Japan is taking a long and very hard look at setting up a sovereign wealth fund (SWF), in response to pressure from political “young Turks”, officials and academics.
Japan is one of the few east Asian countries without such a vehicle now, even though the nation’s foreign exchange reserves stand at something near to $1 trillion, second only to China’s.
But the Japanese government’s huge debt liabilities could thwart any attempt to create an SWF. So too could hidebound legal structures that limit what the Ministry of Finance, which handles most of Japan’s foreign exchange reserves, is able to do.
“If we are to create an SWF we have to enact a new law,” former vice finance minister for international affairs Eisuke Sakakibara told Emerging Markets. “You need to hire experts at high salaries and to create an [enabling] environment. You have to establish an organisation which caters to asset management. It takes time, planning and initiative.”
Another senior former finance ministry official told Emerging Markets that many politicians, particularly younger ones, are “arguing for the establishment of a sovereign wealth fund”, but many of them overlook critical differences between the way that countries acquire and manage reserves.
“Japan has nearly $1 trillion of foreign reserves – but this is from borrowed money, unlike the oil producers of Middle Eastern countries, or Singapore and Australia, which have established sovereign wealth funds out of their budget surpluses,” this source noted.
Japan built up its reserves through official intervention in foreign exchange markets, up until 2003. The finance ministry, acting through the Bank of Japan, bought dollars earned by Japanese exporters in order to prevent dollar sales into the market that would have placed upward pressure on the yen. Currency appreciation was seen as damaging to Japan’s international competitiveness.
In order to finance dollar purchases, the government needed to issue short-term financing bills, which need to be continually rolled-over in the market so long as the foreign exchange reserves are held. By contrast, countries with budget surpluses can use these to purchase foreign exchange, the official said.
China did not simply transfer $20 billion of borrowed foreign exchange reserves from its central bank to fund its wealth fund, the China Investment Corporation. Instead, the government issued the same amount of ten-year government bonds and used this money to purchase reserves for the CIC.
This means it is matching the purchase of long term portfolio or strategic assets by its SWF with long-term liabilities. In theory, Japan could do the same – but there is a question over whether a government whose outstanding debt already exceeds 150% of GDP, much of it in ten-year bonds, should issue even more.
Takatoshi Ito, a former economic advisor to the Japanese cabinet is among the proponents of a Japanese SWF, created by using the interest earned on its reserves rather than the reserves themselves. “Once it is called an investment fund we could retain professional managers to manage it,” Ito told Emerging Markets. “Interest on $1 trillion at 4% would be $40 billion. This could be used as a reserve for future generations.”