The Promotion of Foreign Direct Investment into Japan - The Measures' Impact on FDI Series

At the occasion of delivering the fiscal year 2003 policy speech, Prime Minister Junichiro Koizumi proposed to double foreign direct investment (hereafter, FDI) stock into Japan within five years to revitalize the Japanese economy. Against this background, various measures aimed at promoting FDI into Japan have been investigated and implemented by the government and concerned ministries. A number of significant measures implemented in the most recent years to improve the investment environment include introducing a cross-border equity swap scheme and the Japanese version of the limited partnership (Japanese LPs). Consequently, there is a growing interest in examining how these measures could support a growth of FDI into Japan. The first scheme, cross-border equity swaps, involves using shares of a foreign company. This scheme implies that an existing foreign affiliated company operating in Japan initially acquires the shares of a foreign company (for instance, a foreign parent company). These shares will be used to pay for acquiring a Japanese company through either a triangular merger or through the creation of a subsidiary company. According to the IMF Balance of Payments Manual, fifth edition (BPM5), the acquisition of the shares of a foreign parent company by a subsidiary is identified as a "reverse investment." This transaction is recorded as an offsetting transaction to inward FDI received from the foreign parent company. For this reason, the likely result of cross-border equity swaps would record contraction of inward FDI flow series. In the second scheme, Japanese LPs combine the advantages of being free from the two-stage taxation and assuring limited liability. For this reason, Japanese LPs could be actively used in the future as an investment vehicle in the cases where investors would be unable to effectively assess the business situation and performance of investee companies in industries requiring the large initial investments, such as technology and R&D. The Foreign Exchange and Foreign Trade Law (Foreign Exchange Law) provides the statutory basis for the compilation of Japan's Balance of Payments (BOP) and International Investment Position (IIP), and the collection of data sources. Within this legal framework, investments by non-residents into Japanese LPs, which are not legal persons, are not defined as FDI into Japan. As a consequence, investments by non-residents into Japanese LPs are excluded from inward FDI flow and stock series. The current statistical treatment implies the following issues. [1] Because investments and collections of investments into Japanese LPs are not included in FDI into Japan, the impact of the introduction of this investment vehicle will not be accurately reflected in FDI series. [2] While this will depend on the volume of investments, strictly speaking, international comparisons with countries including investments into LPs in FDI series and Japan are difficult. Against this background, statistics compilers in Japan could possibly consider the inclusion of investments into Japanese LPs under FDI series within the current framework of the Foreign Exchange Law, provided that the capital participation is 10 percent or more. While giving due consideration to the reporting burden, statistics compilers in Japan should examine how to collect adequate data and reflect it in FDI series.