The postwar Japanese capital market—both in stocks and bonds—has developed rapidly since its re-establishment by the enactment of the new Securities and Exchange Law in November 1948. In the following 10-year period, the capital market played a key role in reconstruction. After 1955 and the Korean War boom it developed rapidly, fostering the rapid economic growth of Japan.
During the years 1960-70, the total value of bonds1 publicly offered in Japan increased 4.6 times. However, the Government itself started to issue bonds only in 1966 after an interval of 16 years, and bond issues by public sectors—Government, public corporations, and municipal authorities—have contributed greatly toward the development of the market.2
The total amount of new bonds, excluding bank debentures, offered publicly in the Japanese capital market in 1970 was ¥ 1,357 billion. In 1971 this amount reached ¥2,145 billion with bond issues by public sectors accounting for 53.4 per cent. In comparison, the amount of bonds issued in 1971 totaled US$84.9 billion in the United States and £6.1 billion in the United Kingdom.
The Japanese stock market has grown to such an extent that in 1971 it reached an average daily trading turnover of ¥ 45.4 billion on the Tokyo Stock Exchange, approximately 2.4 times the 1960 daily average. The Japanese stock market is now second only to the New York market in terms of the total value traded.
The rapid growth of the Japanese capital market is largely a result of the rapid increase in total savings. Personal savings increased from ¥ 15,444 billion at the end of 1961 to ¥ 69,016 billion in 1970.
The Japanese capital market has many features that are quite distinct from the markets of the United States and Western Europe. These result from historical factors and the unique nature of the Japanese economy.
One of the characteristic features of the market is the extent of Japanese industry’s reliance on the so-called indirect financing system. In this system, most of the funds from individual savers (suppliers of funds) are channeled indirectly into industries (users) through banks, insurance companies, and other financial institutions, which supply medium-term and long-term funds in the form of loans.3 Direct financing from the capital market to industries by means of bond issues has played a minor role. Since World War II, the Japanese economy has experienced a period of rapid growth; the growth rate between 1955 and 1970 averaged about 10 per cent per annum in real terms.
A major factor in this growth was the heavy investment by key industries in plant and equipment. These industries, having only small capital bases, borrowed heavily from banks for most of their capital investments. banks attracted individual savings more than other institutions, because individuals, whose per capita savings were small, preferred to concentrate their deposits at banks rather than diversify them. Moreover, institutions called long-term credit banks, specializing in medium-term and long-term corporate financing, absorbed large amounts from the market by issuing bank debentures and, in turn, provided industries with medium-term and long-term funds.
This system of indirect financing, together with the rapid economic growth, is reflected in the financial structure of Japanese companies. The net worth of a Japanese company is relatively small. According to Capital International Perspective, a statistical survey on stocks published in December 1971 in Switzerland, the net worth (capital + reserves) of 742 nonfinancial Japanese companies, whose stocks are publicly listed at exchanges in Japan, was only 19.4 per cent of all balance sheet liabilities. This compares with 45.7 per cent for both U. S. and U. K. companies. (These figures are based on the latest available balance sheets for 1970 or 1971.) According to the Ministry of Finance’s statistical survey on 764 major nonfinancial Japanese companies on June 30, 1971, the liabilities due to the issue of bonds was only 4.4 per cent of total liabilities, whereas bank borrowings were 51.5 per cent.
Japanese industries thus have small net worth and rely heavily on external sources of financing. Direct financing through bond issues has played a less important role in financing these industries than has borrowings from banks. This contrasts with European and North American practice, where medium-term and long-term funds are normally channeled directly into industries by means of bond issues and where short-term funds are provided by banks. Although Japanese banks’ primary function is to provide short-term funds, they also operate in medium-term and long-term areas of the money markets. They rely on borrowing from the bank of Japan and on the call money market for funds to provide corporate financing.
A crucially important factor in the rapid reconstruction and development of the postwar economy was Japan’s ability to secure enough funds for the large demand for capital investment by key industries. Since the Japanese economy had to restart from a situation of serious dislocation and destruction, the cost of the funds to industry was to be kept as low as possible. Had the price mechanism been operating, the cost of capital would have been very high as the funds available in the market were limited and the demand was extremely strong. The Japanese Government accordingly adopted a cheap money policy; interest rates on bank loans as well as yields on corporate bonds were held at low levels. Only call money rates (call money is supplied by financial institutions such as trust banks, credit cooperatives, and agricultural institutions), were left to fluctuate quite freely, and at times these were higher than long-term money rates.
With funds being in great demand and short supply, the yield on corporate bonds was not high enough for general investors to invest profitably. Most of the public and corporate bonds were purchased by banks. This was partly because banks could place those bonds as collateral for their borrowing from the bank of Japan and partly because of the traditionally close relationship between industry and banks. In other words, bond issues depended heavily upon purchases by banks.
Despite its unique features, some of which might appear restrictive, the capital market has contributed greatly to the rapid economic growth of postwar Japan. Yet the need to develop a more sophisticated capital market was recognized from the beginning. Progress in the so-called normalization of the capital market is the result of efforts by its many participants, and particularly by the advisory council on the securities market for the Minister of Finance.
By normalizing the capital market, that is, moving toward a freer, more orthodox Western type of market, the Japanese hope that it will provide the essential services of supplying long-term funds by means of bond issues, as do the U. S. and European markets. The Securities and Exchange Law of 1948 prohibits banks from underwriting corporate bonds. The normalization movement, therefore, has been strongly backed by securities houses since their role in underwriting and trading of bonds under a normal market will become more important.
The main objectives in the normalization are
- First, the issuing market will become flexible enough to reflect the actual market situation. Up to now, terms and conditions of corporate bonds have been fixed somewhat artificially by coordination taking into consideration the Government’s policy, although they have been reviewed from time to time. Moreover, the size of corporate bond issues has been regulated by a coordinating body called the Bonds Issuing Committee, consisting of underwriters and commissioned banks, which ensures that adequate funds are allotted to key industries on a selective basis.4 The more flexible market will be established by removing various restrictions in the issuing market and by permitting the price mechanism to operate more freely.
- Second, development of the bond trading market will be encouraged. There had been no close, cohesive relationship between the bond issuing market and the trading market in the Japanese capital market. Generally the yield to original subscribers had been fixed at lower levels during the 1960s than the yield quoted in the bond trading market. banks that used to purchase the largest portion of bonds tended to hold these bonds, sometimes using them as collateral for their borrowing from the bank of Japan. No other institutional investors were very active in selling and buying bonds in the market. Naturally, the trading market could not develop enough to facilitate the normal functions of a trading market.
- Third, the structure of bond holding will be distributed among a broader range of investors. Although bonds are liquid and saleable assets, they could not attract a wide range of investors such as institutional investors and individuals. It is now considered that along with the rapid increase of their financial assets, bonds should be distributed among a wider variety of individual and institutional investors.
World Bank Yen Bonds
The Asian Development bank (AsDB) first floated a loan on the Japanese capital market in December 1970. The AsDB bonds were a de facto private placement, as the largest portion of the issue (80 per cent) was taken up by banks even though the issue was technically offered to the public. Nevertheless, the AsDB’s first issue was quite significant—it was the first issue of yen-denominated bonds by a foreign institution since the end of World War II. Following the AsDB bond flotation, the World Bank first entered the Japanese capital market by means of a public offering of its bonds in June 1971, upon approval of the Japanese Government. The World Bank’s first yen bond issue was a much broader public offering and was welcomed as a major step in the normalization process for three main reasons:
- First, the terms and conditions of the issue reflected the actual market rates of interest and the life of the bonds was extended from the then prevailing 7 years to 10 years.
- Second, the bonds were widely distributed among various investors—individuals purchased 33 per cent, institutional investors 32 per cent, and banks 34 per cent. The portion taken up by individuals was notably high by Japanese standards.
- Third, having to cope with such a large issue strengthened the underwriting function of the syndicate of securities houses.
The World Bank has issued yen bonds three times (totaling ¥38 billion = US$123 million) in the Japanese capital market. These bond issues have been regarded as one of the leading incentives toward the internationalization that has recently been taking place in the Japanese capital market.
The market historically has been isolated from overseas major markets. Capital transactions between Japan and other countries have been mainly overseas borrowings by Japanese companies, either by the flotation of bonds or loans or through direct capital investment by foreigners resulting in an inflow of capital into Japan. In the past few years, this inflow of capital has been steadily increasing by the sale abroad of stocks and bonds. The net acquisition of Japanese stocks by foreigners through exchanges during the period 1968–71 amounted to US$1,289 million. The amount of bonds purchased by foreigners outstanding at the end of December 1971 is estimated at US$500 million, whereas it was almost negligible at the end of 1969.
Investment by Japanese residents in foreign securities (listed stocks and bonds) was permitted for the first time in July 1971.
In November 1971, six Japanese banks, including a U. S.-owned bank, granted a 7-year loan of ¥ 5 billion to Transocean Gulf Oil, a subsidiary of the Gulf Oil Corporation. This was the first medium-term loan ever made to a private foreign enterprise by Japanese banks on a joint financing basis. Last December, Daiwa Securities, one of the four biggest securities houses, headed a syndicate of internationally recognized securities houses to underwrite an issue of Asian dollar bonds by the Development bank of Singapore.
Legislation was enacted in September 1971 permitting foreign securities companies to operate in the Japanese capital market. Merrill Lynch opened a branch office in Tokyo in June 1972, while in April of the same year the Japanese Government for the first time authorized underwriters to place nonlisted foreign bonds with institutional investors. Since then many new issues of Euro-dollar bonds have been offered to institutional investors in Japan. The Commonwealth of Australia yen bonds are expected to be floated on the Japanese capital market in July for the first time since World War II.
The recent internationalization has resulted directly from the accumulation of foreign reserves because of the favorable trade balance and the tremendous inflow of foreign exchange in the wake of yen revaluation after the international monetary crisis of the summer and fall of 1971. But this internationalization is also the product of the Government’s comprehensive measures to liberalize restrictions on financial transactions between Japan and other countries. It is this deliberate policy, rather than the accumulation of foreign exchange that will continue to further the internationalization of the Japanese capital market and to promote its normalization.
The Japanese economy is likely to make a qualitative change toward greater emphasis on social infrastructure. With higher capital expenditure on social services, and less private capital in investment, a slower economic growth rate may result. In fact, investment in these services in fiscal year 1972 (April 1972-March 1973) is expected to increase by 31.6 per cent over the initial budget of fiscal 1971—the largest annual increase in the postwar period.
The bulk of funds needed for the increase of these investments in social infrastructure will be raised by the flotation of bonds. The total issuance of government bonds in fiscal 1972 is expected to be 4.5 times the initial budget of fiscal 1971, possibly reaching ¥ 1,950 billion (US$6.3 billion). This is about 17 per cent of the total fiscal 1972 budget (general accounts). The capital market thus will play a much more important role in the future in funding socially oriented investment.
Since the latter half of fiscal 1970, Japan has been experiencing a type of recession which is new to its economy. The large balance of payments surplus has softened the domestic money market and capital investment has slackened. The consequent weak demand and ample supply of funds have brought about drastic changes in the capital market. As this condition is expected to continue for some time, financial institutions will become even more important in buying and selling stocks and bonds in the market and operating their available funds profitably. The structure of corporate finance may also change toward direct borrowing from the capital market along with the development of the capital market. Individuals, the suppliers of funds, will probably start diversifying their savings from deposits with banks to more profitable investments such as stocks and bonds, in step with the increase of per capita savings.
The internationalization of the capital market, which will bring about more flexible conditions, together with the qualitative change of the Japanese economy, undoubtedly will promote the further development of a more sophisticated Japanese capital market in the future.
Amounts expressed in Japanese yen are converted into U.S. dollars at the rate of ¥ 308 = US$1 throughout the text, according to the international currency realignment agreed upon among the major industrial countries in December 1971.
On the basis of a recommendation made by Joseph Dodge, a Financial Counselor for the Occupation Forces in 1949, the Japanese Government had not generally issued government bonds to supplement the budget deficit.
In this text, short-term funds apply to funds of 1 year or less; medium-term, more than 1 year but less than 7 years; long-term, 7 years or more. The prevailing life of bonds in Japan is currently 7 to 10 years. The average term of long-term bank loans is approximately 7 years.
The Securities and Exchange Law of 1948 authorizes banks to underwrite government bonds, government-guaranteed bonds, and municipal bonds, but prohibits them from underwriting corporate bonds. Their main functions in corporate bond issues are (1) to act on behalf of bond holders (trustee function), (2) to perform bond issuing, i.e., printing bond certificates, (3) to obtain funds for redemption of bonds and payment of interest, and (4) to act as a financial adviser to an issuer.