While it may come as no surprise that Japan is looking to spur foreign direct investment (FDI) in the wake of the global financial crisis, few may realize that the Japanese government has signaled its intention to focus on the Middle East as a potential source of FDI.
The initial steps taken by the Japanese government have been welcomed across Japan’s business community but, in our view, more needs to be done if the authorities are serious about attracting such investment.
For those in the financial industry, acutely aware of Japan’s economic ails—a decrease in exports, an ever-shrinking GDP, and the bottoming out of the Japan Stock Exchange—the issue was always going to be how the government chose to respond. Japan’s response in implementing its 2009 tax reforms and negotiating bilateral tax agreements with a number of Middle Eastern jurisdictions was clearly a step in the right direction, but do they go far enough?
What is agreed by pundits across the financial sector is that a slow U.S. economic recovery and a strengthening yen means Japan is unable to rely on U.S. investment to the extent it has in the past, reinforcing the increasing trend of soliciting FDI from the Middle East.
“Recently we have been fielding more questions about structuring transactions in Japan in an Islamic-compliant manner,” said Tokyo-based international tax attorney and Islamic finance specialist, Paul Previtera.
“And while in principle Japan appears ready to accommodate such investment, its regulatory framework and, in particular, the tax treatment of these transactions needs to be clarified to provide greater certainty to investors,” he said.
The Gulf Cooperation Council (GCC) member countries (Kuwait, Qatar, Oman, Bahrain, Saudi Arabia, and the United Arab Emirates) have become a hotbed for investment activity due to the countries’ lucrative natural resources, steadily-growing economies, and stable financing system.
The GCC nations provide more than 20 percent of the world’s oil, supplying almost 80 percent of Japan’s domestic oil supply. The GCC’s oil-based economy largely insulated it from the extreme shockwaves of the global financial crisis, even amongst falling oil prices and high-profile corporate defaults in the region, like Dubai World.
In fact, the GCC member nations represented the few nations in the world that actually produced a positive growth rate which is expected to increase in 2010, at a rate two to three times that of the United States and Japan.
Another unique feature that makes the GCC an attractive source of investment is its Islamic-based finance principles, which include a ban on high-risk investments, strict asset-backed loan requirements, and no interest charges on loans.
Additionally, a principle underlying all Islamic transactions is that the lender and the borrower are in a business partnership and therefore share in losses, as well as profits.
These rules and attitudes result in a stable banking industry and provide economic liquidity, the lack of which drove the United States economy into a tailspin in 2008.
“With the world’s new distaste for excessive risk and paranoia over financial uncertainty, the GCC markets represent the perfect venue to re-energize the Japanese economy,” said Previtera.
Interestingly, China is also vying for GCC-investor attention, highlighted by its 60 percent increase in trade with the six-member block in 2008 and its current negotiations for a Free Trade Agreement.
“Last year alone there was a 50 percent reduction in trade between Japan and the GCC,” said the CEO of Japan Touchstone, Chris Alderson, whose company increasingly receives inquiries about Middle East investment.
“This figure is only expected to further decline because of a fall in global prices and a steady growth in trade between the GCC and China,” said Alderson.
Japan must take a more proactive stance on its trading relationship with the GCC. While Japan has used tax reforms in recent years to encourage Japanese companies to repatriate income earned overseas to Japan, more can be done to provide tax breaks to foreign investors looking to enter the Japanese market.
We applaud Japan’s enthusiasm for executing bilateral tax agreements with members of the GCC and see these as a key platform from which Japan’s economy can drive forward.
However, in order to convert this intent into results from an FDI perspective, more can be done from the viewpoint of Japan’s domestic legal and tax regulations. Only then will Japan be able to position itself as a more competitive trading partner and a lucrative ground for investment.
Dean Page is CEO of Tokyo based venture capital firm Foreya Partners. He is qualified both as an attorney and as a CPA and was formerly a partner with Ernst & Young.
Dean.Page@VentureCapital.Asia
Jennifer Malaer is an associate at Foreya Partners and is currently completing her legal studies at Miami University in Florida.
Jennifer.Malaer@VentureCapital.Asia
