9:11 PM Apr 25, 1996

THE WORLD'S LARGEST DONOR NATION

But whereas Japan is due some applause for maintaining its comparatively high level of Official Development Assistance (ODA) when other industrialised countries are letting theirs slip, a less publicly considered phenomenon is the debt accrued by recipient countries -- especially when seen against a strong yen.

For while the past two years have seen an increase in Japanese aid grants -- assistance that does not stipulate repayment -- more than half of Japan's vast assistance -- 28.5 billion dollars in 1994 -- is comprised of yen loans which support the development of infrastructure in developing countries.

The impact of the yen appreciation on the debt situation of developing countries is better understood when seen within the context of Japan's growing importance as a creditor country.

In 1992, Japan accounted for 23 per cent of bilateral credit stock, more than twice that of other large creditors such as Germany (11.88 per cent), the United States (11.82 per cent) and France (10.59 per cent).

A large part of Japanese exposure is in Asia. Of total Japanese bilateral credit, around 60 per cent is lent to East and South Asian countries. The increasing indebtedness to Japan is reflected in the rise in yen-denominated long-term debt of many Asian countries.

On the regional level, the yen component of the long-term debt of East Asia and the Pacific increased from 16 per cent in 1980 to 28 per cent in 1986 and sustained thereafter, while that of South Asia increased from 10 per cent in 1980 to more than 16 per cent in 1992.

The Japanese yen started appreciating in value against the United states dollar in the second half of the 1980s. This trend became more dramatic in the 1990s, with the 1994 yen value against the dollar increasing to twice its value in 1980.

To many, this represented a mere correction in Japan's external sector as Japan's trade surplus with the United states soared to 130 billion dollars. Whether on the force of the market or through directed policy, an appreciation of the Japanese yen was necessarily forthcoming.

That trade surplus has since been cut to just over 40 billion dollars and recently the dollar has strengthened, hitting a 26-month high last week when one dollar was trading at 108.86 yen.

Amid these highs and lows, what is lost in the process is an assessment of the impact of the 1980 to 1994 period on the indebtedness of yen loan borrowing of developing countries. The situation is magnified when looking at Asian countries whose yen component of long-term debt exceeds the regional averages.

At least six East and South Asian developing countries have more than 25 per cent of their long-term debt in yen denomination. The movement in the yen value against the U.S. dollar cannot but have an effect on the debt situation of these countries.

Many of the countries heavily indebted to Japan turn a blind eye on the yen appreciation's real effect on their indebtedness.

Firstly, the importance of Japan in crucial areas of their economies compels these countries to approach the issue with caution.

After all, Japan provides: a steady stream of official development assistance; is a major source of foreign direct investment; and is increasingly becoming a major trade partner of these countries.

Jakarta, for instance, brushed aside the impact of the yen appreciation on its debt situation, confident that the negative impact on their debt could be offset by the relocation of Japanese investment to foreign countries including Indonesia.

The second reason why a blind eye is turned to the effect a strong yen has on indebtedness in the region is that the Asian countries heavily indebted to Japan have exerted great efforts to package themselves internationally as having resolved their debt problems.

The countries whose yen component of long-term debt exceeds 25 per cent are classified by the World Bank as either moderately or less indebted. Thus they would not want to jeopardise their improved classification with the acknowledgement of the negative debt impact of the yen appreciation.

To be sure, countries heavily indebted to Japan are differentially affected by the yen appreciation. The extent of impact depends on the importance of Japan as an export market for the indebted country, and the indebted country's importance as destination of Japanese investment.

Indebted countries with large export transactions with Japan and whose foreign direct investment from Japan increased as a result of the yen appreciation, are less burdened.

The immediate impact of the yen appreciation on countries heavily indebted to Japan is on their national budgets. Yen-denominated long-term debt are mainly official debt and are paid for by the national government. When the yen appreciates, the local currency equivalent of principal and interest payments falling due increases.

The budget impact is made even worse when the yen appreciation is not anticipated in the budget assumptions; when the yen value appreciates beyond what is assumed in the programmed budget; when the increased debt service either increases the budget deficit or crowds out what was already programmed for social and economic services. This is especially true in countries like the Philippines, where debt service is automatically appropriated.

The balance of payments (BOP) of countries, which do not have considerable export transactions with, but are heavily indebted to Japan are negatively affected by the yen appreciation. The yen appreciation means more U.S. dollars will flow out of the country in both current (interest) and capital (principal) payments.

Bangladesh, Sri Lanka and the Philippines are examples of Asian countries where yen-dominated debt exceeds 25 per cent of total long-term debt even as Japan remains a secondary export market. The BOP impact of the yen appreciation on these countries are expected to be higher.

The dollar value of total stock for countries heavily indebted to Japan increases when the yen appreciates. While this is seen merely as relative valuation of total debt, the effect becomes real as payments fall due.

The additional costs, beyond project assumptions, in projects financed by Japanese loans that result from the yen appreciation, put to question the economic viability of individual projects since the appreciation can result in serious, long-term losses.

It will perhaps take a serious foreign payments difficulty before countries heavily indebted to Japan officially acknowledge the costs of the yen appreciation to their countries.

However, to simply ignore the impact of the yen appreciation on national budgets as well as the economic viability of projects financed by Japanese loans, would be foolhardy for it bears serious implications on priority, equity and development questions among debtor countries.

A more detailed review of the impact of the yen appreciation on specific countries is in order. When this is done, the next step would be to find mechanisms through which Japan can share part of the costs of the yen appreciation to the debtor country.

With due consideration to individual country capacities, the costs can be deferred by converting part of it to Japanese grant or through a write-off.

Such a gesture may seem magnanimous, but it is in the interest of Japan and other creditor nations that debt service repayments do not become so much of a burden that it threatens the long-term economic and social stability of recipient developing nations.