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FRBSF

WEEKLY LETTER

July17,1987.

Internationalization of the Yen
In the last several years, Japan has taken steps to
deregulate its financial markets, to relax restrictions on inflows and outflows offunds, and to
encourage the development of the euroyen market In addition, Japan has emerged as a leading
capital exporter. The net outflow of capital from
Japan jumped from $19 billion in 1983 to $84
billion in 1986. This increase in capital exports
is the counterpart of the rise in Japan's current
account surplus since the excess of its net purchases of foreign assets must balance with the
excess of its receipts from trade exports over
imports.
These developments have increased the opportunities for investment in foreign assets by Japanese investors and for yen borrowing and
investment by foreigners. Correspondingly, these
developments have increased the use of the yen
as an international currency, i.e., a currency
which corporations regard as desirable to raise
capital, international investors to invest in, and
exporters and importers to denominate international trade transactions.
Signs of the yen's popularity in recent years
include a rise in foreign participation in Japan's
financial markets and an increase in yendenominated liabilities issued by foreigners in
Japan and in the euromarket u.s. borrowers, for
example, who traditionally have borrowed funds
in dollars, now are increasingly considering borrowing in yen by, say, floating euroyen bonds
and then converting the proceeds into dollars for
domestic use. A host of large u.S. corporate borrowers have chosen to issue bonds in yen rather
than dollars to reduce borrowing costs.
This Letter discusses the factors that have led to
the increased international use of the yen in
both financial and trade transactions.
International capital controls relaxed
Japan has the world's second biggest stock and

government bond markets after the United
States, and is home to many of the world's
largest financial institutions. Yet, until the late
1970s, it had pursued a basic policy of regulating virtually all international capital flows and
therefore had only limited links with the rest of
the world's financial markets. Through a variety
of capital controls, the authorities attempted to
dictate the direction and magnitude of financial
flows into and out of Japan to achieve both balance of payments financing and exchange rate
objectives.
Since 1979, however, Japan's regulatory policy
towards international financial transactions has
changed substantially. In May 1979, foreigners
were granted access for the first time to the gensaki market, a major money market in Japan.
This effectively linked Japan's money market
with those abroad. A new foreign exchange law
was initiated in December 1980 (the Foreign
Exchange and Foreign Trade Control Law) that
liberalized most capital controls.
In May 1984, in a report by the Joint Working
Group on Yen/Dollar Exchange Rate Issues,
Japan and the United States announced an
agreement to speed up the process of deregulating Japan's capital markets and integrating them
into world financial markets. The report outlined
specific actions for the Japanese government to
liberalize its domestic capital market by
deregulating interest rates on large denomination deposits, and to develop the external
euroyen bond and banking markets by relaxing
eligibility conditions for nonresident issues of
euroyen bonds and CDs.
Measures that resulted from this agreement
included limited authorization to issue euroyen
bonds by Japanese residents in April 1984, and
by private nonresidents in June 1984. International organizations, such as the World Bank

FR8SF
and foreign national governments, had been permitted to do so in the late 1970s.
In 1985, a greater number of Japanese corporations became eligible to issue euroyen bonds
abroad by meeting particular capital-ratio financial criteria set by Japan's Ministry of Finance
(MOF). Approval was given for a greater variety
of euroyen bonds, such as bonds with stock purchase warrants or with currency conversion
provisions. In addition to stimulating growth in
the size of the market, these changes have permitted greater sophistication and diversity in the
issues.
In 1986, the number of firms with access to the
euroyen market doubled. The opening of a Japanese offshore banking market in December of
last year, through which certain yen loans and
deposits can legally escape some taxes and
restrictions, represents another channel through
which foreign financial institutions may conduct
fi nancial transactions in yen.
Results of relaxation

The opening of Japan's domestic and offshore
capital markets has created additional possibilities for international borrowers and lenders
for transactions involving the yen. Indeed, the
presence of nonresidents in Japan's financial
market and the yen's role in international financial markets have grown considerably.
Foreign investors have become important participants in Japan's gensaki (bond repurchase)
and CD markets, in which some three-fourths of
Japan's open money market assets are traded.
Foreigners hold more than 10 percent of total
gensaki and CDs outstanding. As a result, there
now exists a closer relation between rates in
these markets and those in international markets.
Nonresidents have also become greater participants in the Japanese stock market. It is estimated that they account for 10-15 percent of
total stock transactions, up from less than 5 percent prior to 1980.
The volume of foreign bonds and euroyen bonds
issued by foreign borrowers is also up substan-

tially as foreigners have sought to tap Japan as a
source of capital and as a means to reduce borrowing costs. Since 1982, the annual number of
yen-denomination foreign bonds has ranged
from 60 to 70 issues, up from only 40 issues in
1981 and 14 in 1980. Between 1980 and 1986,
the dollar value of these issues increased
fivefold. From 1977, when the first euroyen
bond was issued, until September 1984, only 29
such bonds were issued. Following the December 1984 liberalization that allowed nonresidents to issue euroyen bonds, the number
jumped to 138 issues in 1985 and even higher
in 1986. Correspondingly, the share of euroyen
bonds in total eurobond issues rose from less
than 1 percent prior to 1984 to almost 10 percent in 1986. This puts the yen behind eurodollar issues, which still maintain a dominant
position with a 60 percent share, and ahead of
the German mark with 9 percent, and the pound
with 6 percent.
The rise in euroyen issues is also a reflection of
the relative cost of yen borrowi ngs. Many U.S.
borrowers, who traditionally have borrowed
funds in dollars, perceive they can lower costs
by borrowing in yen because they can float
euroyen bonds and then convert the proceeds
into dollars for domestic use.
The relative cost of borrowing in dollars or yen
depends on the interest rate differential between
dollar and yen-denominated loans as well as on
possible changes in the dollar-yen exchange rate
between the time the funds are borrowed and
the time they must be repaid. A depreciation in
the dollar over this period effectively raises the
cost to borrowing in yen by increasing the
amount of dollars needed to purchase the yen at
the time of repayment.
With Japanese interest rates low relative to U.s.
rates in recent years, many borrowers have
regarded borrowing in yen as very attractive.
However, the possibility that the dollar may
depreciate further implies that the additional
borrowing opportunities made possible by the
internationalization of the yen do not come
without risk. Efforts by financial market participants to hedge against such currency losses is

evidenced by the rise in the number of yen
futures contracts traded on the International
Monetary Market in Chicago from just 1790 in
1975 to 575,000 in 1980, and 2.4 million in
1985.
Corresponding to the increased use of the yen in
private financial transactions is the rise in holdings of the yen by central banks. Recent statistics
indicate that central banks hold 8 percent of
their official reserves in yen, double the percentage three years ago. This rise is partly the result
of the yen's rise in value against the dollar, but
also is due to the increased use of the yen in private transactions. While this leaves the yen well
below the 65 percent of central bank reserves in
dollars and the 16 percent held in German
marks, it is triple the share of any other currency, including the British pound.

International trade transactions
While substantial progress has been made in the
use of the yen in international financial transactions in the last several years, the yen still
remains an underused currency in international
trade transactions when compared to the size of
Japan's economy in the world economy. With
the recent appreciation of the dollar, Japan's
GNP, when measured in dollar terms, is now
over one-half of that of the United States. Yet, in
1985, only 39 percent of Japan's exports and a
mere 7 percent of its imports were invoiced in
yen. In contrast, for most industrial countries,
the ratios of exports and imports invoiced in
their domestic currencies are roughly 60 and 30
percent, respectively.
The yen's low use in international trade transactions in part reflects Japan's trade structure. The
yen-invoiced portion of Japanese imports tends
to be relatively small because of the high share
of primary products and commodities, such as

energy resources, foodstuffs, and industrial raw
materials, that are traditionally traded in dollars.
The yen's use is greater in exports of products
such as machinery, for which Japanese products
enjoy strong international competitiveness, and
in exports to China and Southeast Asia. In addition, the fact that Japan does not belong to a
regional trading bloc, such as the European Economic Community, also may contribute to the
smaller role of the yen in international trade.
Although low by international standards, the 34
percent share of exports billed in yen in 1985
nevertheless represents a dramatic increase from
the levels of 1 percent in 1975 and 29 percent in
1980. In the past, many Japanese firms that
depended heavily on imports of primary products, such as steel, have often preferred to export
by invoicing in dollars to avoid exchange risk
between the cost of raw materials and revenue
from exports. However, an increasing number of
Japanese firms are expanding their production
bases into overseas markets. Growing trade in
industrial parts and finished products between
parent companies and their overseas subsidiaries
should raise the yen-invoiced portion of Japanese trade. The development of a recently
established bank acceptance market in Japan
may help as well.

Conclusions
The use of the yen in international financial
transactions has increased dramatically in recent
years as a result of Japan's relaxation of international capital controls. The internationalization
of the yen has occurred despite the yen's continuing underuse in international merchandise
trade. The yen's rise signals the growing importance of international finance in determining the
international importance of a currency.

Reuven Glick

Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San
Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Gregory Tong) or to the author .... Free copies of Federal Reserve publications
can be obtained from the Public Information Department, .Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974-2246.

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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)

Selected Assets and liabilities
Large Commercial Banks
Loans, Leases and Investments' 2
Loans and Leases 1 6
Commercial and Industrial
Real estate
Loans to Individuals
Leases
U. S. Treasu ry and Agency Secu rities 2
Other Secu rities 2
Total Deposits
Demand Deposits
Demand Deposits Adjusted 3
Other Transaction Balances4
Total Non-Transaction Balances 6
Money Market Deposit
Accounts-Total
Time Deposits in Amounts of
$100,000 or more
Other Liabilities for Borrowed MoneyS

Two Week Averages
of Daily Figures

Amount
Outstanding

6/24/87
205,153
182,052
52,701
69,257
36,714
5,396
15,870
7,235
203,611
50,237
35,140
18,947
134,427
44,393
32,286
24,142
Penod ended

6/15/87

Change from 6/25/86
Dollar
Percent'

Change
from

6/17/87
-

-

6,389
1,000
279
2,812
4,490
191
5,279
352
1,361
1,241
1,135
3,072
2,952

3.1
0.6
0.5
4.2
- 10.8
- 3.4
49.8
4.6
0.6
2.5
3.3
19.3
- 2.1

-

1,147
797
175
180
79
4
330
16
3,436
2,313
1,854
566
557

-

684

-

2,177

-

4.6

129
1,672

-

4,093
94

-

11.2
0.3

-

-

-

-

-

Penod ended

6/1/87

Reserve Position, All Reporting Banks
Excess Reserves (+ )/Deficiency (-)
Borrowings
Net free reserves (+ )/Net borrowed( -)

51
8
44

56
52
4

1 Includes loss reserves, unearned income, excludes interbank loans
2

Excludes trading account securities

3 Excludes U.S. government and depository institution deposits and cash items
4 ATS, NOW, Super NOW and savings accounts with telephone transfers

S Includes borrowing via FRB, TT&L notes, Fed Funds, RPs and other sources
6 Includes items not shown separately
7 Annual ized percent change