1、Capital Account Liberalization -Japans Experience and its Implications to China-,September 13, 2014 Kenji Aramaki Tokyo University,1,Outline,1. Japans Experience,(1) Postwar Legal Framework (2) Overall Process-Three staged Liberalization (3) Main Features of Liberalization of Capital Account (4) Reg
2、ulatory Response to Unstable Capital Flow in the 1960s and 1970s,2. Implications to China(1) Characteristics of Chinas Capital Account Liberalization(2) Implications from Japans Experience,2,1. Japans Experience (1) Postwar Legal Framework,The Foreign Exchange Law (1949) (and the Foreign Capital Law
3、 (1950) wholly controlled both trade and foreign exchange after the war For trade, imports were placed under the approval system,3,Four major features of foreign exchange regulations under the postwar legal framework, General prohibition A principle of “general prohibition with liberalization for ex
4、ceptions” adopted Foreign exchange concentration system All foreign exchange centrally controlled by the government,4, Foreign exchange budget system The amounts and items to be imported were regulated by this budget Authorized foreign exchange bank system The authorized foreign exchange banks were
5、used as a management mechanism of foreign exchange and capital account transactions,5,(2) Overall liberalization process-Three staged liberalization,Capital account liberalization substantively started in the early 1960s and completed in the late 1990s, i.e., nearly 40 years later The whole process
6、may be divided into three stages:1st stage: Liberalization of trade and current account transactions (mid1960s)2nd stage: Gradual easing and a major shift to a system of general liberalization (latter half of 1960send 1970s)3rd stage: Completion of liberalization (1980slatter half of 1990s),6,The 1s
7、t stage: Liberalization of trade and current account transactions (mid1960s),In 1960, “the Basic Plan for Liberalization of Trade and Foreign Exchange” adopted by the government It called for an increase in import liberalization, and the general liberalization of current account transactions within
8、two years In April 1964, Japan accepted IMF Article obligations, abolished the foreign exchange budget system, and generally liberalized current account transactions,7,The 2nd stage: Gradual easing and a major shift to a system of general liberalization (later half of 1960s 70s),“The Basic Plan” sho
9、wed a cautious stance on capital account transactions and only stated that regulations would be eased gradually In a testimony before the Diet in February 1962, then Minister of Finance SATO, Eisaku stated that the effects of international capital account transactions would be long and deep and ther
10、efore care needs to be paid to their treatment,8,Gradual easing of regulations continued over more than a decade, started with the significant inward direct investment liberalization in 1967 The foreign exchange concentration system abolished and holdings of foreign exchange by residents liberalized
11、 in 1972 The regulatory framework thoroughly revised and a major change from general prohibition to general liberalization implemented by the 1979 reform,9,The 3rd stage: Abolition of remaining regulations and completion of capital account liberalization (1980slatter half of 1990s),Even under the 19
12、79 reform, certain transactions were placed under the approval/prior notification requirements In 1997, the foreign exchange law was revised again, basically abolishing approval/prior notification requirements and liberalizing foreign exchange business, completing liberalization of capital accounts
13、in Japan,10,(3) Main features of capital account liberalization, Main feature (1): Cautious and gradual sequencing of liberalization taking into account of the type of transactionsSubstantive liberalization of capital account started after the liberalization of current account transactionsLiberaliza
14、tion of inward investment generally preceded to liberalization of outward investmente.g., While liberalization of inward direct investment started in 1967, liberalization of outward direct investment started in 1969,11,Liberalization of direct investment generally preceded to liberalization of other
15、 types of transactionse.g., After the major liberalization of direct investment started with the first foreign capital liberalization package in 1967, liberalization of other type of transactions such as portfolio investment followed Certain transactions were treated cautiously until the very late s
16、tage e.g., Such transactions included foreign currency denominated lending between residents and cross-border issuance of banks,12, Main feature (2): Use of foreign exchange banks as a mechanism for foreign exchange control,Under the Foreign Exchange Law, authorized foreign exchange banks played a m
17、ajor management role by tracking overseas transactions and verifying their legal appropriateness These functions basically maintained even after the 1979 reform,13,Approval/prior notification requirements for some transactions exempted for business activities by authorized foreign exchange banks, th
18、us encouraging capital flows to be channeled through foreign exchange banks The 1997 reform, which liberalized foreign exchange business, greatly reduced the management function of banks,14, Main feature (3): Neutral stance for the internationalization of the yen,The use of yen allowed for foreign p
19、ayments in 1960 At the same time, non-resident free yen account was introducedNon-residents were allowed to deposit with free yen account not only those yen received for current account transactions such as import to Japan but also those yen they obtained through the sale of foreign currency to bank
20、s This treatment opened a channel for the inflow of short-term capital for the first time,15,International use of the yen progressed gradually in the 1970se.g., While the ratios of yen-denominated export and import are respectively 17.5% and 0.9% in 1975 and 29.4% and 2.4% in 1980, these ratios for
21、West Germany were greater than 80% and 40-50% respectively around that time. Policy stance at that time seems to have been a neutral one; the internationalization of the yen would proceed as a result of internationalization and liberalization of Japans economy and the government should not employ in
22、tentional measures to promote it,16,Debates on internationalization of the yen in the “Yen-Dollar Committee” in 1984,The internationalization of the yen became a hot issue in the “Yen-Dollar Committee” that was established by the agreement between Japans Minister of Finance and the U.S. Treasury sec
23、retary in late 1983,17,The U.S. argued as follows: The yen/dollar exchange rate issue underlying the trade imbalances between Japan and the U.S. is caused by the lack of appropriate valuation of the yen due to the closed nature of Japans financial and capital markets Japan needs to liberalize financ
24、ial and capital markets and internationalize the yen,18,In relation to the former (i.e., liberalization of domestic markets), Japan took a position that liberalization of financial and capital markets was beneficial to Japans economy and therefore Japan would cope with the issue on its own initiativ
25、e. As for the latter (internationalization of the yen), Japan took a position that may be described as a “Natural Evolution” approach as below:The internationalization of the yen will proceed basically as a result of choice made by parties concerned in transactionsThe role of policies is to remove b
26、arriers to the use of the yen when parties concerned chose to use it.,19,While Japan implemented measures incorporated in the Committees report such as the abolition of yen conversion limit (a type of over-sold position limit) and the internationalization of the yen progressed to a certain extent in
27、 the latter half of the 1980s, the international role of the yen stayed relatively low or decreased subsequently partly reflecting stagnation of Japans economy since the 1990s,20,(3) Regulatory responses to the unstable short-term capital flows in the 1960s and 1970s,In the liberalization process, J
28、apan extensively used capital control measures to cope with destabilizing capital flows in the late 1960s and 1970s Direction of policies frequently reversed under the changing international environments,21,Japan: Short-term Capital Controls and Developments in Balance of Payments, Exchange Rate and
29、 Foreign Reserves, 1965-1981,22,Sharp rise in foreign reserves toward end 1960s Major policy reversal from inflow promotion to inflow restriction (a switch from “heater” to “cooler”) Three main channels of short-term capital inflow at the “Nixon Shock”,Period ：late 1960s to mid 1971,non resident fre
30、e yen accounts portfolio investment in bonds by non-resident export pre-payments,Policy responses,balance limit imposed on free yen accounts de-facto ban on the acquisition of bonds by non-resident ban on the yen conversion of export pre-payments,23,A very rough estimate: The inflow of short-term ca
31、pital, at an annualized rate, was equivalent to more than 10 % of Japans GDP,Outstanding balance of free yen accounts; $ 0.6 bil. at end Feb.1971 to $ 0.8 bil at end May 1971 Purchase of bonds by non-residents; $ 0.001 bil/year in the past to $ 0.1 bil./Month in Mar. and Apr. 1971 Export prepayment;
32、 $ 0.05 bil./month to $ 2 bil. in Aug. 1971 Annualized amount of these three inflows combined is 26billion/year (0.2/30.12）12） and equivalent to 12 % of Japans GDP in 1971(80.7 trillion yen or $ 224.2 bil. If converted by the rate of 360 yen to the dollar),24,Period ：end 1971 to around mid-1973,Rela
33、xation of restrictions immediately after the Smithsonian Accord Re-strengthening of controls under a massive inflow of short-term capital Some relaxation of purchasing and holding of foreign currency by residents,25,Period :end 1973 to mid 1974,Return to the inflow promotion policy under a sharp dep
34、reciation of the yen after balance of payments deteriorations under a rising inflation and the first oil crisis e.g., Reserve rate for increases in free yen account significantly lowered Some outflow restrictions also adopted,Period : 1975 to mid1977,Under the relative stability of the international
35、 financial markets, both inflow and outflow restrictions eased,26,Period : end 1977 to 1978 With resurgence of massive inflow of short-term capital, policies switched again to inflow restrictionse.g., Reserve rate for increases in free yen account raised (0%50100),27,Period : 1979 to 1980,With a sha
36、rp depreciation of the yen after the second oil crisis, policies reversed again to inflow promotionSubsequent situations With the capital account liberalization promoted by the comprehensive revisions to the Foreign Exchange Law (1979), and with Japans continued growth and its further strengthened e
37、xternal position, such policy ceased to be observed after entering the 1980s,28,Summary of Japans experience,(1) Substantive capital accounts liberalization started in the early 1960s and liberalization was completed in the late 1990s, taking nearly 40 years, and it proceeded through three stages; c
38、urrent account liberalization, a switch to a generally liberalized system, and abolition of remaining restrictions.,29,(2) With regard to the type of capital account transactions, the liberalization of inward investment generally preceded the liberalization of outward investment, liberalization of d
39、irect investment preceded to liberalization of other investment, and investments with higher risk were treated cautiously until the last stage of liberalization.,30,(3) Throughout the liberalization process, the authorized foreign exchange banks were used as an effective foreign exchange management
40、mechanism. (4) Non-resident free-yen accounts were introduced at an early stage, which later became one of the key channels for the inflow of short-term capital. Portfolio securities investment and trade-related payments also became key channels for the short-term capital flow.,31,(5) Foreign exchan
41、ge controls and regulations on capital transactions were frequently adopted in order to manage short-term capital flows and are thought to have had effectiveness of a certain degree in preventing market instability,32,(6) Regarding the internationalization of the yen, while the yen settlement was al
42、lowed as early as in 1960, and the government made efforts to remove obstacles to internationalization of the yen partly in response to the request from the U.S., international use of the yen has not come to the level that matches the size of Japans economy.,33,2. Implications to China,Characteristi
43、cs of Chinas capital account liberalization In around mid-1980s, China had a total state control of external transactions Subsequently, it liberalized the current account transactions in 1996, and gradually liberalized capital account transactions, while maintaining overall regulatory framework.,34,
44、In terms of three stage division of Japans process, China is in stage 2 There are many commonalities with Japan, including the adoption of a firm gradualism, and sequencing of liberalization by type of transactions with inward direct investment coming first and the cautious treatment given to risky
45、investment While Chinas liberalization somewhat accelerated after entering the 2000s, the most distinctive feature is the fact that the pace of progress of liberalization for the internationalization of renminbi seems to be faster than the pace of liberalization in other areas.,35,Implications from
46、Japans experience (a) Control of risk,The most important thing is to control concomitant risk when liberalizing capital account In Japans experience, the most important inflow channels included capital flows through foreign exchange banks, purchase of securities by non-residents, and trade-related c
47、apital flows,36,Trade-related flows can be very significant and in this respect China may be already facing risk of huge capital outflows There was a huge outflow of “other investment“, amounting to -$25.50 billion in 1997, and -$43.70 billion in 1998 .,China: Trends of Portfolio Investment and Othe
48、r Investment, 90-03,37,Behind the outflow of other investment, there was a massive outflow of trade credit (increase in assets) from China under devaluation expectation of renminbi during the Asian crisis China: Trends of Trade Credits, 97-03,38,That is just the same (while in an opposite direction)
49、 with what happened to Japan under the revaluation expectation of the yen around the Nixon shock,Japan: Trends of Trade Credits, late 60s to early 70s,39,A few points may be noted regarding the control of risk,First, the effectiveness of management will be enhanced if capital transactions are basica
50、lly conducted through financial institutions including banks. Second, in the case of Japan, it was direct quantitative measures that finally effectively managed short-term capital flows under major external shocks,40,In this regard, we should take not that, in the case of Thailand before and after the Asian crisis, what flew in most and what flew out most was “Other investment”, mainly composed of bank credit,
