Summary : Internationalization of the Yen for the 21st Century

Provisional Translation

Internationalization of the Yen for the21st Century

- Japan's Response to Changes in GlobalEconomic and Financial Environments -

(Summary)

April 20, 1999

Council on Foreign Exchange and Other Transactions*

I. Current International Status of the Yen and Recent Changes inDomestic and International Economic Environments: Why It Is Important toInternationalize the Yen Now

Given that the Japanese economy today accounts for about 14% (1997) of the global economy and that Japan ranks as the world's largest net creditor country, the current international status of the yen reveals that the internationalization of the yen has not necessarily advanced to an adequate level.
The failure to achieve a higher international status for the yen in the 1990s in trade and capital transactions in particular can be attributed to the following factors:

Concerning trade transactions: (a) internationally-traded raw materials traditionally quoted in dollars account for a high percentage of Japan's imports; (b) Japanese parent companies tend to assume the foreign exchange risks.
Concerning capital transactions: (a) some restrictions on cross-border capital transactions remained until recently, (b) means for holding and managing yen assets by non-residents were limited; and (c) the general environment for the use of the yen by non-residents, including the tax system and others was inadequate.

Against the background of the changes in the domestic and international economic and financial setting, including the Asian Currency Crises, the introduction of the euro and progress of the Big Bang, the promotion of the internationalization of the yen has re-emerged as a vital issue as Japan stands on the threshold of the 21st century.

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* The Council on Foreign Exchange and Other Transactions is an advisorygroup of the Minister of Finance. The council made this report in response to the mandateby the Minister to provide recommendations regarding the internationalization of the yenin light of the changes in the economic and financial environments in Japan and overseas.

II. The Need to Internationalize the Yen: Why theInternationalization of the Yen Is Being Promoted

1. International Perspective

The dollar, euro, and yen support the world's three major economic regions. As such, the euro representing Europe and the yen as the principal Asian currency are in a position to complement the dollar. Such complementary arrangements can contribute to the establishment of a stable international monetary system supported by the sound economic policies of the United States, Euroland and Japan.
The strengthening of the international role of the yen will contribute to the stability of foreign exchange markets, particularly those in Asia, and to the stability of Asian economies.

2. Domestic Perspective

The diversification of currencies used in international transactions creates the possibility for developing new financial service businesses and contributes to vitalizing the Tokyo market, the mother market for the yen.
The growth of yen-based international financial transactions and business will serve to create new business opportunities for Japanese financial institutions and reduce the availability risks of foreign-currency denominated funds. This will also effectively contribute to restoring and improving the competitiveness of Japanese financial institutions.
The expansion of yen-invoiced international transactions can serve to reduce the foreign exchange risks of Japanese companies.

III. Issues in Promoting the Internationalization of the Yen: WhatMust Be Done to Internationalize the Yen

1. Basic Concept and Approach

In promoting the internationalization of the yen, Japan will have to be prepared to accept and to respond to international responsibilities, including the maintenance of stable domestic economic growth and the stabilization of the value of the yen.
It is vital to improve the general environment for the use of the yen in international transactions and to enhance confidence in the yen. Furthermore, it will be necessary for the government and private sectors to undertake various efforts and reviews, including the revision of the conventional perception of the yen. Also, an awareness must be developed that this is an issue to be addressed over the long term toward the 21st century.
It is most realistic to begin with efforts aimed at boosting the use of the yen in Asia which shares very strong economic ties with Japan. For this purpose as well, it is important that Japan rapidly restore and expand its ties with the real aspects of Asian economies. Such transactions would supply yen to the Asian region and establish a foundation for the circulation of yen in international transactions.

2. Recommendations

(1) The prerequisite for assuring the broad acceptance of the yen as an internationalcurrency is to restore and to enhance domestic and international confidence in theJapanese economy by promptly stabilizing the financial system and by achievingeconomic recovery. This requires the restoration of medium- and long-term macroeconomicbalance.

(2) Achieving relative stability in the exchange rates among the dollar, euro,and yen is the responsibility of the United States, euro-zone countries, and Japan.

(3) One of the options for Asian countries would be to establish a system whichstabilizes Asian currency exchange rates against a currency basket containing the dollar,yen, euro, and other currencies, each being assigned a weight in light of trade and othereconomic factors. In this system, it would be desirable that the correlation betweenthe Asian currencies and the yen be strengthened. Japan must become activelyinvolved in discussions concerning future monetary systems in the Asian region.

(4) To internationalize the yen, infrastructure improvements in financial and capitalmarkets must be made to provide greater assurance to yen users.

(A) Improvements in Financial and Capital Markets

The revised Foreign Exchange and Foreign Trade Control Law came into effect in April 1998. In December 1998 the Japanese government announced measures to facilitate the internationalization of the yen, and later implemented necessary arrangements in legal and other frameworks. All of these measures were important advances for the internationalization of the yen. The measures announced in December 1998 include the initiation of FB issuance via competitive price auctions, exempting withholding tax on original issue discounts for TBs and FBs, and exempting non-residents and foreign corporations from tax on the interest from interest-bearing government bonds. Further improvements in the financial and capital markets are important.

(a) In order to promote non-resident participation in Japans repo market, the transaction scheme should be promptly adjusted to promote transactions based on repurchase agreements adopted in the United States and Europe.
(b) To promote efficient yield-curve formation of government bonds, a five-year interest-bearing government bond should be introduced to be used as a medium-term benchmark issue.
(c) It is important to pursue further diversification of available products in government bond markets to match the various needs of investors. Introduction of the STRIPS (Separate Trading of Registered Interest and Principal of Securities) program, which has already been introduced in government bond markets in the United States and Europe, should be considered.

(B) Improvement of the Settlement Systems

The improvement of Japan's settlement systems
constitutes an important issue in the internationalization of the yen and is an essential requirement for non-residents to procure and manage yen-based assets with confidence and security.

(a) It is highly important that the ongoing restructuring of the Bank of Japan Financial Network System (BOJ-NET) to an RTGS system and the extension of operating hours by the end of the year 2000 be carried out as scheduled.
(b) Considerations are currently underway to refine settlement systems for CP and CD with the aim of realizing DVP and other improvements. It is hoped that this will lead to early results.
(c) From the medium- and long-term perspectives, it is necessary to consider establishing more comprehensive and centralized settlement systems for all securities.

(C) It is necessary to expand yen-denominated facilities offered by the Bank of Japan to foreign central banks, to diversify the commodities traded in Japan's international commodity markets, to review Japanese accounting rules and standards continuously, and to improve bankruptcy laws.

(5) Given the ongoing major changes in domestic and international economicenvironments, it appears that it is now necessary to review past practices in tradeand capital transactions and to examine the use of the yen from a new angle.

(A) Trade Transactions

There is a growing need to re-evaluate the risks and costs associated with the choice of currency, to review past currency choices, and to examine the possibility of expanding the use of the yen in individual transactions.
The yen holdings of non-residents must be expanded to promote the internationalization of the yen. To achieve this, it is crucial that Japan expand its yen-invoiced imports.

(B) Capital Transactions

Supplying yen funds through capital transactions will not only deepen the yen markets and serve to promote the internationalization of the yen, but will also constitute a critical element in the yen-denominated recycling overseas of Japan's excess savings.
Both lenders and borrowers must review past arrangements for overseas funding, and it is important to utilize yen-denominated funding to promote the restoration and upgrading of the financial intermediation functions of Japanese financial institutions.
In view of the current economic conditions in Asia and the recent status of Japanese financial institutions, official financial assistance must play an even more important role than it has in the past in providing yen funds to Asia. (Utilizing the sovereign bond guarantee facilities of the Japan Bank for International Cooperation*, providing yen funds under the New Miyazawa Initiative, etc.)

(C) Expansion of yen-denominated financing by international financial institutions and Japans active use of the yen in figures in business and official presentations are also important.

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* A governmental financial institution which will be created with themerger of the Export-Import Bank of Japan and the Overseas Economic Cooperation Fund inOctober 1999.

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