November 29, 1999
Bank of Japan

Introduction

Ladies and Gentlemen,

It is my great pleasure today to be a part of this important Financial Forum of Europlace. Listening to the lively comments of the distinguished guests regarding industrial reorganization in the area was indeed stimulating and thought provoking.

In the limited time I have, I would like to talk about three issues: recent developments and tasks facing Japan's economy, the internationalization of the yen, and the relationship between the EU and Japan.

1. Recent Developments and Tasks Facing Japan's Economy

During the eight years since the bursting of the bubble, Japan's economy has experienced mounting deflationary pressures and the need to effect radical structural reform. While Japan's economy has stopped deteriorating and is currently beginning to improve with exports and production increasing, clear signs of a self-sustained recovery in private demand have not yet been observed. Based on such a judgment, the Bank of Japan has been pursuing its zero interest rate policy, which will be maintained "until deflationary concerns subside." While keeping such a policy in place, we have taken a flexible stance in monetary operations, for example by providing ample funds over the year-end in view of the possible increase in fund demand related to Year 2000 problems.

For monetary easing to have an effect on the real economy and for private demand to recover in a self-sustained manner, the intermediation function of financial institutions needs to be restored and the demand for funds in the corporate sector strengthened. With regard to financial intermediation, it might be safe to say that the extremely cautious lending stance of financial institutions once observed has largely retreated due to steady progress in the disposal of non-performing assets and the injection of public funds to recapitalize major banks at the end of March. In addition, financial consolidation has advanced faster than expected, as witnessed by the recent announcements of a big merger and alliance among financial institutions. At present, however, the non-performing asset problem has yet to be totally resolved, and it may well take some time before we see a marked improvement in the financial intermediation function.

Regarding the demand for funds, the bursting of the bubble had a deep impact on the corporate sector. With lingering excess capacity and excess debt, many firms have tended to repay debt rather than engage in forward-looking activities as cash flows have improved.

This line of thinking highlights the importance of structural adjustment for bringing the Japanese economy back to a sustainable growth path. As you know, the United States has enjoyed an upbeat economy since March 1991, and the Schumpeterian process of "constructive destruction" has often been cited to have played an important role in its success to date. And, as I learned today, industrial reorganization across countries in the EU area is gaining momentum triggered by monetary unification. Unfortunately, in Japan, we have not seen the birth of many new firms which are likely to lead the economy, and we have yet to see the visible progress of structural changes. It will be an urgent task for industries to revitalize themselves by promoting structural changes in a competitive framework which is conducive to increasing risk-taking activity. I hope that the "Comprehensive Economic Policy Package" which was recently announced by the government will encourage such changes. Though it may take a little more time, I am convinced that the Japanese economy will exhibit the potential to transform itself once again into an economy with vitality and high productivity.

2. Internationalization of the Yen

Let me now turn to the second issue, the internationalization of the yen. This issue has been discussed since July last year by the Council on Foreign Exchange and Other Transactions, an advisory group to the Minister of Finance and of which I was a member. In April this year, the Council published a report called "Internationalization of the Yen for the 21st Century." The Council not only studied the significance of the yen's internationalization, but also discussed specific measures to promote and implement internationalization, taking into account such dramatic changes as the Asian currency crises, the introduction of the euro, and the progress of Japan's Big Bang.

According to the Council's report, one of the main reasons for the recent crises was that Asian countries had linked their currencies to the dollar without paying due attention to trade and investment ties with other countries. Now, having been forced to de-couple their currencies from the dollar and adopt a floating exchange rate regime, some Asian countries may consider it desirable to link their currency to a currency basket. The basket is composed of multiple currencies, which, given the close trade and investment relationships between the Asian region and Japan, naturally includes the yen. To support such a development, it is necessary for Japan to prepare an environment in which the yen can be more easily used as an international currency.

In addition, a single key currency system based on the dollar runs the risk of developments in the US economy triggering significant adverse effects on the world economy. In this regard, I hope that the euro and the yen will complement the dollar to contribute to the stability of the international monetary system.

Bearing this in mind, to promote Japan's Big Bang and enable the Tokyo market to be on a par with other major international financial markets such as London and New York, we need to improve the attractiveness of the yen and create an environment conducive to investment from overseas.

Based on such thinking, the Council's report pointed out that, as a prerequisite for assuring the broad acceptance of the yen as an international currency, it is necessary to effect measures to make the yen more convenient to use. To these ends, the report called for measures to improve financial and capital markets as well as settlement systems, and to review practices related to both trading and capital transactions.

That was a brief outline of the Council's report. Now, I would like to tell you how the Bank of Japan views the internationalization of the yen. The Bank of Japan has repeatedly stated the importance of improving financial market infrastructure to make it more conducive to the internationalization of the yen. Greater usability of the yen both domestically and abroad would enhance its international credibility, thereby promoting internationalization. In this context, it is important to ensure that Japan's economy is on a sustainable recovery path as well as to make its financial and capital markets more efficient and stable.

Related to enhanced efficiency and stability, one of the important issues we have focused on recently is the liquidity of Japanese government bond markets. When one wants to hold yen assets, government bonds with negligible credit risks are likely to be selected for investment. If a large volume of transactions can be executed quickly with a minimum impact on prices in government bond markets, in other words if the markets are highly liquid, government bonds will become more attractive as an investment instrument. To have highly liquid government bond markets is also desirable for a central bank as they are important markets for its daily monetary operations.

Current Japanese government bond markets are not necessarily very liquid, and it is essential to increase their liquidity. In this regard, various reforms had been made from April through September. For example, financing bills have been issued through auction. Withholding taxes on the redemption of treasury bills and financing bills have been exempted. Withholding taxes on non-residents' interest income from government bonds have also been exempted under certain conditions. And, the securities transaction tax has been abolished.

In addition, since the Bank of Japan handles actual operations from issuance to the redemption of government bonds as well as their settlement, it is of crucial importance that we properly respond, both in terms of operations and computer systems, to the diversification of government bonds and changes in the tax system. And I can assure you that we have been putting highest priority on dealing with these issues. Furthermore, we have been cooperating with market participants in expanding and improving both market functions and the infrastructure through such efforts as realizing delivery versus payment, which links funds settlement with securities settlement, and shortening settlement periods.

As regards the future, 5-year government bonds will be introduced in February next year aiming at establishing a benchmark bond in the market, and discussions are underway on such issues as bringing repurchase transactions in line with global practice by shifting from the current bond lending and borrowing with cash collateral to the Western style of bond trading, introducing a special government bond program, which is called STRIPS, and the further shortening of bond settlement periods.

We have been making utmost efforts both operationally and systemically aiming at making the Bank of Japan Financial Network System a real time gross settlement system by the end of next year. We are also committed to making further efforts to establish more user-friendly financial markets by improving market infrastructure. At the same time, we would like to continue exploring, in cooperation with central banks abroad, the research and analysis of such issues as market transaction methods, the price discovery mechanism, and behavior of market participants so as to enhance our understanding of market forces which is necessary for formulating various policy prescriptions.

3. Relations between Europe and Japan

The EU area has tackled the unprecedented task of monetary unification and cleared the hurdles through determined efforts. Triggered by monetary unification, the economy of the area seems to have been vitalized as witnessed by intensified competition among firms and progress made in the privatization of public enterprises.

Such moves in the EU area have been reflected in the balance of payment relationship with Japan. In fiscal 1998, Japanese investment in foreign securities shifted from the US to the EU area. Looking at the total of four EU countries - France, Germany, the Netherlands, and Luxembourg - whose individual figures are available, there was a net investment of 7 trillion yen in the four countries and 3 trillion yen in the US. Such a trend has been continuing in fiscal 1999, and the investment in the four countries had already reached more than 5 trillion yen in the April to September period compared with 3 trillion yen in the US. Such a shift may have been induced by the enhanced attractiveness of euro-denominated assets stemming from monetary unification and the increased issuance of corporate bonds backed by active M&A in the EU area. Direct investment into Japan also reached a record high, a little over 1 trillion yen in the first half of 1999, exceeding by far the past record of 0.4 trillion yen for full 1998. The major factor behind the surge is industrial reorganization on a global scale as evidenced by Renault's capital participation in Nissan.

These developments illustrate that economic dynamism in the EU area since around the time of monetary unification has had a significant impact on Japan's economy and finance. I believe that both Japanese policymakers and firms can learn quite a lot from such dynamism in the EU area. The Bank of Japan sincerely hopes that dynamism will soon be restored to the Japanese economy through structural changes. And, the Bank of Japan would like to actively contribute to the discussion and analysis of such changes and necessary supporting measures.

Thank you for your attention.