japan's demand for long-term external financial assets in the 1980's

JAPANS DEMAND FOR LONG-TERM EXTERNAL FINANCIAL ASSETS

IN THE 1980s*

Masahiro Kawai Universiry of Tokyo

I. INTRODUCTION One of the most urgent issues facing the world economy in the

early 1990s is how to reduce current account disequilibria and stabilize net external asset positions among the major industrialized countries, notably the United States, Japan and the Federal Republic of Germany. Without major shifts in the investment-savings gaps in these countries, current account disequilibria will remain large and the international stock imbalance will widen. In the meantime U.S. current account deficits will have to be financed by capital inflows to assure the smooth functioning and adjustment of the U.S. and world economy. So far, the U.S. deficits have been financed largely by Japanese and German capital. Japan, in particular, has been the major source of savings for the United States. It is clear, however, that to the extent that the large current account disequilibria and international stock imbalances are considered as unsustainable, Japanese investors will not wish to continue to accumulate U.S. dollar assets indefinitely at the risk of possible capital losses due to dollar depreciation (See Krugman [ 19881).

The U.S. net external debt, the negative value of the Net Inter- national Investment Position (NIIP) as defined by the U.S. Commerce Department, which was about zero at the end of 1984 climbed to $368 billion at the end of 1987. A conservative debt projection for the end of 1990 would be $700 billion and it could go

Earlier versions of this paper were presented at the NBER Summer Institute Meetings held in Cambridge, Mass., in August 1987, and at the Seventh JCIF/IIE Core Group Meeting held in Washington. D.C., in October 1987. The author is grateful to the parti- cipants of these conferences for valuable comments. The paper is an updated version of the paper with the same title include in the Annals of the Insfifufe of Social Science, Institute of Social Science, University of Tokyo, NO. 30, 1988.

66 ASIAN ECONOMIC JOURNAL SEPTEMBER 1989

as high as $950 billion by 1993.' Assuming that U.S. nominal GNP grows at 7.5% per annum, which is the average growth rate during the 1981-88 period, the ratio of net external debts to nominal GNP (-NIIP/GNP) would rise from 8.1% in 1987 to 12.5% in 1990 and reach 14% in 1993. This implies that payments of interests, divide

EXTERNAL FINANCIAL ASSETS

FIGURE 1 NET INTERNATIONAL INVESTMENT POSITION OF THE USA AND JAPAN

(AS A RATIO TO NOMINAL GNP)

/ .- I I

, I

67

1970 1975 1980 1985


incurred heavy capital losses since 1985 when the U.S. dollar started to fall sharply. An important question, therefore, is whether Japanese investors continue to invest in dollar denominated assets at the risk of further dollar depreciation.

This paper attempts to analyze the major determinants of Japans stock demand for long-term external financial assets. The analysis would provide us with important insight into the future willingness (or reluctance) of Japanese investors to continue to accumulate long-term external assets in the form of securities, loans and trade credits. The next section (11) briefly sketches the overall picture of the Japanese capital account and emphasizes the trends and features of long-term capital outflows from Japan in the 1980s. In section 111, recent developments in Japans external asset and liability positions are reviewed. Section IV examines econometrically the factors affecting the Japanese stock demand for long-term external financial assets such as foreign securities, external loans and export credits, all expressed as ratios of private financial assets, It points out the importance of the interest rate, exchange risk and income factors in the estimated demand equations. The concluding section (V) summarizes the results and dis- cusses the implications of the rising U.S. net external debt position.

11. RECENT DEVELOPMENTS IN JAPANS CAPITAL

1 . Japans Overall Capital Account Table 1 summarizes the recent trends in Japans capital

a c c ~ u n t . ~ The table shows that in the 1980s surpluses in the current account (domestic savings over domestic investment) and in the short-term capital account (including the authorized foreign exchange banks account) have matched long-term capital outflow and the official accumulation of external short-term assets.

The current account surplus has risen quite rapidly throughout the 1980s, from $5 billion in 1981 to $86 billion and $87 billion in 1986 and 1987, respectively, though it declined to $79 billion in 1988. It is observed that the rising current account surplus has been accompanied by a widening long-term net capital outflow. The long-term capital account has registered a deficit since 1981,

ACCOUNT

Table 1.

Japan's Capitol Accouwr" (US$ Billion)

1965 1970 1975 1980 1981 1982 1983 1984 1985 1986 1987 1988

Current Account Long-term Capital Account

Direct Investments Trade Credits Loans Securities Others

Short-term Capital Accountb Authorized Foreign Exchange Banks' Balance Errors and Omissions Official Balance' Changes in Foreign Exchange Reserves

0.932 -0.415 -0.030 -0.252 -0.097 0.012

-0.048 -0.061

1.970 -1.591 -0.261 -0.780 -0.548 0.234

-0.236 0.724

-0.682 -0.272 -1.537 -0.055 -1.129 2.729

-0.280 -1.138

-10.746 2.324

-2.107 -0.733 -2.784 9.360

-1.412 3.141

4.770 -9.672 -4.705 -2.746 -5.269 4.443

-1.395 2.265

6.850 -14.969

-4.101 -3.245 -8.083 2.117

-1.657 -1.579

20.799 -17.700

-3.196 -2.581 -8.462 -1.876 -1.585 0.023

35.003 -49.651 -5.975 -4.934

-11.999 -23.60 1

-3.142 -4.295

49.169 85.845 -64.542 -131.461

-5.810 -14.254 -2.788 -1.876

-10.502 -9.315 -43.032 -101.432

-2.410 -4.584 -0.936 -1.609

87.015 -136.532 -

- 18.354 -0.536

-16.309 -93.838

-7.495 23.865

79.488 130.326 3 -34.621

F -6.690 - 15.024 -66.832 2 -7.153 $ 19.536 5

F 44.460 p 2.320 2

-15.478 2

16.183

-0.285 -0.051 -0.120

-0.366 0.271

-1.008

1.880

0.796 -0.584

13.144 -3.115 -4.748

6.386 0.493

-4.242

0.035 4.727 4.936

-3.570 2.055

-1.607

17.560 3.743

-2.360

10.848 58.506 3.991 2.458 1.470 -13.739

71.801 -3.893

-42.256

0.108 0.903 -0.703 4.905 3.171 -5.141 1.234 1.817 0.197 15.729 39.240

a. Minus sign indicates capital outflow. b. Excluding authorized foreign exchange banks' transactions. c. Equal to - (Current Account + Long-term Capital + Short-term Capital + Authorized Foreign Exchange Banks' Balance + Errors & Omissions). Source: The Bank of Japan, Balance of Paynietiis Monrhly, various issues.


exceeding the current account surplus every year, reaching $130 billion or above in the 1986-1988 period.

The rise in net long-term capital outflow reflects a remarkable improvement in the balance of securities investments, which increased from $43 billion in 1985 to a historical record of $101 billion in 1986. In 1987 and 1988, the net outflow experience a decline to $94 billion and $67 billion, respectively. Direct investments have risen steadily in net outflow from $6 billion in 1985 to $14 billion, $18 billion and $35 billion in 1986, 1987 and 1988, respectively. The net outflow of loans, which was relatively stable in the 1980s, has risen very recently from $9 billion in 1986 to $16 billion and $15 billion 1987 and 1988. The net outflow of trade credits declined steadily from the peak of $5 billion in 1984 to less than $1 billion in 1987, but rose to $7 billion in 1988.

The short-term capital account has not exhibited any clear-cut trend in the 1980s. It recorded a deficit (capital outflow) of $2 billion in 1986 but turned into a surplus of $24 and $20 billion in 1987 and 1988.

The balance of authorized foreign exchange banks reflects changes in assets and liabilities of those commercial banks which are permitted by the Japanese authorities to operate in the foreign exchange market. This balance has shown a large surplus in the last few years, and the Japanese banking sector as a whole was a net importer of short-term capital, the amount imported rising from $11 billion in 1985 to $59 billion, $72 billion and $44 billion in 1986, 1987 and 1988, respectively. The sharp rise in commercial- bank capital imports in the last three years was the result of their increased demand for impoact loans, which may be used for any purpose without restrictions. Counting errors and omissions as unrecorded short-term capital transactions, Japans private sector as a whole (the nonbanking and banking sectors combined) imported $59 billion, $92 billion and $66 billion in short-term capital in 1986, 1987 and 1988, respectively, as opposed to a mere $14 billion in 1985. Thus the private sector has been borrowing short and lending long in recent years. Put another way, Japans long-term capital outflow has been financed not only by a current account surplus but also by short-term capital inflows.

The trend of the official balance has been much more stable than the current account, the long-term capital account and the

EXTERNAL FINANCIAL ASSETS 71

short-term capital account (including the commercial-bank balance). The official sector increased its net assets by $14 billion, $42 billion and $15 billion in 1986, 1987 and 1988 mainly as a result of foreign exchange market intervention to support the U.S. dollar. Indeed, the stock of foreign exchange reserves increased from $42 billion at the end of 1986 to $81 billion at the end of 1987, and then to $98 billion at the end of 1988. Japanese monetary authorities, in addition to long-term capital outflows, have accom- modated the surpluses in the current account and short-term capital account (by both the private banking and nonbanking sectors).

2. Long-term Capital Outflow The detailed composition of the long-term capital account is

reported in Table 2. Japanese residents capital outflow has risen persistently over time, reaching $132 billion, $133 billion and $149 billion in 1986, 1987 and 1988, respectively. Foreigners long-term investment in Japan has been relatively steady in the first half of the 1980s. After it declined sharply from $17 billion in 1985 to $1 billion in 1986 and to -$4 billion in 1987, it recovered to $19 billion in 1988. Thus the large net outflow of long-term capital in recent years was mainly the result of the increased outflows of Japanese capital (and the reduced inflows of foreign capital for the 1986-87 period).

The bulk of Japanese long-term capital outflows took the form of investment in foreign securities, which almost doubled from $60 billion in 1985 to $102 billion in 1986, followed by a decline to $88 billion and $87 billion in 1987 and 1988, respectively. Table 3 shows the breakdown of securities investment. It is obvious that the recent rapid rise in Japans investment in foreign securities is centered on bonds. Investment in bonds grew strongly in the 1980s, reaching the unprecedented level of $93 billion in 1986 followed by a slight decline to $73 billion and $86 billion in 1987 and 1988. In the 1980s, investment in stocks and shares was small except in 1986 and 1987 when outflows of $7 billion and $17 billion were recorded. It was $3 billion in 1988. Investment in yen-denominated external bonds, has also been small and recorded an inflow of $2 billion in 1987 and 1988. [Foreigners investment in Japanese securities has remained at a relatively high level in the first half of the 1980s. However, it declined rather sharply from $17 billion in

Table 2.

Japans Long- Term Capital TransactionP (US$ Billion)

1965 1970 1975 1980 1981 1982 1983 1984 1985 1986 1987 1988

Japanese Capital Direct Investments Securities Investments Export Credits Loans Extended Others

Direct InvestmentsO.047 Securities Investments Import Credits Loans Received Others

Foreign Capitalb

Netb Reference: Current Account

-0.446 -0.077 -0.OOO -0.243 -0.115 -0.011 0.031 0.094

-0.061 0.011 0.018

-0.036 -0.415 0.932

-2.031 -0.355 -0.062 -0.787 -0.628 -0.199 0.440 0.226 0.296 0.007 0.080

-0.037 -1.591 1.970

-3.392 -1.763 -0.024 -0.029 -1.295 -0.281 3.120 0.278 2.753 -0.026 0.166 0.001

-0.272 -0.682

-10.817 -2.385 -3.753 -0.717 -2.553 -1.409 13.141 0.189

13.113

-0.231

2.394

-0.016

-0.003

-10.746

a. Minus sign indicates capital outflow. b. Excluding foreign investors Gensaki transactions.

-22.809 -27.418 -32.459 -56.775 -4.894 -4.540 -3.612 -5.965 -8.777 ,-9.743 -16.024 -30.795 -2.731 -3.239 -2.589 -4.937 -5.083 -7.902 -8.425 -11.922 -1.324 -1.994 -1.809 -3.156 13.137 12.449 14.759 7.124

13.220 11.860 14.148 7.194 0.439 0.416 -0.010 0.642

-0.015 -0.006 0.008 0.003 -0.186 -0.181 -0.037 -0.077 -0.071 0.337 0.224 0.014 -6.449 -14.969 -17.700 -49.651 4.770 6.850 20.799 35.003

-81.815 -132.095 -6.452 -14.480

-59.773 -101.977 -2.817 -1.836

-10.427 -9.281 -2.346 -4.521 17.273 0.634 0.226 1.165

16.741 0.545 0.029 -0.040

-0.075 -0.034 -0.064 -0.063

-64.542 -131.461 49.169 85.845

-132.830 -19.519 -87.757 -0.535

-16.190 -8.829 -3.702 -0.489 -6.081 -0.001 -0.119 1.334

87.015 -136.532

-149.286 b -34.138 E -87.135 Z -6.678

-14.942 Q Z -6.393 0

18.960 $ 20.303 2 -0.012 id z -0.082 -0.760

-130.326

c 79.488

Source: The Bank of Japan, Balance of Payments Monthly, various issues.

Tab

le 3

.

Japa

ns

Fore

ign

Inve

sttn

ent i

ti S

ecur

ities

n (U

S$ B

illio

n)

1980

19

81

1982

19

83

1984

19

85

1986

19

87

1988

Japa

ns

Inve

stm

ent

in F

orei

gn S

ecur

ities

-3

.573

-8

.777

-9

.473

-1

6.02

4 -3

0.79

5 -5

9.77

3 -1

01.9

77

-87.

757

-87.

135

!? St

ocks

& S

hare

s 0.

213

-0.2

40

-0.1

51

-0.6

61

-0.0

51

-0.9

95

-7.0

48

-16.

874

-2.9

93

3 B

onds

b -2

.996

-5

.810

-6

.076

-1

2.50

: -2

6.77

3 -5

3.47

9 -9

3.02

4 -7

2.88

5 -8

5.81

2 $

Y en

-den

omin

ated

$

Ext

erna

l B

onds

, etc

b -0

.970

-2

.727

-3

.516

-2

.858

-3

.971

-5

.299

-1

.905

2.

002

1.67

0 2 z >

in J

apan

ese

Secu

ritie

s

13.1

13

13.2

20

11.8

60

14.1

48

7.19

4 16

.741

0.

545

-6.0

81

20.3

03 z

Stoc

ks &

Sha

res

6.54

6 5.

916

2.54

9 6.

126

-3.6

10

-0.6

73

-15.

758

-42.

835

6.81

0

Bon

ds

5.33

1 5.

936

5.03

0 2.

359

3.45

4 4.

524

-2.1

09

6.67

5 -2

1.62

8 E

xter

nal B

onds

1.

236

1.38

6 4.

281

5.66

3 7.

350

12.8

90

18.4

12

30.0

79

35.1

21

5 in

Sec

uriti

es

9.36

0 4.

443

2.11

7 -1

.876

-2

3.60

1 -4

3.03

2 -1

01.4

32

-93.

838

-66.

832

3

Fore

ign

Inve

stm

ent

Net

Inv

estm

ent

rn

a. M

inus

sig

n in

dica

tes

capi

tal o

utfl

ow.

b. U

nit

1984

, iss

ues

and

rede

mpt

ions

of

fore

ign-

curr

ency

den

omin

ated

bon

ds b

y no

n-re

side

nts

in t

he d

omes

tic

mar

kets

are

incl

uded

in

c. E

xclu

ding

Gen

saki

tran

sact

ions

. B

onds

.

Sour

ce:

The

Ban

k of

Jap

an,

Bal

ance

of

Paym

ents

Mon

thly

, va

riou

s is

sues

.


1985 to $1 billion and -$6 billion in 1986 and 1987, respectively, and quickIy recovered to $20 billion in 1988. The negative value (i.e., outflow) in 1987 was due to sales of Japanese stocks and shares by foreigners.]

Returning to Table 2, direct investment outflows have also gained in importance, reaching $14 billion, $20 billion and $34 billion in 1986, 1987 and 1988, respectively, as compared with $6 billion in 1985. It is believed that several factors contributed to the growth of Japanese direct investment abroad by making domestic production less profitable than production elsewhere. These factors included the internationalization and globalization of Japanese business activities in general, real effective appreciation of the yen, and protectionist sentiments and pressures in the United States and the European Community countries. Moreover, a large part of the recent rise in direct investment is alleged to take the form of real estate purchases, particularly in the United States.

Loans provided to foreigners showed a steady rise until 1984, reaching $12 billion, mainly to LDCs (see also loans extended to other countries in Table 4) and multilateral international financ- ing institutions (IMF, IBRD, etc.). In 1985-86 when the debt situation of many LDCs worsened in terms of the future prospect of debt-servicing capabilities, the amount of loans extended abroad declined slightly (to $10 billion in 1985 and $9 billion in 1986), although these loans recovered to $16 and $15 billion in 1987 and 1988.

Trade credits on exports steadily rose until 1984 when an outflow of $5 billion was recorded. Then they started to decline to negligible levels for three years, and recovered to $7 billion in 1988.

The geographical distribution of long-term capital outflows from Japan is summarized in Table 4. The table demonstrates that most outflows were directed toward the United States and the European Community (EC) countries in 1987. The outflows to these advanced countries took the form of securities investment. The increase in securities investment in the advanced countries was due to the favorable investment environment - the deep capital market in terms of size, diversification and liquidity, and the low country risk (OECD [1986, p.631). Direct investments were also channeled toward the United States and the EC countries in addi-


Table 4.

Japan's Long-Term Capital Outflow - By Area and By Type" (US$ Billion)

Investment Direct Trade Loans in

Year Investment Credit Extended Securities Other Total

United States 1970 1975 1980 1985 1987

EC 1970 Countries 1975

1980 1985 1987

Other O E C D 1970 Countries 1975

1980 1985 1987

Communist 1970 Bloc 1975

1980 1985

' 1987 Other 1970 Countries 1975

1980 1985 1987

International 1970 Institutions 1975

1980 1985 1987

World 1970 1975 1980 1985 1987

0.091 0.638 0.833 2.557 9.641 0.051 0.140 0.262 1.534 3.594 0.050 0.081 0.146 0.420 1.682

0.000 0.003 0.058 0.183 0.163 0.904 1.141 1.883 4.419

-

- - - - -

0.355 1.763 2.385 6.452

19.519

0.027 -0.026 -0.026 0.588 0.488 0.094

-0.048 -0.013 0.472 1.066 0.045

-0.053 -0.036 0.793

0.032 0.208 0.206

-0.274

-0.521 -0.077 0.589 0.052 0.586 1.485

-0.668 - - - - -

0.787 0.029 0.717 2.817 0.535

0.022 -0.014 0.281 0.702 1.470 0.001

-0.029 0.012 0.774 2.193 0.033 0.043 0.046 2.165 3.617

0.208 0.321 1.086

0.365 1.077 1.922 4.843 7.332 0.207 0.010

-0.029 0.857 1.977 0.628 1.295 2.553

10.427 16.190

-

-0.389

0.032 -0.040 -1.609 31.599 37.380 0.002

-0.030 2.035

18.471 42.092

0.005 0.024 2.713 5.122 3.642 - - -

0.695 0.870 0.006 0.037 0.428 0.146

0.017 0.033 0.186 2.248

0.062 0.024 3.753

59.773 87.757

-0.864

-0.069

0.128 -0.034 0.212

-0.062 1.584 0.000 0.039 0.106 0.193 1.133 0.000 0.041 0.006 0.014 0.51 1 - - -

0.002 0.264 0.005 0.001 0.048 0,600 0.520 0.066 0.234 1.037 0.883 1.828 0.199 0.281 1.409 2.346 8.829

0.300 0.524

35.384 50.536 0.148 0.072 2.402

21.444 50.078 0.133 0.136 2.875 8.514 9.178 0.032 0.416 0.530 1.320 0.851 1.128 1.967 4.125 9.227

10.729 0.290 0.277 1.194 3.988 3.736 0.290 3.392

10.817 81.815

132.830

-0.309

a. Minus sign indicates inflow to Japan.

Source: The Bank of Japan, Balance of Payments Monrhfy, April issues.


tion to other countries, i.e., LDCs. Loans were provided mainly to LDCs and Western Europe. Export trade credits were extended to LDCs and the EC countries, although significantly small in mag- nitude. In sum, it is postulated that a greater proportion of Japans savings have been invested in securities and in markets where the expected yields were high and the perceived risks low.

3. Capital Account Liberalization There is no doubt that the liberalization of government regula-

tions on international capital transactions contributed significantly to the rapid increase in long-term capital flows to and from Japan. Figure 2, for example, provides information concerning the process of deregulation of foreign securities investment.6

International capital transactions were tightly controlled in the 1950s and 1960s. In the early 1970s, controls on capital outflows were slightly relaxed reflecting secular balance of payments surpluses. When the current account truned into a deficit as a result of the first oil-price shock in 1973, controls on capital inflows were relaxed to help finance the deficit, though controls on capital outflow were strengthened to avoid yen depreciation. As economic growth slowed down after the first oil shock and the rate of return on domestic investment declined, Japanese investors sought to widen their investment opportunities abroad and diversify their assets. This required liberalization of external capital outflows for many institutional investors and financial institutions. As the balance of payments improved in the last half of the 1970s, controls on capital outflows were increasingly relaxed (though they were strengthened once again right after the second oil crisis in 1979- 1980).

In December 1980, the Foreign Exchange Law was revised drastically to liberalize, in principle, all foreign exchange transactions and abolish the system requiring approval for each foreign- securities investment. This led to a significant degree of integration of the domestic and overseas capital markets. Nonetheless, an elaborate system for monitoring capital transactions was retained, and discretionary controls and administrative guidance remained in place, hindering complete financial integration with the rest of the world and perfect capital mobility. The so-called Yen/Dollar Committee established in November 1983 investigated the ways to


FIGURE 2 DEREGULATION OF FOREIGN SECURITIES INVESTMENT

30 -

25 -

(US$ bil.)

illowed to invest'

Banks allowed to invest2

20.

15.

10 -

5 -

0 -

owed to invest'

Trust Fund Bureau of MOF, and Postal Savings allowed to invest

Banks allowed to invest w/o hedging

Loan trusts allowed to invest

credit associations allowed to Agricultural cooperatives and

Postal Life Insurance allowed tt

Pension trusts allowed to invest

Investment in foreign securities freed in principle'

1 nsurar.ce companies

invest

!

77


accelerate the liberalization of domestic financial markets and the internationalization of the yen (Frankel [ 19841). Further liberalization measures have been implemented since May 1984 based on agreements reached by the committee. These measures included relaxation of restrictions on nonresident issue of yen-denominated bonds, and permission to Japanese residents to purchase foreign issued CPs (commercial papers) and CDs (certificates of deposits). The YedDollar Agreement was clearly successful at increasing Japans integration into world financial markets by stimulating net capital outflows (but not necessarily at promoting capital inflow into Japan, according to Frankel [1988]).

111. ACCUMULATION OF EXTERNAL ASSETS AND

I. Japans External Assets and Liabilities The significant relaxation of external financial controls no

doubt contributed to the accumulation of large amounts of both external assets and liabilities. Reflecting recent current account surpluses (i.e. , domestic excess savings over investment), the balance between Japans external assets and liabilities has improved substantially. The overall stock position of external assets and liabilities is summarized in Table 5. In principle, changes in each item of the table correspond to balance of payments statistics (flow data) and changes in net external assets to current account. However, the correspondence is not perfect because of various valuation adjustments, such as changes in exchange rates and stock prices. (The conversion factor used in constructing these asset-liability statistics is the basic rate defined by the Ministry of Finance, which changes much more slowly than the market exchange rate.)

Total external assets held by Japanese residents rose to $727 billion at the end of 1986 and to $1,072 billion at the end of 1987, as compared with $438 billion at the end of 1985. Total external liabilities reached $547 billion in 1986 and $831 billion in 1987 in contrast to $308 billion in 1985. The net external position therefore improved from $130 billion in 1985 to $180 billion in 1986 and to $241 billion in 1987. The continuing current account surplus during the first half of 1988 suggests that the net position may reach $300 billion by the end of 1988.

LIABILITIES

lapati's El-rerrial Assets arid Liabiltrics (US$ Eilliorr)

1971 1975 1980 1981 1982 1983 1984 1985 I986 1YR7 - 476.136 424.704

~ 6 . 1 ~ 1 565.100 77.022 37.189 97.46Y

Long term Assets 11.270 Private Sector 7.626 24.522

Direct Investments 1.851 8.322 Trade Credits on Exports 4.950 6.832 Loans Extended 0.330 Securities Investments 0.348 Other 0.147 0.280

Government Sector 3.644 7.835 Trade Credits on Exports 0.175 0.330 Loans Extended 2.476 5.497 Other 0.993 2.008

Short terms Assets 21.483 25.977 Private Sector 6.241 13.162

Monetarv Movements 6.020 12.947

32.357 87.881 117.090 89.269 24.506 13.225

139.451 110.025

170.905 138.051

229.184 191.946

301.297 264.458 66.540

19.612 9.773

14.839 21.439

0.841 21.377 0.689

15.507 5.181

71.699

28.969 15.905 23.228 40.070

1.853 29.426

1.124 20.436

7.866 88.237

32.178 18.110 29.266 56.155 2.382

37.921 22.824

43.974 23.603 46.870

145.748 4.263

36.839 1.062

23.293 12.484

136.404 108.753 99.719 9.034

27.651 27.650 0.001

437.701

58.071 31.992 69.21 1 4.984

4.104 18.944 31.538

1.056 27.821

1.148

40.601 87.578 3.022

257.933 7.497

339.677 13.743 81.081 32.854

1.165 22.473

37.238 1.189

24.491 11.558

112.024 84.761 77.562 7.199

27.263 27.261 0.002

341.208

5 1.432 1.423

33.558 16.451

25 1.170 207.876

1.664 43.145 36.272

425.450 343.26 1

19.936 6.737

92.167 62.912 61.074

1.838 29.255 29.252 0.003

9.216 101.051

46.047 45.158 0.889

25.652 25.648

0.004 159.580

63.927 61.117 2.810

75.492 72.087 3.405

25.559 25.556

0.003

194.713 13.163 43.294

320 171 23.090 82.189 82.175

Other

Monetary Movements Other

Government Sector

External Assets (total)

0.221 15.242 15.235 0.007

32.753

0.215 12.815 12.815

24.310 24.308

0.002 43.294

O.Oo0 727.306

O.Oo0 58.334

0.014 1.07 I .631 209.257 227.688 271.956 . ~~

Long term Liabilities 9.554 13.603 47.289 70.335 77.645 102.794 113.222 122.328 192.336 236.181 Private Sector 8.121 11.591 34.744 49.738 53.097 76.551 83.738 91.776 152.192 178.810

Direct Investments 1.337 2.084 3.270 3.915 3.998 4.364 4.458 4.743 6.514 9.018 0.097 0.098 0.021 0.005 O.Oo0 0.016 0.024 0.131 0.033 0.035 Trade Credits on Imports

Securities Investments 3.838 7.695 29.744 43.982 47.076 69.948 77.081 84.847 143.611 166.206 Other 0.899 0.012 0.086 0.358 0.698 0.903 0.909 0.844 0.835 2.450

Government Sector 1.433 2.012 12.545 20.597 24.548 26.243 29.484 30.552 40.144 57.371 Loans Received 0.667 0.414 0.225 0.178 0.149 0.124 0.103 0.084 0.066 0.047 Securities Investments 0.235 0.509 12.320 20.419 24.399 26.119 29.381 30.468 40.078 57.324

Short term Liabilities 13.426 37.713 100.757 128.004 125.361 131.903 153.640 185.552 354.619 594.706 Private Sector 12.834 36.395 94.466 120.980 118.809 125.064 145.900 176.985 341.847 583.057

Monetary Movements 7.491 26.418 77.974 100.103 107.308 130.098 160.984 322.163 530.072 Other 0.234 0.606 2.433 3.102 2.688 3.074 4.150 4.010 5.669 7.727

External Liabilities (total) 22.980 51.316 148.046 198.339 203.006 234.697 266.862 307.880 546.955 830.887 Net External Assets

Private -7.088 -10.302 -16.659 -18.357 2.046 11.928 47.069 104.450 138.541 146.494 Government 16.861 17.320 28.193 29.455 22.636 25.331 27.277 25.371 41.810 94.250 Total 9.773 7.018 11.534 10.918 24.682 37.259 74.;246 129.821 180.351 240.744

Loans Received 1.950 1.702 1.623 1.478 1.325 1.320 1.266 1.211 1.199 1.101

Other 0.531 1.089 0.000 O.Oo0 O.OO0 0.000 O.Oo0 O.Oo0 O.OO0 O.Oo0

Source: Ministry of Finance, Motitlily Sforistics oti Govenirtietif Fitiorrce and Banking, various issues.


The net external asset position deterioFated in 1974-75 and in 1979-81 due to oil-price shocks but has grown steadily since 1983. This steady growth has been brought about mainly by increases in private sector net external assets. The change in the net position of the private sector is most remarkable, moving from a net liability of $19 billion in 1981 to a net asset position of $146 billion in 1987. The long-term net asset position of the private sector, in particular, gained ground during this period, rising from $40 billion in 1981 to $386 billion in 1987. In fact, the private sector had a short-term net liability position throughout the period, recording $240 billion in 1987.

The rapid rise in Japans net external asset position in the 1980s can then be ascribed to the improvement in the private sectors long-term net asset position. One must note that the counterpart of this accumulation has been current account surpluses, or domestic excess savings over investment. It seems to be generally accepted that Japans growing net savings (current account surpluses) since 1984 have been stimulated by Americas high real interest rates, driven by U.S. macroeconomic policies (Frankel [1988]).

2. Long- Term Assets and Liabilities Four components of gross long-term assets - securities invest-

ments abroad, loans extended abroad, direct investments abroad and trade credits on exports - expressed as ratios of gross total long-term assets are depicted in Figure 3 for the period January 1980-September 1987. As is clear from the figure, securities investments are the only item that has increased in relative share over this period. All other components have increased in absolute size, but at much slower rates than total long-term assets.

Four components of gross long-term liabilities - securities, loans received, direct investments received and trade credits on imports - are shown in Figure 4 as ratios of gross total long-term liabilities. The weight of foreigners investment in Japanese securities has been persistently large and on the rise, dominating all other long- term liability components.

Figure 5 shows the relative shares of the four components of net long-term assets. The figures demonstrates that the net loan position (the balance between loans extended and received) . relative to net total long-term assets (the balance between long-


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term assets and liabilities) has been the most dominant component, although this trend has been downward recently. The weight of net securities investments was the smallest among the four components depicted in the figure until the middle of 1985, although this component has risen strongly since 1983. In the middle of 1987, the net securities investment position became the largest of the four, dominating the net loan position. The relative shares of other net positions (loans, direct investments, and trade credits) are declining.

3. Foreign Securities Demand by Institutional Investors As a result of the relaxation of restrictions on foreign securities

investments (see, once again, Figure 2), a wide range of investors started to participate in international capital transactions. Institu- tional investors such as life and non-life insurance companies and financial institutions, in particular, began to regard foreign securities investment as a vehicle for portfolio diversification and fund management. As summarized in Table 6a, the largest foreign securities holders include life insurance companies (Y 13,085 billion), the banking account of all banks (Y11,082 billion), the trust account of all banks (Y8,168 billion), securities investment trust (Y4,783 billion) , postal life insurance and postal annuity accounts (Y2,239 billion) , non-life insurance companies (Y2,045 billion), and The Norinchukin Bank (The Agriculture, Forestry and Fishery Bank, Y2,031 billion). These yen amounts in the parentheses are outstanding stocks for December 1988.

With the increase in foreign securities investment, the weight of these transactions in the portfolio of institutional investors has rapidly risen. For example, the share of foreign securities in the total securities of all institutions expanded from 3.4% at the end of 1980 to 9.9% at the end of 1984 and to 17.0% at the end of 1987, but declined slightly to $l6.6% in 1988 (Table 6b). The share of total assets also grew from 0.7% in 1980 to 2.1% in 1984 and to 4.0% in 1987 and ,1988 (Table 6c). This steady rise in the foreign securities share held by institutional investors is a direct result of the absolute and relative growth of contractual-type savings institutions (such as insurance companies and the trust account of trust banks) and investment trusts in all financial institutions. Con- tractual-type savings institutions hold a higher proportion of

Tab

le 6

a.

Inve

stm

ent i

n Fo

reig

n Se

curi

ties

Cla

ssifi

ed b

y Ty

pe of

Fin

anci

al ln

stiiu

tiori

s (Y

Bill

ion)

End

of Y

ear

1980

19

81

1982

19

83

1984

19

85

1986

19

87

Ban

king

Acc

ount

of A

ll B

anks

C

ity B

anks

R

egio

nal B

anks

T

rust

Ban

ks

Tru

st A

ccou

nt of

All

Ban

ks

Sogo

Ban

ks

Shin

kin

Ban

ks

The

Nor

inch

ukin

Ban

k Li

fe In

sura

nce

Com

pani

es

Non

-Lif

e In

sura

nce

Com

pani

es

Post

al L

ife I

nsur

ance

& A

nnui

ty

Secu

ritie

s Inv

estm

ent T

rust

1,06

2 1,

430

592

808

96

174

129

135

172

33 1

21

56

189

290

238

313

68 1

1,12

3 19

3 23

5 1

- 21

3 -

2,11

9 1,

138

347

176

559 86

29

4 32

2 1,

901

336 4

170

2,72

2 1,

317

540

298

943

111

363

283

2,92

7 57

0 19

4 23

8

4,41

4 1,

891

876

783

1,43

5 16

5 49

4 37

9 3,

841

819

558

843

7,32

7 9,

516

2,80

2 3,

553

1,83

7 2,

530

1,30

3 1,

747

3,46

1 6,

213

548

888

72 1

783

955

1,62

4 4,

771

7,30

6 1,

022

1,37

5 94

6 1,

465

1,63

5 3,

908

10,6

19

3,88

8 2,

799

1,90

2 7,

871

908

745

1,60

7 10

,342

1,

744

1,96

8 4,

145

~~

~

1988

m

11,0

82

m

;d

4,23

5 z

2,96

4 2,

185

8,16

8 3

886

% 73

3

5

2,03

1 r

13,0

85

& 2,

045

$

2,23

9 cf

4,78

3 _

__

__

Tot

al (e

xcl.

Sec.

Inv.

Tru

st)

2,53

5 3,

723

5,53

5 8,

002

11,9

40

19,2

03

28,2

82

35,8

07

40,2

74

Sour

ce:

Ban

k of

Jap

an, E

cono

mic

Sta

tistic

s M

onth

ly.

The

Nor

inch

ukin

Ban

k, M

onth

ly R

evie

w of

Agr

icul

ture

, For

estr

y, a

nd F

ishe

ry F

inan

ce.

Tab

le 6

b.

In ve

stm

ent i

n F

orei

gn S

ecur

ities

Cla

ssifi

ed b

y T

ype of

Fina

ncia

l Ins

titut

ions

-

For

eign

Sec

uriti

es- T

otal

Sec

uriti

es R

atio

-

(Yo)

End o

f Yea

r 19

80

1981

19

82

1983

19

84

1985

19

86

1987

19

88

> z B

anki

ng A

ccou

nt o

f All

Ban

ks

2.67

3.

31

4.65

5.

54

8.40

12

.68

14.1

8 13

.96

12.5

9 P

4.66

6.

42

6.87

9.

39

12.6

8 13

.55

12.5

4 11

.42

m C

ity B

anks

3.

54

Reg

iona

l Ban

ks

0.69

1.

10

2.08

3.

09

4.79

9.

47

11.6

1 11

.89

11.1

1 (7

Trus

t Ban

ks

3.26

3.

09

3.59

5.

39

12.1

1 16

.88

19.2

6 18

.99

18.5

3 2

Trus

t Acc

ount

of A

ll B

anks

2.

23

4.07

4.

80

6.41

7.

27

13.9

8 17

.08

16.7

1 15

.31

Sog

o B

anks

0.

58

1.19

1.

73

2.10

3.

07

9.08

12

.55

11.6

6 10

.16

8 4.

20

3.88

4.

66

6.10

8.

66

8.68

7.

70

7.20

5

Shin

kin

Ban

ks

3.33

T

he N

orin

chuk

in B

ank

4.30

5.

55

5.21

3.

80

4.71

10

.34

14.8

4 14

.98

18.3

0 C

;d

Life

Insu

ranc

e Com

pani

es

8.98

12

.38

17.5

2 22

.23

24.8

8 26

.40

28.9

1 31

.35

31.0

6 z

Non

-Life

Insu

ranc

e Com

pani

es

7.42

7.

98

9.75

13

.71

17.1

6 19

.37

21.5

2 21

.50

22.3

2 Po

stal

Life

Insu

ranc

e & A

nnui

ty

-

0.02

0.

04

1.82

4.

58

6.71

9.

15

11.1

9 11

.26

Secu

ritie

s Inv

estm

ent T

rust

-

3.54

2.

19

2.00

5.

35

9.37

14

.34

12.2

7 12

.61

Tot

al (e

xcl.

Sec.

Inv.

Tru

st)

3.36

4.

47

5.86

7.

44

9.87

13

.96

16.5

3 17

.04

16.6

0

Sour

ce:

Bank

of J

apan

, Eco

nom

ic S

tatis

tics

Mon

thly

. T

he N

orin

chuk

in B

ank,

Mon

thly

Rev

iew

of A

qric

ultu

re, F

ores

try,

and

Fis

hery

Fin

ance

.

Lo !! m 5 m ;cc

Tab

le 6

c.

Inve

stm

ent i

n Fo

reig

n Se

curi

ties

Cla

ssifi

ed b

y T

ype o

f Fi

nanc

ial I

nstit

utio

ns

- F

orei

gn S

ecur

ities

-Tot

al A

sset

s R

atio

-

(Yo)

End

of Y

ear

1980

19

81

1982

19

83

1984

19

85

1986

19

87

1988

A

Ban

king

Acc

ount

s of A

ll B

anks

0.

46

0.57

0.

78

0.91

1.

33

1.95

2.

26

2.23

2.

10

2 $ 4.

41

4.86

4.

87

5.17

i! e z

City

Ban

ks

0.48

0.

62

0.80

0.

85

1.11

1.

44

1.61

1.

55

1 S

O

Reg

iona

l Ban

ks

0.14

0.

23

0.42

0.

61

0.89

1.

70

2.18

2.

16

2.07

T

rust

Ban

ks

1.05

0.

97

1.06

1.

51

3.27

T

rust

Acc

ount

sof A

ll B

anks

0.

40

0.79

1.

11

1.56

1.

99

4.13

5.

46

5.47

4.

89

$ S

ogo

Ban

ks

0.07

0.

16

0.22

0.

27

0.40

1.

25

1.92

1.

76

1.60

Sh

inki

n B

anks

0.

46

0.65

0.

61

0.71

0.

89

1.22

1.

23

1.07

0.

96

The

Nor

inch

ukin

Ban

k 1.

83

2.14

1.

95

1.46

1.

80

4.09

6.

26

5.70

6.

61

Life

Insu

ranc

e C

ompa

nies

2.

70

3.87

5.

70

7.67

8.

76

9.29

11

.68

13.7

3 14

.41

Non

-Lif

e In

sura

nce

Com

pani

es

2.75

3.

04

3.89

5.

95

7.78

8.

67

9.76

10

.38

10.4

2 2

Post

al L

ife I

nsur

ance

& A

nnui

ty

-

0.01

0.

02

0.87

2.

24

3.38

4.

68

5.57

5.

61

2.95

1.

82

1.69

4.

61

8.19

12

.18

9.25

9.

04

Secu

ritie

s Inv

estm

ent T

rust

-

Tot

al (e

xcl.

Sec.

Inv.

Tru

st)

0.68

0.

92

1.23

1.

60

2.13

3.

03

3.86

3.

99

4.00

%

Sour

ce:

Ban

k of

Jap

an, E

cono

mic

Sta

tistic

s M

onth

ly.

The

Nor

inch

ukin

Ban

k, M

onth

ly R

evie

w o

f A

gric

ultu

re, F

ores

try,

and

Fish

ery

Fin

ance

.


foreign securities than depository-type savings institutions because regulation concerning foreign securities investment in the former is less restrictive.

Important here is the fact that institutional investors started to increase their foreign investment in a staggered fashion. Life and non-life insurance companies began active investment in 1982 and 1983, followed by the trust account of trust banks, postal life insurance and postal annuity accounts, commercial banks, and securities investment trusts in 1984 and 1985, and finally regional banks, Sogo banks (mutual loan and savings banks), The Norin- chukin Bank, and the banking account of trust banks in 1985 and 1986. The staggered start of investment in foreign securities is important in understanding the relationship between the accumulation of foreign securities and the extent of exchange risk exposure. The reason is that staggering investments help spread exchange risk over a large number of institutional investors in succession through time. With non-financial business corporations still relatively unexposed to foreign exchange risk, their participation in foreign securities investment would make risk spreading among Japanese investors even easier.

It is not surprising, however, to observe that, with the rise in the relative weight of foreign securities in their portfolio, some institutional investors have begun to pay increasing attention to foreign exchange risk. In fact, there is some evidence (see Kawai and Okumura [1988]) that after 1984, on a monthly basis, Japanese investment in foreign bonds, in terms of flow, correlates negatively with exchange rate volatility That is, holding other variables constant, Japanese portfolio capital outflows decline when exchange rates behave in a volatile way, and vice versa. In the following section, we note this point and examine the determinants of the stock demand for external financial assets, including foreign securities, by Japanese investors.

IV. AN ECONOMETRIC ANALYSIS OF THE STOCK DEMAND FOR LONG-TERM EXTERNAL FINANCIAL ASSETS

1 . Specification of the Demand Function In this section, we attempt to identify econometrically the

determinants of Japanese investors stock demand for long-term


external financial assets. '" We focus on long-term external assets because they are the driving force of Japanese external asset accumulation in the 1980s and the major vehicle through which Japanese savings are mobilized to finance its current account surpluses. We also concentrate on the analysis of the demand for external financial assets (that is, securities, loans and trade credits) and do not consider direct investments (or investment in real assets) because the latter cannot be analyzed in a simple portfolio framework. Direct investment would involve, among others, a transfer of real capital and managerial resources, decisions on labor employment, intermediate input purchases and plant and equipment investment, and sales decisions in the presence of barriers to entry in a particular market. Although external loans and trade credits may not be fully explained by portfolio considera- tions alone, we examine the extent to which return-risk factors influence their demand. The stock demand for each component of long-term external financial assets (normalized by private sector financial assets) is postulated to depend on, among other things, expected return variables, risk factors and activity parameters.

The nominal interest rates on Japanese and U.S. assets are used for the return variables, the U.S. rate being adjusted for one- year expected rates of change in the yen/dollar exchange rate. The maintained hypothesis is that U.S. dollar assets are the major form in which external financial assets are held." Thus Japanese investors are assumed to face the choice between holding yen- denominated (domestic) assets and dollar-denominated (external) assets. The specific interest rates chosen in both countries depend on the type of external financial assets to be examined. In constructing the measure of expected rates of change in yen/dollar exchange rates, four proxies were considered:

(a) the twelve-month-ahead in-sample forecast rate of change in the exchange rate based on an estimated autoregressive (AR) process,

(b) the twelve-month-ahead out-of-sample forecast rate of change in the exchange rate based on an estimated A R process.

(c) the twelve-month-ahead in-sample forecast rate of change in the exchange rate based on an estimated vector-autoregressive (VAR) process,


(d) the twelve-month-ahead out-of-sample forecast rate of change in the exchange rate based on an estimated VAR process.

A fourth order autoregressive process (AR4) is used for (a) and (b). The VAR process used for (c) and (d) includes twelve-month lags of (the natural logarithm of) the spot exchange rate, the Japanese interest rate, and the U.S. interest rate.

As for the risk factor, a measure of exchange rate volatility is used on the assumption that yen/dollar exchange risk is the only type of uncertainty Japanese investors face. Two proxies of exchange rate volatility were tried:

(e) the standard deviation of daily exchange rates within a

(f) the variance of the twelve-month in-sample forecast of the

The monthly real GNP has been constructed as the activity parameter. l2

Preliminary regressions suggest that the external-asset demand function should contain the lagged dependent variable on the right hand side as well as serially correlated error terms, and that proxies (a) and (e) yield the best outcome among the possible alternatives. Therefore, we assume that Japanese investors in long- term external financial assets compare twelve-month returns on Japanese and U.S. assets and form expectations of twelve-month- ahead rates of change in the yen/dollar exchange rate based on a known monthly AR4 p r o c e ~ s ' ~ (semi-rational expectations), and that the standard deviation of daily exchange rates during a given month represents the future riskiness of holding external financial assets as opposed to holding domestic financial assets.

Based on the preliminary investigation above, the following two equations for each of the three types of long-term external financial assets have been estimated:

month,

exchange rate based on the VAR process used in (d).

Zt = Po + P l i t + P z (is" +et)+P,at + P 4 Y t + P S z t - l + u t '

where


zt = the natural logarithm of each of Japans external financial assets (gross or net) expressed as a ratio of private financial assets (gross or net),

it it* el

= the Japanese nominal interest rate, = the U.S. nominal interest rate, = the twelve-month-ahead forecast rate of change in the

yen/dollar exchange rate, based on the estimated AR4 process,

= the standard deviation of daily yeddollar exchange rates during month t,

= the natural logarithm of Japanese real GNP.

0 ,

y, Theory suggests that 8, < 0, P2 > 0 (hence P < 0) and P , < 0. The sign of P4 is generally expected to be ambiguous.

Kawai and Okumura [1988] found in a monthly regression analysis (see footnote 9) that Japanese flow investment in long- term foreign bonds has been inversely affected by exchange risk for the sample period January 1984 - September 1987, although it was positively affected by exchange risk before that. In other words, they suggest the possibility that there was a structural change in foreign-bond investment behavior. Taking this possibility into account, the external asset demand equations are also estimated by allowing the coefficients of the interest rates and exchange risk to be different before and after 1984. Specifically. PI , P 2 , P 3 and P are replaced respectively by P I + 6 Dt , P 2 + 6 Dt , P 3 + 6 D,, and P + 6 Dt , where the 6s are the coefficients to be estimated and

Dt = the dummy variable taking on value 0 fort d 1983.12 and

Exactly identical sets of equations are estimated with zt repre- senting gross external financial assets as well as net external financial assets. Gross external financial assets are expressed as a ratio of the private nonbanking sectors gross financial assets. Net external financial assets are expressed as a ratio of the private sectors net financial assets.

value 1 for t 3 1984.1.

2. Variables Used in Regression Analyses Figure 6 and 7 depict the dependent variable zt. Figure 6 shows

the ratio of gross long-term external financial assets relative to private nonbanking gross financial assets. Private nonbanking gross financial assets consist of those assets held by the corporate busi-

FIG

UR

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F V

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-v-.

-. . . . .

, . . .

. . -

1980

19

81

1982

19

83

1984

19

85

1986

19

87

1988

W

lA


ness sector and personal sector. Figure 7 plots the ratio of net long- term external assets relative to private net financial assets. Private net financial assets consist of high-powered money, government debts held by the private sector, and private net external assets, the last of which are net national external assets minus net short- term foreign assets held by the central monetary authorities.

Figure 8 plots the rate of change in the actual yeddollar exchange rate, st - stSl2 (where st is the natural logarithm of the period average spot rate in month t), and the twelve-month-ahead in-sample forecast rate of change in the exchange rate lagged by twelve months, er-12 = Et-12St - Sr-,2 The forecast is based on the estimated AR4 process (see footnote 13). As is expected, the actual exchange rates exhibit much more volatile behavior than do the forecast exchange rates, reflecting semi-rational expectations.

Figure 9 and 10 depict the Japanese long-term nominal interest rate (i), the U.S. long-term nominal interest rate (i*), and the U.S. interest rate adjusted for expected rates of change in the exchange rate (i*+e). The interest rates depicted in Figure 9 are the nominal yields of long-term government bonds. Specifically, they are the arithmetic average yields to maturity of all government bonds with 10 years maturity for Japan, and the yields on the most actively traded issues adjusted to 30 years maturity for the United States. These interest rates are used to estimate the stock demand for foreign securities. The interest rates plotted in Figure 10 are the contracted interest rate on loans and discounts (an average for all banks and all maturities) for Japan, and the twelve-month Eurodollar interest rate for the United States. These interest rates are used to estiamte the stock demand for external loans and trade credits.

It is noted from Figures 9 and 10 that it + et has generally risen since late 1985 as a result of the expectation of yen depreciation (until late 1986) and the rise in the U.S. nominal interest rate (after 1987). Our interpretation of the expectation of yen depreciation for late 1985 to late 1986 is that, in the face of a continuously appreciating yen vis a vis the dollar since the first quarter of 1985, investors must have anticipated a fall in the yen over the course of one year. thus the expected relative return was perceived as favorable to the United States while the nominal interest rate differential was moving in favor of Japan. This interpretation appears


0 0 0 0 2 c? p? P v!


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rn

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he J

apan

ese

cont

ract

ed i

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the

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#-

1981

19

82

1983

19

84

1985

19

86

1987

19

88

?i

1980

1


consistent with the Tokyo foreign exchange market survey data collected by the Japan Center for International Finance (JCIF) - see, for example, Ito [1987, 19881.

Finally, Figure 11 shows the standard deviation of daily exchange rates for each month (a), which is regarded as represent- ing exchange risk.

3. The Estimation Result Tables 7 and 8 report the Ordinary Least Squares (OLS) esti-

mation results of the external assets demand equations, and Tables 9 and 10 report the Residual Adjusted Aitken (MA) estimation results. Also Tables 7 and 9 report the results for gross external assets (normalized by the private nonbanking sectors gross financial assets), and Tables 8 and 10 report the results for net external assets (normalized by the private sectors net financial assets). Tables labeled a report the estimation results when the Japanese interest rate (i) and the U.S. interest rate adjusted for the expected rate of change in the exchange rate (i*+e) are put separately on the right hand side of the equations. Tables labeled b report the estimation results when the two interest rates are put jointfy as a differential (i-i*-e) on the right hand side. Each table contains the results with or without the dummy variable D, which separates the entire sample into two, i.e., the 1982.1-1983.12 period and the 1984.1-1987.9 period and allows the interest rates and exchange risk to exert varying effects on the demand for external financial assets in the two subsample periods. Considering the fact that the dependent variable zt is a stock at the end of month t and the explanatory variables (interest rates, the standard deviation of daily exchange rates, and real GNP) are variables during month t, the pToblem of a possible simultaneity bias due to the endogeneity of some of the explanatory variables is absent, or not very serious.

The OLS estimations in Tables 7 and 8 indicate the presence of high serial correlations in the error term, which together with the lagged dependent variable on the right hand side makes the estimators inconsistent. In order to restore the consistency and improve the asymptotic efficiency of the estimators, the Hatanaka RAA (Residual Adjusted Aitkens) method is employed. The results are summarized in Tables 9 and Since the RAA estimation yields results that are qualitatively similar to those of

m w k Q Lz

5 Q

0

n L L

z 0

d F: I > W CI

in


7


Table 7a.

Estimation Results of The Stock Demand for Gross External Financial Assets (January I982 - September 1987)

Foreign Securities' External Loansb Trade Credits'

OLS OLS OLS OLS OLS OLS

Constant -5.795 -12.772 -5.334 -13.128 -5.658 -8.490 (5.407) (6.471) (2.386) (3.599) (2.401) (3.600)

1 -2.164 1.797 -0.987 1.283 1.402 2.584 (0.674) (0.697) (1.373) (1.565) (1.641) (1.911)

D . i - -0.011 - -0.751 - -0.298 (0.293) (0.266) (0.273)

i ' +e 0.713 1.045 0.822 0.602 0.791 0.649 (0.120) (0.201) (0.112) (0.140) (0.105) (0.152)

D . (i' + e) - -0.358 - 0.765 - 0.363 (0.231) (0.213) (0.2 19)

0 -0.0014 -0.0012 -0.0023 0.0009 -0.0018 -0.0003 (0.0020) (0.0029) (0.0018) (0.0026) (0.0018) (0.0028)

(0.0038) (0.0036) (0.0039) D . 0 - -0.0005 - -0.0033 - -0.0013

Y 0.453 0.993 0.374 0.956 0.379 0.584 (0.414) (0.498) (0.175) (0.271) (0.172) (0.268)

LaggedDepVar 0.925 0.875 0.818 0.719 0.836 0.794 [z(-l)l (0.059) (0.062) (0.041) (0.048) (0.040) (0.050)

R2 0.997 0.997 0.943 0.951 0.965 0.965 SSR 0.0380 0.0349 0.0365 0.0298 0.0356 0.0340 DW 1.42 1.33 1.44 1.44 1.36 1.25

Note 1. Numbers in parentheses are estimated standard errors. 2. i = Japanese long-term interest rate (for foreign securities), or Japanese contracted

interest rate on loans and discounts, general (for external loans and trade credits). i' = US long-term interest rate (for foreign securities), or twelve-month Eurodollar interest rate (for external loans and trade credits).

3.a. Defined as log [Gross Foreign SecuritiedPrivate Nonbanking Sector's Gross Financial Assets].

b. Defined as log [Gross External Loans Extendedprivate Nonbanking Sector's, Gross Financial Assets].

c. Defined as log [Trade Credits on ExportdPrivate Nonbanking Sector's Gross Financial Assets].


Table 7b.

Estimation Results of The Stock Demand for Gross External Financial Assets (January 1982 - September 1987)

Foreign Securitiesa External Loansb Trade Credits


Constant

0

D . 0

Y

Lagged Dep Var [4-1)1

-9.612 (5.342) -0.592 (0.112)

-0.0017 (0.0021)

0.747 (0.409) 0.915

(0.060)

-11.623 (5.787)

(0.193) 0.395

(0.231) 0.0002

(0.0029) -0.0037 (0.0035) 0.900

0.890 (0.062)

-0.887

(0.445)

-4.780 (0.965)

(0.113) -0.861

-0.0021 (0.0018)

0.331 (0.073) 0.824

(0.032)

-9.060 (1.618)

(0.129)

(0.192)

(0.0023)

(0.0031) 0.653

(0.123) 3.761

(0.037)

-0.608

-0.559

-0.0003

-0.001 4

-2.187 (0.820)

(0,105) -0.815

-0.0018 (0.0017)

0.131 (0.065) 0.880

(0.026)

-2.861 1.461

(0.138)

(0.192)

(0.0024) 0.0014

(0.0033) 0.179

0.866 (0.031)

-0.699

-0.114

-0.0023

(0,115)

R2 0.997 0.997 0.943 0.949 0.966 . 0.964 SS R 0.0413 0.0389 0.0365 0.0320 0.0350 0.0363 DW 1.33 1.36 1.42 1.41 1.42 1.38

Note I . Numbers in parentheses are estimated standard errors. 2. i = Japanese long-term interest rate (for foreign securities), or Japanese contracted

interest rate on loans and discounts, general (for external loans and trade credits). i = US long-term interest rate (for foreign securities), or twelve-month Eurodollar interest rate (for external loans and trade credits).

3.a. Defined as log [Gross Foreign Securities/Private Nonbanking Sectors Gross

b. Defined as log [Gross External Loans Extendedprivate Nonbanking Sectors

c. Defined as log [Trade Credits on Exports/Private Nonbanking Sectors Gross

Financial Assets].

Gross Financial Assets].

Financial Assets].


Table 8a.

Estimation Results of The Stock Demand for Net External Financial Assets (January 1982 - September 1987)


OLS OLS OLS OLS 0 LS OLS

Constant

I

D . i

i * + e

D ' (i' + e)

U

D.U

Y

Lagged Dep Var [Z(-l)l

-8.905 (4.995) -2.451 (2.061)

1.736 (0.370)

-0.0066 (0.0065)

0.722 (0.387) 1.005 (0.036)

- 15.274 (8.359)

(2.185) 0.759

2.470 (0.664)

(0.791) 0.0025

(0,0098)

-2.142

(0.911)

-0.994

-0.0 134 (0.0 120) 1.216 (0.654) 0.963

(0.046)

-0.586 (1.712)

(1.139) -3.255

0.792 (0.114)

-0.0017 (0.00 18)

0.020 (0.129) 0.756 (0.045)

-1.965 (3.324)

(1.452)

(0.290) 0.702

0.252 (0.206)

(0.0029)

(O.OO40) 0.125 (0.255) 0.723 (0.054)

-3.114

-0.263

(0,155)

-0.0008

-0.0004

-1.250 (1.799) 0.307 (1.379)

0.770 (0.115)

-0.0010 (0.00 19)

0.033 (0.134) 0.746 (0.048)

1.049 (3.333) -0.397 (1.694)

(0.294) 0.731

-0.022 (0.213) -0.0009 (0,0032) -0.0000

-0.148

-0.232

(0,164)

(0.0043)

(0.255) 0.746 (0.057)

R2 0.968 0.967 0.922 0.920 0.965 0.964 S S R 0.3561 0.3402 0.0369 0.0360 0.0412 0.0406 DW 1.38 1.44 1.49 1.46 1.52 1.54



3.a. Defined as log [(Net Foreign Securities + $60 billion)l(High Powered Money + Government Debt Held by the Private Sector + Private Net External Assets)].

b. Defined as log [(External Loans Extended Net of Loans Received)/High Power Money + Government Debt Held by the Private Sector + Private Net External Assets)].

c. Defined as log [(Trade Credits on Exports Net of Trade Credits on Imports)/(High Powered Money + Government Debt Held by the Private Sector + Private Net External Asets)].


Table 8b.

Esrimaion Resulrs of The Stock Demand for Net External Financial Assers (January 1982 - Seprember 1987)

Foreign Securities External Loansb Trade CreditsC


Constant

D .(i- i*-e)

0

D . 0

Y

Lagged Dep Var [Z(-l)l

- 10.384 (3.115)

(0.333) -1.677

0.0068 (0.0064)

0.836

1.004 (0.036)

(0.244)

- 13.534 (4.926)

(0.586) 0.923

(0.726) 0.0029

(0.0095)

-2.374

-0 .O 148

1.080 (0.388) 0.969

(0.01 10)

(0.042)

-3.704 (0.955)

(0,117) -0.799

-0.0017 (0.0018)

0.252 (0.075) 0.733

(0.045)

-5.995 (1.685) -0.735 (0.142) -0.263 (0.206) 0.0010

(0.0026) -0.0039 (0.0033) 0.428

(0.130) 0.694

(0.052)

0.089 (0.989)

(0.113) -0.756

-0.001 1 (0.0019)

-0.049 (0,082) 0.767

(0.040)

0.779 (1.529)

(0.147)

(0.203)

(0.0026)

(0.0034)

(0.123) 0.772

(0.045)

-0.775

-0.075

-0.0024

-0.0023

-0.117

R2 0.968 0.968 0.917 0.918 0.965 0.964 SSR 0.3569 0.3408 0.0397 0.0380 0.0416 0.0412 DW 1.36 1.44 1.36 1.40 1.54 1.58


interest rate on loans and discounts, general (for external loans and trade credits). i = US long-term interest rate (for foreign securities), or twelve-month Eurodollar interest rate (for external loans and trade credits).

3.a. Defined as log [(Net Foreign Securiries + $60 billion)/(High Powered Money + Government Debt Held by the Private Sector + Private Net External Assets)].

b. Defined as log [(External Loans Extended Net of Loans Received)/High Power Money + Government Debt Held by the Private Sector + Private Net External Assets)].

c. Defined as log [(Trade Credits on Exports Net of Trade Credits on Imports)/(High Powered Money + Government Debt Held by the Private Sector + Private Net External Asets)].


the OLS estimation, and because the former has more desirable properties econometrically than the latter, we focus our discussion entirely on the M A estimation results in Tables 9 and 10.

Table 9a summarizes the results for the stock demand for gross external financial assets when the Japanese interest rate (i) and the expectation-adjusted U.S. interest rate (i* +e) are used separately on the right hand side as explanatory variables. The table reveals that, in the absence of the dummy variable D, the Japanese interest rate (i) has significantly negative coefficients in the foreign securities equation, as anticipated by portfolio theory, while it has the wrong sign (positive but insignificantly different from zero) in the external loan and trade credit equations. The table also shows that the expectation-adjusted U.S. interest rate (i* +e) has significantly positive coefficients in all equations, as is consistent with portfolio theory. Exchange risk (a) has a negative, though insignificant, coefficient in the foreign securities equation and positive (but insignificant) coefficients in other equations. Japanese real income (y) has significantly positive coefficients in all equations.

The equations with the dummy variable D suggest that the Japanese interest rate (i) has a greater impact, and the expectation- adjusted U.S. interest rate (i*+e) has a smaller impact, on the demand for foreign securities in the 1984.1-1987.9 period than in the 1982.1-1983.12 period. When the dummy variable is included the exchange risk (a) has negative coefficients in the 1984.1-1987.9 period while it has positive coefficients in the 1982.1-1983.12 period in all equations. In other words, the exchange risk factor was not perceived as important when the share of foreign assets in the portfolio of Japanese investors was relatively small in the earlier subsample period, and has become increasingly relevant as larger amounts of foreign assets have been accumulated since 1984. Thd coefficients of real income (y) are larger with the dummy variable included.

Table 9b reports the results for the stock demand for gross external financial assets when the Japanese and the expectation- adjusted U.S. interest rates are used jointly in a form of differential (i-i*-e) on the right hand side. The results in Table 9b are more satisfactory than those in Table 9a in the sense that the expectation-adjusted interest rate differential (i-i*-e) now has significantly negative coefficients in all equations with a higher explanatory


Table 9a.

Estimation Results of The Stock Demand for Gross External Financial Assets (January 1982 - September 1987)


RAA RAA RAA RAA RAA RAA

Constant

I

D . i

i '+e

D . (i' + e)

0

D . 0

Y

Lagged Dep Var [4-1)1 Ii(-l)

P

-11.845 (6.284)

(0.783) -1.779

-

0.748 (0.135) -

-0.0011 (0.0019) -

0.918 (0.481) 0.872

(0.069) 0.126

(0.086) 0.411

-33.317 (9.035) -1.450 (1.002) -0.261 (0.412) 1.151

0.265 (0.3 14) 0.0004

(0.0028) -0.0008 (0.0034) 2.571

(0.694) 0.667

(0.099) 0.014

(0.063) 0.652

(0.264)

-10.488 (5.776) -0.996 (3.794) -

1.209 (0.137) -

0.001 1 (0.0015) -

0.716 (0.434) 0.631

(0.087)

(0.047) 0.702

-0.056

-14.229 (4.468) 1.256

(2.468) -0.555 (0.340) 0.866

(0.196) 0.558

(0.251) 0.0036

(0.0026)

(0.0033) 1.039

(0.339) 0.709

(0.069) -0.121 (0.062) 0.400

-0.0043

-9.592 (5.528) 4.226

(3.943) -

1.205 (0.131) -

0.0006 (0.00 14) -

0.605 (0.414) 0.648

(0.085)

(0.044) 0.713

-0.048

(0.086) (0.063) (0.047) (0.062) (0.044)

R2 0.994 0.974 0.650 0.839 0.767 0.815 SS R 0.0319 0.0307 0.0301 0.0259 0.0277 0.0262 DW 1.81 1.91 2.15 1.68 . 1.99 1.81

,13.031 (5.477) 4.924

(3.592)

(0.369) 0.992

(0.206) 0.359

(0.262) 0.0031

(0.0025)

(0.0031) 0.886

(0.41 7) 0.673

(0.085) -0.050 (0.040) 0.649

(0.040)

-0.270

-0.0037

Note 1. Numbers in parentheses are estimated standard errors. 2. i = Japanese long-term interest rate (for foreign securities). or Japanese contracted

interest rate on loans and discounts, general (for external loans and trade credits). i* = US long-term interest rate (for foreign securities), or twelve-month Eurodollar interest rate (for external loans and trade credits).

3.a. Defined as log [Gross Foreign SecuritiedPrivate Nonbanking Sector's Gross Financial Assets].

b. Defined as log [Gross External Loans Extendedprivate Nonbanking Sector's Gross Financial Assets].

c. Defined as log [Trade Credits on Exports/Private Nonbanking Sector's Gross Financial Assets]. RAA = Hatanaka's Residual-Adjusted Aitken procedure. [In RAA, aconstant, y. log of Japanese high powered money, the Japanese discount rate and i' are used as instruments.]


Table 9b.

Estimation Results of The Stock Demand for Gross External Financial Assets {January 1982 - September 1987)

Foreign Securities" External Loansb Trade Credits'


Constant -15.531 -26.263 -7.796 -10.337 -4.102 -5.593 (6.189) (8.032) (1.598) (1.683) (1.512) (2.069)

(0.129) (0.253) (0.135) (0.174) (0.134) (0.192)

(0.309) (0.244) (0.251)

i-i*-e -0.696 -0.991 -1.161 -0.757 -1.170 -1.017

D.(i-i*-e) - 0.177 - -0.671 - -0.296

0 -0,0010 0.0017 0.0008 0.0023 -0.OOO1 0.0011 (0.0019) (0.0028) (0.0015) (0.0025) (0.0015) (0.0025)

(0.0033) (0.0030) (0.003 1) D . 0 - -0.0025 - -0.0020 - -0.0018

Y 1.202 2.026 0.531 0.729 0.242 0.358 (0.474) (0.615) (0.125) (0.130) (0.126) (0.171)

LaggedDepVar 0.856 0.741 0.691 0.676 0.769 0.762 [z(-l)l (0.071) (0.092) (0.059) (0.050) (0.050) (0.055)

(0,085) (0.068) (0.102) (0.082) (0.109) (0.090)

(0.085) (0.068) (0.102) (0.082) (0.109) (0.090)

ii(-1) 0.139 -0.026 -0.031 -0.082 -0.074 0.074

P 0.452 0.537 0.560 0.385 0.642 0.680

R2 SSR DW

0.994 0.984 0.786 0.865 0.871 0.860 0.0330 0.0326 0.0301 0.0263 0.0296 0.0286 1.77 1.73 1.98 1.82 1.89 1.83

Note 1. Numbers in parentheses are estimated standard errors. 2. i = Japanese long-term interest rate (for foreign securities). or Japanese contracted


3.a. Defined as log [Gross Foreign Securitiesmnvate Nonbanking Sector's Gross Financial Assets].

b. Defined as log [Gross External Loans Extendedlprivate Nonbanking Sector's Gross Financial Assets].

c. Defined as log [Trade Credits on ExportdPnvate Nonbanking Sector's Gross Financial Assets]. RAA = Hatanaka's Residual-Adjusted Aitken procedure. [In RAA, aconstant, y , log of Japanese high powered money, the Japanese discount rate and i' are used as instruments.]


power measured by the R2. Exchange risk ((I) has a pattern of coefficients similar to that in Table 9a, and real income (y) has significantly positive coefficients in all equations as in Table 9a.

The equations with the dummy variable in Table 9b demonstrate that, in the 1984.1-1987.9 period, a 100 basis point increase in the expectation-adjusted interest rate differential (i-i*- e) reduces the stock demand for foreign securities, external loans, and trade credits (all expressed as gross ratios of the private nonbanking sectors gross financial assets) by O.8%, 1.4% and 1.3%, respectively, in the short run, and by 3.1%, 4.4% and 5 . 5 % , respectively, in the long run. The income elasticities of the stock demand for foreign securities, external loans, and trade credits (relative to private nonbanking financial assets) are respectively 2.0%, 0.7% and 0.6% in the short run, and 7.8%, 2.3% and 1.5% in the long run. Thus, the interest rate differential adjusted for exchange rate expectations has a slightly smaller impact on foreign securities than on external loans and trade credits, and income growth has a much more pronounced impact on foreign securities than on the other two. There is also some weak evidence that exchange risk (u) inversely affects the stock demand for foreign securities, particularly in the 1984.1-1987.9 period.

Tables 10a and 10b summarize the RAA estimation results for net external financial assets, the balance between external assets and liabilities deflated by the private sectors net financial assets. As in the case of the demand for gross external financial assets, the results of Table 10b with the expectation-adjusted interest rate differential (i-i*-e) on the right hand side are more satisfactory than those of Table 10a, where the two interest rates (i and i+e) are put separately on the right hand side. The expectation-adjusted interest rate differential (i-i*-e) has significantly negative coefficients in all equations in Table lob, whereas the Japanese interest rate (i) in Table 10a is insignificant in all equations and in some cases has the wrong sign. Exchange risk (a ) has a reasonable though not significant sign, particularly in the case of the demand for foreign securities.

In the 1984.1-1987.9 period based on specification with the dummy variable D in Table lob, a 100 basis point increase in the expectation-adjusted interest rate differential (i-i*-e) reduces the stock demand for net foreign securities, net loan positions, and net


Table 10a.

Estimation Results of The Stock Demand for Net External Financial Assets (January 1982 - September 1987)

~~

Foreign Securities' External Loansb Trade Creditsc


Constant

I

D . i

i '+e

D . (i' + e)

Q

Y

Lagged Dep Var [z(- 111 il(-1)

P

R2 SSR DW

- 15.885 (7.126)

(2.583) -0.694

1.592 (0.469)

-0.0060 (0.0061)

1.259 (0.553) 0.955 (0.053) 0.008 (0.058) 0.349 (0.058)

0.937 0.3094 1.75

-62.960 (24.739) 4.086 (3.289)

(1.326) 1.070 (0.771) 0.817 (0.971) -0.0035 (0.008 1) 0.0012 (0.0097) 4.892 (1.952) 0.491 (0.118) -0.002

0.913

-0.435

(0.012)

(0.012)

0.410 0.31 15 1.85

-3.007 -2.685 (6.804) (4.609)

(4.354) (2.405)

(0.375) 0.985 0.794 (0.149) (0.213) - 0.311

(0.270) 0.0010 0.0018 (0.0016) (0.0029) - -0.0020

(0.0037)

-1.505 -3.151

- -0.134

0.160 0.173 (0.523) (0.358) 0.507 0.675 (0.096) (0.078)

(0.039) (0.081) 0.752 0.381 (0.039) (0.081)

-0.045 -0.113

-0.176 (7.2 19) 3.388 (4.698)

0.960 (0.157)

0.0007 (0.0017)

-0.148 (0.558) 0.436 (0.101)

(0.040)

(0.040)

-0.039

0.756

3.994 (7.588) 1.626 (4.460) -0.502 (0.455) 0.836 (0.248) 0.156 (0.320) 0.0018 (O.OO30) -0.0015 (0.0037) -0.473 (0.591) 0.433 (0.103)

(0.043) 0.734 (0.043)

-0.023

0.481 0.776 0.0360 0.0316 2.36 2.00

0.618 0.0411 2.29

0.669 0.0392 2.25



3.a. Defined as log [(Net Foreign Securities + $60 billion)/(High Powered Money + Government Debt Held by the Private Sector + Private Net External Assets)].

b. Defined as log [( External Loans Extended Net of Loans Received)/(High Powered Money + Government Debt Held by the Private Sector + Private Net External Assets)].

c. Defined as log [(Trade Credits on Exports Net of Trade Credits on Imports)/(High Powered Money + Government Debt Held by the Private Sector + Private Net External Assets)]. RAA = Hatanaka's Residual-Adjusted Aitken procedure. [In RAA, aconstant, y , log of Japanese high powered money, the Japanese discount rate and i' are used as instruments.]

-

4.


Table lob.

Estimation Results of The Stock Demand for Net External Financial Assets (January I982 - September 1987)

Foreign Securities" External Loansb Trade Credits'

RAA RAA RAA RAA RAA R&l

Constant

0

D . 0

Y

Lagged Dep Var [z(-l)l li(-1)

P

-12.690 (3.522)

(0.385) -1.579 .

-0.0065 (0.0064)

1.013 (0.275) 0.971

(0.045) 0.036

(0.070) 0.176

(0.070)

-46.937 (17.029)

-1.358 (0.766) -0.444 (0.961) -0.0031 (0.0084) -0.0017 (0.0100) 3.658

(1.341) 0.553

0.003

0.862

(0.120)

(0.02 1)

(0.02 1)

-4.013 (2.629) -0.994 (0.144)

0.0009 (0.0015)

0.243 (0.214) 0.538

(0.092)

(0.054) 0.686

(0.054)

-0.078

-6.423 (1.842) -0.788 (0.184) -0.276 (0.247) 0.0019

(0.0028)

(0.0034) 0.460

(0.146) 0.682

(0.067)

(0.089) 0.266

(0.089)

-0.0026

-0.119

0.465 (1.675)

(0.148) -0.936

-0.0002 (0.0019)

-0.117 (0,144) 0.671

(0.069) 0.011

(0.125). 0.435

(0.125)

0.702 (2.154) -0.913 (0.208) -0.025 (0.276) -0.0010 (0.0030) 0.0013

(0.0036)

(0.178) 0.671

(0.067) 0.004

0.426 (0.108)

-0.136

(0.108)

RZ 0.961 0.511 0.533 0.835 0.907 0.904 SSR 0.3186 0.3268 0.0352 0.0322 0.0391 0.0390 DW 1.56 1.91 2.29 1.83 2.11 2.11



3.a. Defined as log [(Net Foreign Securities + $60 billion)/(High Powered Money + Government Debt Held by the Private Sector + Private Net External Assets)].

b. Defined as log [( External Loans Extended Net of Loans Received)/(High Powered Money + Government Debt Held by the Private Sector + Private Net External Assets)].

c. Defined as log [(Trade Credits on Exports Net of Trade Credits on Imports)/(High Powered Money + Government Debt Held by the Private Sector + Private Net External Assets)]. RAA = Hatanaka's Residual-Adjusted Aitken procedure. [In RAA, a constant, y, log of Japanese high powered money, the Japanese discount rate and i' are used as instruments.]

4.


trade credits (relative to private net financial assets) by 1.4'/0, 0.8% and 0.9%, respectively in the short run, and 3.0%, 2.5% and 2.8%, respectively, in the long run. their income elasticities are respectively 3.7%, 0.5% and -0.1% in the short run, and 8.170, 1.4% and -0.4% in the long run. Thus, unlike in the case of the

japan's demand for long-term external financial assets in the 1980's

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