Japan mulls more aggressive approach to forex investment

by Yasushi Azuma

Kyodo News

The government is expected to face growing pressure in 2008 to more actively invest its nearly $1 trillion (¥113 trillion) in foreign reserves to help restore the health of state finances.

The nation’s foreign reserves — the world’s second-largest after China — have been a source of debate over whether the government should more actively invest the funds for higher returns.

Recent data from the Finance Ministry showed that the government scored a 4 percent return on the investment of its foreign reserves in fiscal 2006, the highest return in five years until the year to last March.

But some lawmakers and academics are not satisfied with such “conservative” returns coming mostly from interest income from U.S. Treasuries, and are calling for Japan to launch its own version of a sovereign wealth fund.

Part of the investment returns from foreign reserves can be used as general-account budgetary spending and help improve Japan’s fiscal conditions, currently the worst among major developed countries.

On Dec. 5, about 40 lawmakers of the ruling Liberal Democratic Party set up a group to lobby for the launch of Japan’s sovereign wealth fund using part of the nation’s foreign reserves or other assets, including pension funds. They plan to draw up a report for the government next spring.

Hidenao Nakagawa, one such lawmaker and former secretary general of the LDP, has also called on the government to seriously consider ways to actively invest its massive foreign reserves.

Sovereign wealth funds refer to state funds or entities that manage national savings, typically from ample cash from crude oil exports and accumulated foreign reserves, for investment purposes.

Their clout is rapidly growing in global financial markets, with the total value of such public funds around the world estimated to be around $1.9 trillion to $2.9 trillion (¥215 trillion to ¥329 trillion).

The figures compare with the value of hedge funds, believed to be around $1.5 trillion to $1.6 trillion (¥170 trillion to ¥181 trillion), according to the International Monetary Fund.

Countries that operate sovereign wealth funds include China, Kuwait, Norway, Russia, Saudi Arabia, Singapore and the United Arab Emirates.

Some academics, including Takatoshi Ito, a member of the government’s Council on Economic and Fiscal Policy and professor at the University of Tokyo’s graduate school of economics, urge the government to invest its foreign reserves — at least their interest income — more actively.

The government remains cautious about such a proposal. Finance Minister Fukushiro Nukaga and senior ministry officials said the first priority should be given to ensure stability and liquidity in the nation’s foreign reserves and that investment must be made within that framework.

Hideo Kumano, chief economist at Dai-ichi Life Research Institute, also questions a call from lawmakers and academics for an active investment of foreign reserves.

“We saw three major plunges in global stock prices in 2007. We could have incurred a huge loss if we had invested foreign reserves by launching a sovereign wealth fund,” Kumano said.

“Who will take the responsibility for the loss and how?” he asked, adding the government should be cautious about investing foreign reserves due to risks of fluctuations in exchange rates and interest rate hikes.

But the economic situation appears to be encouraging these lawmakers and academics to ratchet up their demands as tax revenues are unlikely to post sharp growth in the coming few years due mainly to lower revenue from corporate taxes.

The Finance Ministry projects tax revenues will total ¥53.554 trillion in fiscal 2008, up only ¥87 billion, or 0.2 percent, from the initial estimate for the fiscal 2007 state budget.

The government wants to raise the consumption tax from the current 5 percent in fiscal 2009 to cover revenue shortfalls stemming from the scheduled increase in the ratio of the state burden in the basic pension system in the same fiscal year through March 31, 2010.

Such a hike, however, could curb consumer spending and trigger an economic downturn if it comes at a time when Japan’s economic outlook remains uncertain. The economy is now facing such downside risks as financial market fluctuations and a slowdown in the U.S. economy amid the U.S. subprime mortgage woes.