* This is an English translation of the Japanese original released on March 8, 2005.

June 16, 2005
Bank of Japan
International Department

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I. Summary¹

A. Overview

Japan's balance of payments (BOP) in 2004 recorded a current account surplus of 18.6 trillion yen, increased from a surplus of 15.8 trillion yen in 2003. This represents a new record high for the second consecutive year. The capital and financial account recorded a net inflow of 1.5 trillion yen, decreased from a net inflow of 7.7 trillion yen in 2003; reserve assets increased by 17.3 trillion yen, which was smaller than the increase recorded in 2003 (21.5 trillion yen);² and errors and omissions recorded a debit of 2.8 trillion yen.

B. Highlights of Japan's BOP for 2004

1. A sharp increase in surplus in the balance of goods (Summary Chart 1)

   The surplus in the balance of goods increased sharply from the previous year, and marked a new record high for the second consecutive year as growth of exports exceeded that of imports. Exports recorded double-digit year-on-year growth due to buoyant Asian demand for a wide range of export items, as well as to the growth of machinery other than electric exports to the United States and that of motor vehicle-related goods exports to the European Union (EU). Imports also registered double-digit year-on-year growth due to the conspicuous increase of mineral fuels (petroleum, coal, etc.), reflecting their higher market prices, and the increase of finished goods, such as machinery from Asian countries.

   However, the year-on-year increase in the surplus in the balance of goods began to shrink in the second half of the year. This is explained by a slowdown in exports with the continued strength in imports.

2. An increase in the deficit in the overall balance of services, and a sharp decrease in the deficit in the balance of other services

   The deficit in the balance of other services shrank sharply. In the balance of merchanting and other trade-related services, the receipts of merchanting fees increased as a result of the growth of merchanting trade in audio-visual apparatus, precision instruments, and computer game equipment. In the balance of royalties and license fees, the receipts of fees for industrial property rights, etc., continued to increase, especially for the motor vehicle-related industry. Meanwhile, deficits in the balances of travel and transportation increased. This was due particularly to the increase in the number of Japanese travelers overseas and the higher level of cross-border movement of goods.

3. Larger surplus in the balance of income

   The surplus in the balance of income increased and reached a new record high. Credits of direct investment income increased against the background of the sustained strong performance recorded by the foreign subsidiaries of Japanese companies. Credits of portfolio investment income increased reflecting the accumulation of the outstanding amount of outward portfolio investment. At the same time, debits of direct investment income and portfolio investment income also increased reflecting the buoyant performance of Japanese companies.

4. An increase in inward portfolio investment

   Inward investments in bonds and notes showed a significant net inflow. This is attributed to the fact that foreign hedge funds and foreign banks purchased a large amount of Japanese government bonds (JGBs) to create arbitrage positions, a combination of spot buying and forward selling, while several foreign institutional investors engaged in the outright purchase of JGBs. Inward investment in equities also registered a large net inflow, as in the previous year. This could be attributed to active purchases by foreign investors, due to their sustained preference for Japanese equities supported by the relatively good performance of Japanese companies, and their expectations of a rise in Japanese stock prices following the rise in the overseas stock prices.

   Outward investments in bonds and notes registered a slightly lower level of net outflow, compared to the previous year, as investments by "life insurance companies" and "others" declined. Contributing factors included a narrowed spread between domestic and foreign interest rates, and higher foreign exchange hedging costs following the rise in short-term U.S. interest rates. Meanwhile, outward investments in equities recorded a sharp increase in net outflow. This expansion reflected the purchase of foreign equities, following a good performance on overseas stock markets, and, the increased popularity of overseas funds, such as "fund of funds" and real estate investment trusts (REITs).

5. A continued net inflow in the capital and financial account³

   The capital and financial account recorded a net inflow for the second consecutive year. This was mainly due to the inflow of nonresident funds in the form of portfolios, such as stocks and bonds, and other investments. The sustained net inflow in the capital and financial account for two consecutive years was noted for the first time in 40 years, the previous occasion being in 1963 and 1964. On a quarterly basis, a high net inflow was recorded only in the first quarter, and net outflows were recorded in the remaining quarters (Summary Chart 2).

1 Data for 2004, including charts, are preliminary unless otherwise stated. Annual, semiannual, and quarterly data in this report, including charts, are on a calendar-year basis unless otherwise stated.

2 An increase in assets in the capital and financial account denotes a capital outflow (increase in assets) in the BOP.

3 "Capital and financial account," a standard component of the fifth edition of the International Monetary Fund's (IMF's) Balance of Payments Manual (BPM5), includes reserve assets as its sub-component. Thus, the relationship between the current account, and the capital and financial account, based on the definitions in the BPM5, is shown in the following identity.

Current account + capital and financial account + errors and omissions = 0 ... (a).

The scope of Japan's "capital and financial account" is different from that of the BPM5, in that it does not include reserve assets as its sub-component. Changes in reserve assets are recorded separately from the capital and financial account in Japan's BOP. Therefore, the above identity has been modified for Japan's BOP as follows.

Current account + capital and financial account + changes in reserve assets + errors and omissions =0 ... (b).

In Japan's BOP for 2004, "capital and financial account" + "changes in reserve assets" in identity (b), which corresponds to "capital and financial account" in identity (a), recorded a deficit equivalent to the deficit of "current account" + "errors and omissions." Thus, identity (a) holds true.