will be strictly evaluated and continuous reforms of the FILP will be carried out. Specifically, it is preferable to establish a system of periodic and objective evaluation and supervision of the project activities of public corporations.
These attempts at evaluation will make policy making more transparent and contribute to the establishment of discipline not only for public corporations, but also for the FILP system itself.
Furthermore, with respect to public corporations, etc., further disclosure should be promoted in a form that is easy to understand.