FDI IS BRIGHT SPOT IN JAPAN'S ECONOMIC GLOOM

UNCLAS SECTION 01 OF 04 TOKYO 000099

SENSITIVE
SIPDIS

DEPT FOR EAP AMBASSADOR HASLACH AND EAP/J
DEPT ALSO FOR EEB/IFD
DEPT PASS USTR FOR CUTLER AND BEEMAN
USDOC FOR 4410/ITA/MAC/OJ
JUSTICE FOR ANTITRUST DIVISION - CHEMTOB
TREASURY DEPT FOR IA/CARNES AND POGGI
GENEVA FOR USTR

E.O. 12958: N/A
TAGS: EINV ECON PGOV OECD JA
SUBJECT: FDI IS BRIGHT SPOT IN JAPAN'S ECONOMIC GLOOM

REF: A. 08 TOKYO 3542

B. 08 TOKYO 3417

C. 08 TOKYO 2029

D. 08 TOKYO 1421

E. 08 TOKYO 1337

F. 08 TOKYO 1950

G. 08 TOKYO 402

Sensitive But Unclassified. Please protect accordingly.


1. (SBU) Summary. Foreign direct investment (FDI) is a
relative bright spot in the Japanese economy despite global
economic difficulties. Although recent financial market
turmoil reduced the pace of Japan's FDI inflows, those flows
remain positive. The GOJ is quietly pursuing policy
initiatives intended to improve Japan's investment climate
that could, as the global economic picture improves, lead to
greater FDI inflows. The Cabinet Office and METI are
drafting a new investment promotion strategy, Japan's first
since 2006, in response to recommendations in the May 2008
Investment Experts Report. The Ministry's Corporate Value
Study Group updated its guidelines on adopting corporate
takeover defenses. METI also established a study group to
examine the issue of outside directors on corporate boards
and to recommend whether the GOJ should revise the definition
of "outside" and require all listed companies to have a
minimum number of such directors, something the USG has long
advocated in the Regulatory Reform Initiative. End Summary


2. (SBU) Amidst Japan's recent gloomy economic outlook (Ref
B),FDI has been a relative bright spot. Although Japan's
FDI inflows between January and November 2008 were down 13.2
percent compared to the same period in 2007, those flows
remain positive. This deceleration of inward FDI largely
reflects dramatically reduced global liquidity rather than
Japan-specific factors.

3. (SBU) Meanwhile, Japan's overall FDI stock continues to
rise. As of September 2008, the latest figures available,
Japan's FDI stock was 17.02 trillion yen, equivalent to 3.3
percent of nominal GDP, according to preliminary Ministry of
Finance (MOF) figures, and up 12 percent from the end of
CY2007. This figure does not reflect the November 2008 sale
of combined 700 million dollars in stakes in Suzuki Motors
and Mazda by U.S. automakers General Motors and Ford,
respectively. The GOJ continues to promote the national goal
of raising Japan's FDI stock to the equivalent of five
percent of GDP by the end of FY2010 (March 2011),although
GOJ investment officials admit privately this goal may be
difficult to achieve given the current economic climate.

4. (U) On the portfolio side, non-resident investors, both
individual and institutional, were net sellers of
Tokyo-listed stocks in 2008 for the first time since 2002.
Between January and December, foreigners sold, on balance,
7.38 trillion yen (USD 82 billion at current exchange rates)
worth of shares in Japanese companies. The most aggressive
selling took place in March and April, when the Nikkei 225
benchmark index was well above current levels, and again
between July and November as the global credit crunch hit.
M&A Also Down but Not Out
--------------

5. (SBU) The severe tightening of global liquidity has had a
similar effect on the value and volume of merger and
acquisition (M&A) deals involving Japanese companies. The
total number of M&A transactions involving Japanese companies
fell 11 percent to 2399 while the value of those deals was
down marginally to 12.5 trillion yen, according to
Tokyo-based M&A consultancy Recof. The value of deals
involving foreign purchases of Japanese companies -- always a

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small subset of the total amount -- fell even further, down
82 percent to 503 billion yen. Although the number and value
of Japanese-related M&A deals in 2008 declined to its 2004
level, it was still the fourth highest amount on record.
Government Policy Quietly Positive
--------------

6. (SBU) In the midst of this gloomy economic news, the GOJ
has begun to take a number of positive steps to improve
Japan's overall investment climate. Although GOJ policies
are by no means countering the impact of the global financial
crisis on inward investment, they may have prevented an even
worse outcome by reversing a string of negative international
press reports about Japan's investment climate between
January and May.

7. (SBU) Within the bureaucracy, officials continue quietly
implementing the pro-FDI policy direction set out by
then-Minister for Economic and Fiscal Policy Hiroko Ota in
the first half of 2008. Ota's chief success was establishing
the Investment Experts Committee under prominent pro-reform
economist Professor Haruo Shimada. The group, which included
the Presidents of the American Chamber of Commerce in Japan
and the European Business Council, submitted a report in June
2008 recommending measures the GOJ should take to
dramatically expand inward FDI (Ref D). The Committee's
recommendations, all of which echoed proposals the USG has
advocated in the Regulatory Reform and Investment
Initiatives, urged the GOJ to: (1) Clarify rules governing
the introduction of anti-takeover defense measures and to
examine why foreign investors have not made more use of the
triangular merger provisions in the 2006 Company law;" (2)
Conduct a "comprehensive study" of the scope and grounds for
national security or public order restrictions on foreign
investment based, which were used in the May 2008 J-Power
case; (Ref E-F); (3) Identify priority sectors for the
promotion of inward FDI that have the potential to revitalize
the Japanese economy or improve citizens quality of life,
with special emphasis on improving citizens' access to
advanced medical devices and pharmaceuticals; (4) Reduce
business costs, in part by lowering corporate tax rates, and
increase regulatory transparency; and 5) Develop strategies
to promote regional economic revitalization through
attraction of foreign capital. Since the issuance of the
Committee report, the GOJ has taken steps to implement each
of the recommendations.
Cabinet Office Preparing New Investment Strategy
-------------- ---


8. (SBU) The Council on Economic and Fiscal Policy
incorporated the main thrust of the Shimada Committee report
into the government's annual Economic and Fiscal Policy
Strategy document issued in July 2008. Since then, the
Cabinet office has begun drafting a new national investment
strategy, the first since June 2006, which should be complete
by the end of January 2009.

9. (SBU) Two key pillars of that strategy, according to a
top official in METI Trade and Investment Facilitation
Division, are tax relief for certain types of portfolio
investors and new programs to encourage FDI in Japan's
regions. The GOJ is concerned that currently 80 percent of
inward FDI goes to Tokyo and its three neighboring
prefectures. As part of this strategy, METI and JETRO will
organize up to six regional investment matching seminars in
2009 focused on foreign companies with existing investments
in Tokyo. The aim is to encourage these companies to expand
operations to other parts of the country. This approach
matches a pattern Toyota successfully followed in the
mid-1980s when it expanded from its Nagoya base to set up
manufacturing plants in Miyagi and Northern Kyushu.

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10. (SBU) The Cabinet Office at the same time has begun to
target seminars at regional government economic promotion
officials, focusing on prefectures with little existing FDI.
The aim is to accelerate inward FDI into Japan's regions,
provide training to local economic development officials on
investment promotion strategies, and disseminate information
on past "success stories" of foreign investors in the
Japanese market. The first seminar takes place January 30 in
Matsuyama, Ehime prefecture.

11. (U) Even before the new investment strategy is complete,
the GOJ included in its annual year-end tax amendment
legislation a proposal to eliminate capital gains for
non-residents who own shares in Japanese firms through
investment funds. The aim is to promote additional portfolio
investment. The current withholding rate on such gains is 40
percent. To be eligible for the proposed exemption, the
funds must hold the stake for a minimum of one year.
METI Becomes Proactive on M&A Rules
--------------


12. (SBU) Simultaneous with the drafting of the Shimada
Committee report, METI reconstituted its Corporate Value
Study Group (CVSG) to re-examine the issue of corporate
takeover defenses. Since the last CVSG report on the subject
in 2005, more than 500 listed companies had adopted some form
of takeover defense, a trend that foreign investors and
equity analysts sharply criticized. Mid-level METI officials
recognized the defense measures many firms had adopted were
inconsistent with joint METI-Ministry of Justice guidelines
and were undermining investor confidence in Japan. The study
group issued its report in July 2008, immediately fulfilling
one of the Shimada Committee's recommendations. The report
included the statement that shareholders and management have
"common interests in increasing corporate value", and M&A,
even if hostile, can have a potential positive impact on the
corporate value of the target company. The report emphasized
that improper implementation of takeover defense measures
"deprives shareholders who support a takeover bid of the
opportunity to sell their shares to a potential acquirer" and
that it is never acceptable to use takeover defenses for the
purpose of entrenching management.


13. (SBU) Such a pro-FDI report from a ministry that at
times had been publically critical of the increasing amount
of hostile M&A since 2005 was a welcome change of tone. A
few months earlier, then-METI Vice Minister Takao Kitabata
had publically criticized U.S-based investment fund Steel
Partners as an example of the "greedy" and "irresponsible"
behavior of activist shareholders (Ref G).

14. (SBU) In another sign of changing METI attitudes,
foreign fund managers report ministry officials have begun
engaging them to discuss Japan's investment climate. While
the two sides do not always agree, the fund managers say they
are satisfied METI officials are at least willing to listen.
A senior executive of Steel Partners Japan even credited the
CVSG report and its active promotion by METI officials with
triggering a more cooperative attitude among executives of
companies in which the fund invests and an increased
willingness of those managers to listen to Steel's
suggestions for corporate improvement.
Re-examining the Issue of Independent Directors
-------------- -

15. (SBU) The same METI Division Director who oversees the
CVSG established a Corporate Governance Study Group in
December 2008 tasked with examining Japan's current corporate
governance structures and advising on possible changes to
Japan's company Law. Specifically, METI asked the new study
group, chaired by Tokyo University Law Professor Hideki Kanda

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and including 21 business executives, lawyers, and academic
experts on corporate law, to examine whether listed firms
should have a minimum number of outside directors on their
boards and whether the current legal definition of "outside
director" is adequate to protect the interests of minority
shareholders, especially in cases in which parent and
subsidiary companies are separately listed. The Study
Group's mandate includes several issues the USG has included
in its commercial law-related recommendations in recent
Regulatory Reform Initiative reports. The Study Group's work
is expected to be completed by June 2009.
Security Related FDI Rules
--------------

16. (SBU) Similarly, in response to another of the Shimada
Committee's recommendations, the GOJ in late December
established a director general-level inter-ministerial
liaison group tasked with reviewing existing GOJ regulations
that govern approval of FDI in sensitive sectors. The group
will review which sectors are covered by the Foreign Exchange
and Foreign Trade Control Law and may also make
recommendations regarding the review process for potentially
sensitive transactions. A report to the Council on Economic
and Fiscal Policy is due by March 2009.
ZUMWALT