USJI Voice Vol.26
Japan’s Foreign Aid Policies: An unprecedented phenomenon of bilateral ODA loan amounts overtaken by repayment
While the Japanese economy has stagnated in recent years, the world economy has experienced positive growth. Developing countries, particularly China, India, and other emerging nations, have achieved rapid economic growth. The beginning of this century saw drastically improved performance in the Millennium Development Goals (MDGs) that mainly concern the universal theme of reducing poverty. Recently, these countries have confronted new energy and environmental issues on a global scale in the form of Sustainable Development Goals (SDGs). With Brexit and the inauguration of a new US president as well as rising tensions on the Korean peninsula and in the East and South China seas, the international community surrounding Japan finds itself in an even greater state of upheaval. Against this backdrop, we need to consider how Japan should establish a global position and fulfill its international responsibilities.
2. Japan’s International Cooperation and Development Assistance
Traditionally serving as a mainstay of international cooperation, the Japanese government has long provided Official Development Assistance (ODA) to developing countries. According to the Organization for Economic Co-operation and Development (OECD), the goal of ODA is the welfare improvement and economic growth of recipient countries. In principle, this aid must be donated for the benefit of recipient countries. ODA is divided into grants, which do not have to be paid back, and loans, which need to be repaid. Grants include technical cooperation or assistance, whereas loans are so concessional that their interest rates are low, and they are often given a payment moratorium period.
When donors are the governments of various countries such as the OECD nations, their ODA is referred to as bilateral assistance. They contribute multilateral assistance to international organizations such as the UN and the World Bank. In addition to managing the greater part of Japan’s grants, the Japan International Cooperation Agency (JICA) is responsible for most concessional loans from Japan [i]. Most of the JICA’s ODA loans are bilateral in the form of international yen loans. The total loan size is so enormous that JICA is the world’s leading development assistance organization. The Japan Bank for International Cooperation (JBIC) is responsible for other public lending (OOF: Other Official Flows); however, they will not offer the recipients an interest close to its international market rate. JBIC’s loans target developing as well as developed countries.
The first characteristic of Japan’s bilateral aid is the high loans-to-grants ratio compared to other major donor countries, approximately 50-50 in recent years. Still, this ratio had decreased by the end of this century[ii], which leads to the second characteristic. The amount for project aid tends to be large and is intended for economic, social, and educational infrastructure. Sizeable ODA loans make possible dams, irrigation, roads, railways, harbors, airports, and other related investments, which improve the production potential in the recipient country. Third, Japanese aid distribution is focused on Asia. This trend has been consistent since Japan first started offering foreign aid. In the past, Asia’s share was over 80%, and it is still high at over 60%, though it has gradually decreased in recent years. East Asia’s share has been rapidly falling below 30% since approximately 2000, while Northern and Central Asia had climbed up to 60% by 2013.
With stagnant economic growth in recent years, the performance of Japanese ODA has also been sluggish. Regarding the total amount of annual ODA expenditure, there are two definitions. One is gross ODA expenditure, which is the sum of grants and new loans. The other is net ODA expenditure, which consists of grants and net loans, that is, new loans minus the repayments for past loans. Figures 1 and 2 show the gross and net amounts of bilateral and multilateral ODA by major donor countries from 2006 through 2015, published by the Japan Ministry of Foreign Affairs (2016). A serious sub-prime loan problem (the Lehman shock) and a catastrophic earthquake (the Great East Japan Earthquake) are to blame for the extremely negative effects on Japanese ODA. In this century, Japan’s reputation as a leading ODA donor in the international community has steadily diminished.
The repayment to Japan by recipient countries of past ODA loans has been on schedule in recent years. Although Japan as a lender should be pleased with the sound repayments, this suggests that its net ODA expenditure (gross ODA minus repayments) is smaller at the same time. From 2007 onward, Japanese net ODA has been the fifth largest, trailing the US, the UK, Germany, and France (excluding 2013), and it returned temporarily to the fourth largest in 2015. Since 2014, Japanese gross ODA has been the fourth largest, following the US, the UK, and Germany. Japanese GDP is the third largest in the world and the second among developed economies. While Japan has maintained its bilateral ODA as the second largest, it falls to the fourth or fifth as a net ODA donor and to the fourth even as a gross ODA donor. Confronted with this unprecedented phenomenon, the Japanese government must do anything to overcome it.
3. Japan’s ODA Lending and Policy Direction
To improve the ranking of its gross and net ODA amounts, Japan must increase both multilateral and bilateral amounts or increase at least one of them. Since a multilateral amount to each organization by each donor is determined according to the size of its economy, a donor government will not receive enough backing of public opinion once it deviates from the expected amount. Even if Japan contributes more to a certain organization than is required, Japan will not reap any positive benefits directly from any recipient, while the organization would be at least appreciated by the recipient countries. It is efficient, then, to increase bilateral aid in order for Japan to maintain its favorable relationships with various developing countries.
What is the best way to increase gross bilateral ODA? Gross bilateral ODA (net bilateral ODA plus repayments) is low partly because net bilateral ODA is low and partly because repayments are high. Net bilateral ODA is low owing to the small bilateral amounts of grants and net loans (new loans minus repayments). Figure 3 below indicates the annual bilateral amounts of new loans and repayments in recent years (from 2000 to 2014). Because of stagnating new loans and rising repayments, the net amount shows a deficit. This is a direct cause of Japan’s dismal position in the net and gross ODA ranking. In recent years, developing countries, as a whole, make more payments than they receive new loans. Since they supply a net positive payment to Japan, the international community (especially developing regions) could be dissatisfied with Japan’s recent ODA performance. This dissatisfaction might well explain the global support for China to establish the Asian Infrastructure Investment Bank (AIIB).
Since the Japanese gross ODA does not correspond with its economic size, a reasonable goal concerning the gross annual ODA should be to become the second largest among the OECD members and the second, or at least third, in the world. Japanese annual new ODA loans should be sustained such that the net amount does not run a deficit. Each year, given that new ODA loan amounts are determined to be larger than the repayments, Japan can stop further deterioration in its net ODA expenditures ranking because the net amount will be larger than the grants.
The simplest policy direction is for each country to receive more new loans than repayments, which guarantees more new loans than repayments for each region and eventually for the world. However, if Japan maintains its Asia pivot ODA policy or gives priority to some recipients, it can propose a system that balances ODA loan and repayment amounts among multiple regions and countries.
For example, net loans in Asia are adjusted to be in surplus, but in the remaining regions, they are adjusted to be in deficit. The result is balanced net loans worldwide. Likewise, we can make net loans to East Asian countries in red and those to Central and South Asian countries in black. The former have already experienced rapid economic growth, while the latter have just started their growth.
There is an internationally agreed upon ODA distribution standard, depending on income inequality among recipients by OECD. For example, ODA loans are reduced or terminated for the Upper Middle Income Countries (UMICs), and for the Low Income Countries (LICs), ODA loans and grants are increased. ODA grants are reduced or terminated and ODA loans increased for Lower Middle Income Countries (LMICs).
4. Japan’s ODA Loans to Major Recipient Countries
An emphasis on Asia as an ODA recipient is clearly observed by the ranking of an accumulated sum of annual gross ODA (1960–2014). The top ten are Indonesia, India, China, the Philippines, Vietnam, Thailand, Pakistan, Malaysia, Sri Lanka, and Bangladesh, in descending order. Figure 4 below shows the balance of ODA loans for Indonesia as the largest recipient. Since Indonesia is an important partner as well as a major power in many respects, including in trades and security, Japan has long provided Indonesia with a vast sum of ODA loans. However, resulting from Indonesia’s continued high growth in recent years, Japanese ODA loans to Indonesia have exhibited a deficit. The annual amount of repayments exceeds that of new loans.
At the last moment, Japan lost a major contract to China for a high-speed rail construction project in Indonesia. There are several possible reasons for this loss. The deficit in ODA loans is sure to offend Indonesia and could be a major factor for this loss. It is natural that China runs deficits from 2009 without any new ODA loans coming from Japan. ODA loans to the Philippines have been in deficit since 2008, which is likely to cast a shadow on the relationship between the two countries. It is fairly justified that net loans for India and Vietnam have been in surplus until recently. This is because both countries are not only high performers in economic growth but are also strategically important.
5. Japan’s International Cooperation Expenditures and Future Policy
Japan is often forced to reduce new ODA loans to those developing countries whose income levels are not necessarily low. If some of those countries are strategically important, one simple remedy might be a shift from ODA loans to OOF. The efficient distribution of Japanese public spending to developing countries should incorporate both ODA and OOF. I would like to propose a bilateral strategy between Japan and each developing country that evaluates this international cooperation expenditure, the sum of ODA loans and OOF. Figure 5 below shows the outflow (lending) and inflow (repayments) of Japanese OOF to developing countries in recent years.
Unfortunately, Japan’s OOF lending has not been in an upward trend, nor has it been very stable. It is clear that the decrease in ODA loans is not fully compensated by an increase in OOF to developing countries. The ideal growth model for developing countries is a transformation from a lower to a higher income stage among LLDC (Least Less Developed Countries), LIC, LMIC, and UMIC.
If this model is applied to the international cooperation expenditures above, LLDCs begin with grants and then move on to ODA loans with extremely low interest rates. Their interest rates gradually increase until they no longer receive ODA loans. After ODA recipients graduate, they receive OOF with increasing interest rates. After a greater part of their international flows (including FDI: Foreign Direct Investment) become private, they ultimately become a developed country and supply ODA to other developing countries.
Therefore, one Japanese policy objective is the developing countries’ smooth shift from ODA to OOF in terms of total, regional, and bilateral expenditures. One criterion for this objective is a comparison between international cooperation expenditures (ODA loans and OOF) and repayments.
At present, Japan’s ODA policies are strictly ruled to each recipient. New loans are finalized and conditional, based on repayment options for each project of each recipient country. However, the utilization of OOF is a promising option for the strategic and flexible operations as mentioned above. In the case of Indonesia’s high-speed rail, Japan could propose larger ODA loans and OOF by adjusting other conditions (including interest rates) so that it can surpass the competition.
In the low growth economy, the Bank of Japan has managed the official discount rate into the negatives as an unprecedented monetary easing device to reach its inflation targeting goal. Official international loans, including ODA loans and OOF, are financed by the Fiscal Investment and Loan Program, most of which originates from Japan Post Bank savings and life insurance. ODA loans and OOF to developing countries with high growth potential yields higher investment returns than domestic projects without positive multiplier effects in Japan. Since even an ODA loan can expect a minimal but positive interest rate, it satisfies the national interest in Japan. The Japanese government must consider more drastic measures and comprehensive discussions for the benefit of both Japan and developing countries.
[i] From now on, the data source of Japan’s bilateral ODA and OOF (commitments in millions of US dollars) is the OECD (http://stats.oecd.org). I would like to thank Hidetaro Yamaguchi for his invaluable RA work collecting the data and creating the graphs.
[ii] In the past, the former JICA oversaw over half of the Japanese grants. The Overseas Economic Cooperation Fund (OECF) managed the Japanese ODA. The former Japan Import-Export Bank was in charge of the Japanese OOF. The OECF and the Japan Import-Export Bank joined together to form JBIC. Afterward, the ODA loan division of JBIC was split off and merged into the former JICA, forming the present JICA. Takase (1999) discusses the redemption issues of the loans by the OECF and Import-Export Bank (“Financial and Macroeconomic Efficiency of Economic Cooperation Lending in Japan [in Japanese],” Financial Review No.52). At that time, normal repayments of the principal and interest by developing countries were assumed to occur in the distant future, which is totally different from the present situation.
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