Journal of International Development: Vol. 7, No. 2, 281-284 (1 995)

JAPAN’S DEBT-DEVELOPMENT DILEMMA

ADRIAN HEWITT Overseas Development Institute, London

The Japanese development dilemma consists, in part, in the following. Japan has become the world’s largest aid donor, at over $11 billion annually these last three years, and is likely to remain so. Japan’s official aid is still substantially in the form of yen loans. The yen has strengthened massively over the past decade (and notably since the Plaza Agreement). This has not only assisted Japan towards the position of top aid donor ($11.3 billion according to the DAC 1994 report) which it would otherwise have achieved in time’; it has also left aid-receiving developing countries holding large amounts of yen debt.

Japan is also by far the largest creditor of developing countries nowadays. However, while its commercial bank loans tend to be denominated in dollars, the government’s aid loans are denominated in yen. Developing countries face rising yen debt service charges, in real terms, precisely on their aid arrangements, as well as a substantial debt overhang from the same source. (Japan’s OECF alone has 8 trillion yen - about $84 billion -outstanding to developing countries.)

So Japan is both the top aid-giver and the top creditor to developing countries: this represents a remarkably fast evolution to mature donor status in thirty years. Japan’s position vis-a-vis bilateral donors parallels that of the World Bank/IDA among multi-lateral institutions; clearly the largest and weightiest donor but suffer- ing from the problems of a mature lending institution (in the World Bank’s case it has taken fifty years) facing positive return flows on some accounts. This is an awkward position for any development agency to be in.2

Japan, like the World Bank, could be deemed to be prejudicing its development assistance credentials by taking back more in debt service than it provides in development finance on some accounts.

For financial, cultural and perhaps legal reasons, official Japan is opposed to giving debt relief to developing countries. Japan is not totally alone in its position; the World Bank also refuses to reschedule or write-off debts for a similar set of reasons (the difference is that the World Bank encourages other aid donors to write off their debts, however). Just as the World Bank prefers refinancing to debt relief, so Japan prefers to give more aid (including new soft loans) to developing countries in debt difficulties. The paradox for any major aid donor in this position is that it could end up with a limited range of clients for its new loans, and may be unable

’ For instance, France too will overtake the USA as second most important donor in 1996 when the criteria for graduation are finally changed.

See, for instance, the highly defensive section on multilateral debt in Reducing the Debt Burden of Poor Countries: A Framework for Action. Washington, DC: World Bank, 1995.

0 1995 by John Wiley & Sons, Ltd. CCC 0954-1748/95/020281-04

282 A . Hewitt

to promote development in a lot of the more needy countries as the financial flows would be running in reverse.

Let us examine these propositions in greater detail, and seek a way forward. First, the nature of Japan’s aid finance. The grant share of Japan’s aid averages 42.6% (1991-92), in other words 57.4% is in the form of loans. The Development Assistance Committee of the OECD and its 20 other Member Governments con- stantly encourage Japan to supply more of its official aid in grant form, but Japan remains bottom of the list, with Spain (most of the leading donors are at or near 100%). Consequently, Japan is also 20th and bottom3 in terms of grant element too (76.6% in 1992-93): this is the measure of the overall concessionality of its aid programme.

Now, even if there are domestic cultural and legal reasons why Japan’s official aid should remain based on credit, there is a new dilemma forming when Japan is now the leading OECD aid donor. One has to lead by example, but the more modest bilateral donors are ahead of Japan. Alternatively, the very ethos of the DAC’s persistent criticism of the loan-based aid programme would have to be questioned. That would, however, reverse a powerful trend in aid-giving and do nothing to help poor countries out of their debt problems (at a time when the February 1995 Mexico rescue package was quite clearly skirting moral hazard for a relatively rich country which had already become an OECD member).

So is there any validity in the cultural and legal argument that Japan is virtually forbidden, constitutionally, to give debt relief overseas? The argument against setting precedents can be understood. Why write off foreign sovereign debts when some major domestic Japanese banks are in a fragile position and cannot be helped likewise? But that Rubicon has been c r o ~ s e d . ~ The Japanese government is now bailing out domestic financial institutions, just as other developed country govern- ments have to do once in a while.

The constitutional argument cannot be sustained, for not only is Japan’s post- war constitution not its own (it was drafted by a handful of officers under the command of General Douglas MacArthur), but it is in the process of being changed in its international aspects, not least the notorious article nine forbidding the establishment of armed forces and their deployment oversea^.^ A more convincing argument is, in fact a practical one - that Japan’s gross public debt (including that held by the social security fund) is already higher, at 62% of GNP, than all the other G7 countries (though not yet of Italian or Belgian proportions). On those grounds, fiscal conservatism and no concessions to debts falling due would be the order of the day. There remains concern in the Ministry of Finance in Tokyo that any concession to foreigners would encourage the idea of debt-forgiveness among Japan’s own private-sector lenders. Yet this remains an awkward position for the leading aid donor to sustain when dealing with very poor developing countries.

So the real impediments to Japanese debt relief seem to be practical rather than cultural. Under the Japanese budget system and under a rapidly rising aid programme (albeit a slight falling back in yen terms in 1993), it is easier for Japan to provide

Luxembourg, which became the 21st member of the DAC in 1993 is not included in statistics of grant

‘Ailing Japanese banks thrown lifeline’, Financial Times, 11 December 1994. The two ‘banks’ were,

See Look Jupun, January 1995, p. 19.

element or grant share.

in fact, Credit Unions, but the precedcnt had been set.

Japan’s Debt- Development Dilemma 283

refinancing (more loans, not always grants) than to reschedule or write off old loans and loan arrears. Japan has been prepared to fight its corner in the Paris Club, arguing that its generosity in refinancing was enough to allow it to offset its hardline position on debt relief. However, it did apparently agree to ‘Naples Terms’ in 1994, and so should in theory be prepared to offer two-thirds debt write-offs to very poor developing countries which come to the Paris Club and accept an IMF programme. This has yet to be seen in its practical implementation by the Ministry of Finance, although on-the-record briefing by the Ministry of Foreign Affairs after the G7 Summit on 8 July 1994 implies that the breakthrough has occurred, albeit at the cost of Japan’s compromising one of its pseudo-cultural-cum-legal traditions:

Japan’s basic philosophy is very simple. Whoever borrows money has to repay the debt. That spirit of determination to repay the debt enhances the ability and determination of a borrower to do its best to survive and develop and so on. This is our philosophy. So debt relief, we think, is the last resort we have vis-a-vis a certain number of countries. We have been engaged in debt relief measures vis-his the poorest and most-indebted countries in the past, jointly with other donor countries. This time we are going to be com- promising on one of the important measures of this Summit, to deepen our debt relief measures vis-a-vis the most-indebted countries, amounting to a little more than 20 countries, by extending the ceiling of our debt relief measures from 50% of the debt at most to 67% of the debt, on a maturity basis. It is very difficult to explain. That means whenever a part of the debt comes to maturity, we are ready to forgive or are ready to make similar measures to make the payment by a specific country to us forgiven or delayed for a much longer period with much lower interest rates. In any case, the G7 Summit leaders will agree on this measure of accelerated debt relief vis-his certain countries most affected by the burden of debt. However, I would like to reiterate that Japan’s position is that if we enlarge easily this sort of last- resort measures, that would create a sort of moral hazard to other countries. Most countries are making their utmost efforts to pay their debts to their creditors. An easy money policy vis-84s a certain number of countries does not help other countries to do their best or repayment. However, Japan, as the number-one donor country, does not want to be left behind the other countries, so we have decided to make joint efforts to enhance the debt-relief measures for a certain number of countries. But the details will be discussed not in this forum, but in the Pans Club, a creditors’ club vis-A-vis each of the ,indebted countries.6

What is significant in this decision is that a decades-long aversion to giving debt relief even to the poorest countries has been overturned not just by the deep-seated cultural fear of Japan’s being in a minority of one among Western countries in the G7 or OECD (for the World Bank and the IMF institutionally still deploy the same arguments as Japan for not giving debt relief and not even rescheduling) but because Japan now wishes to demonstrate aid leadership as well as aid solidarity.

This has not been an easy process although in the history of aid politics it will

Statement on-the-record by Mr Hiroshi Hirabayashi, Director-General of the Economic Cooperation Bureau of the Ministry of Foreign Affairs, 8 July 1994.

284 A. Hewitf

be seen to have been a fairly rapid one, after all. Japan until now had spent thirty years as an aid donor responding to US pressures. It is not easy to switch from that position to one where independent decisions are being taken; in a sense the international political decisions may be easier than the domestic political and administrative ones, for the former, at least, are informed by a need to maintain or secure Japan’s representation at the Top Table, not just in the G7 but ultimately in the United Nations Security Council too.7

It seems to me that we’re paying the price now for hiding under the US umbrella and failing to make our own independent political decisions as befits a sovereign nation. After all this time we’re being asked to venture out from under the umbrella, act on our own initiative, and build on equal partnership. We find ourselves at the forefront of internationalisation, but our politicians and our bureaucrats are so inexperienced that they don’t know how to deal with it.8

Not only is there growing evidence that Japan’s bureaucrats and perhaps its politicians are capable of innovating and leading on aid policy, there is the further intriguing prospect that Japan’s policy change on debt relief leaves the Bretton Woods Institutions defending their preferred creditor status on their own. Already, Japan has challenged the Bretton Woods position on adjustment and conditionality and on their private sector dogma (the ‘East Asian Miracle’ studies). Significantly it was the OECF - bureaucrats rather than politicians - who took the lead on this: this is how Ronald Dore described the high politics of that conflict:

‘Under the onslaught of the Japanese who finally rebelled against the World Bank’s and IMF’s doctrinaire anti-statist marketism and insisted that East Asia’s history showed clearly how benign and growth-accelerating judicious state intervention can be, the free marketeers were forced to make a strategic retreat .9

These are indeed encouraging signs that a new generation in Japan is resolving its development dilemmas and offering to the developing world - and to the other donors - not just the sort of leadership which is required of any institution occupy- ing the number one position, but, more significantly, the fruits of its development experience. This transition needs to be carefully nurtured domestically and de- serves support and encouragement from abroad.

A campaign has started for UN Security Council membership, for which UK Foreign Secretary, Douglas Hurd voiced ‘strong support’ on 17 September 1994-the same day that former UK Prime Minister Margaret Thatcher pointedly endorsed India’s bid to join the Security Council. * Motozumi Y. and Moroi K. (1994). ‘Bureaucrat bashing is not the answer’ Economic Eye, 15(3). Tokyo: Japan Institute for Social and Economic Affairs.

Dore, R. (1994). ‘Why visiting sociologists fail,’ World Development, 22(9).