Download Is A Weak Japanese Yen A Problem For The Rest Of Asia?

Economic Research:
Is A Weak Japanese Yen A Problem
For The Rest Of Asia?
Credit Market Services:
Paul F Gruenwald, Asia-Pacific Chief Economist, Singapore (65) 6216 1084;
[email protected]
Table Of Contents
Trade Shares: Japan On Sale, But With Shrinking Influence
Competitiveness: The Yen's Big Retracement
Portfolio Flows: Push Or Pull?
Positive On Balance, But What To Watch?
Notes
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Economic Research:
Is A Weak Japanese Yen A Problem For The Rest
Of Asia?
The Japanese yen has depreciated sharply since late 2012. Against the U.S. dollar, the yen weakened to about 102 at
the end of May from an average of around 79 in the third quarter of 2012, a decline of about 30%, before turning
slightly stronger to about 100 currently (see chart 1). The Japanese currency has experienced similar declines against
other major currencies.
Overview
• The Japanese yen has depreciated by some 30% against the U.S. dollar over the past six months.
• Some believe that the yen's depreciation is a problem for the rest of Asia. To gauge the effects of a weaker yen
we look at three transmission channels to the rest of the region: trade, competitiveness, and portfolio flows.
• On balance, we see a weaker yen as beneficial for the rest of Asia, although a further steep decline could bring
competitiveness concerns into play.
The proximate cause for the weakening of the yen has been the first of Prime Minister Shinzo Abe's three "arrows"
(which together aim to stimulate Japanese economic growth and end the country's persistent deflation). This first
arrow is the Bank of Japan's adoption of a 2% inflation target. The central bank has committed to double the size of its
balance sheet (or more) until the target is achieved, a process that is expected to take two years (see "What To Look
For From The Bank of Japan’s New Leadership," published Feb. 12, 2013, on RatingsDirect).
One of the outcomes of a looser monetary policy is a weaker currency. Although the channels from policy actions to
market outcomes are complex, for our purposes it suffices to say that purchasing power parity (essentially, the "law of
one price") implies that higher prices in Japan will be offset by a weaker yen, all else being constant.
The sharp depreciation of the yen suggests that markets have priced in a reasonably large probability of success for
Abenomics--a term often used to refer to the Japanese prime minister's economic strategies. This includes the Bank of
Japan reaching its inflation objective, which implies a weaker yen for a sustained period. However, the repercussions
from a weaker yen extend outside Japan to the rest of Asia, if not beyond.
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Chart 1
Trade Shares: Japan On Sale, But With Shrinking Influence
The mechanics of the trade channel are straightforward. A weaker yen should make imports from Japan cheaper for
the rest of the world, including the rest of Asia. To gauge the importance of this channel we will first look at the
importance of Japan as a trading partner, and then turn to the composition of that trade.
Japan has been declining steadily as a trading partner for the rest of Asia so far this century. This mainly reflects the
"changing of the guard" in Asia. That is, Japan's share of regional GDP (and, by implication, its share of purchasing
power) has been falling steadily as a result of its own slow growth and the fast rise of China. It also reflects the
development of sophisticated supply chains in the region. These are centered on China, and serve to raise the flow of
goods between the rest of the region and the Middle Kingdom.
This decline at the regional level comes through clearly in the data, although most metrics show a leveling out in the
post-crisis period (see chart 2). Moreover, this diminishing trade share for Japan is evident in almost every economy in
the region. Exports to Japan as a share of the rest of Asia's total exports have fallen by an average of three percentage
points to 10.3% in 2012. Only the Philippines has increased the share of its exports going to Japan. Notably, Japan's
share of Chinese exports has more than halved and stood at 7.7% in 2012. Imports from Japan show a similar pattern,
having fallen by 5.5 percentage points on average to 10.3% in 2012. No economy in Asia has seen a rising share of its
imports coming from Japan.
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Economic Research: Is A Weak Japanese Yen A Problem For The Rest Of Asia?
Chart 2
The picture is similar when we look at trade with Japan as a share of GDP, albeit the decline is somewhat less
dramatic. Under this measure, exports to Japan fell to 5.3% of GDP in 2012 from 6.7% in 2000, although Hong Kong
and Vietnam increased their shares. Imports from Japan as a share of GDP fell by three percentage points to 6.2% in
2012, but with rising shares in Hong Kong, Thailand, and Vietnam.
Of course, it is the balance of trade that ultimately matters, not just the size. The region as a whole runs a 1% of GDP
trade deficit with Japan, but what about individual economies? Are they net exporters or net importers with Japan?
Since a weaker yen will make the rest of the region's imports from Japan cheaper (more yen per U.S. dollar, which
remains the currency of choice for trade denomination in Asia), economies running a trade deficit with Japan will
benefit. Conversely, Japan will have to pay more in yen terms for its imports from the rest of the region, so economies
that are net exporters to Japan will be worse off.
So who are the winners and losers? The two biggest beneficiaries of a weaker yen through the trade channel are Hong
Kong and Thailand, which run trade deficits against Japan of 7.8% of GDP and 6.4% of GDP, respectively. Hong Kong
is a heavy importer of consumer goods, while Thailand has historically strong foreign direct investment links with
Japan as an importer of intermediate goods. Korea will also benefit with a 2.1% of GDP trade deficit vis-à-vis Japan.
Malaysia, Vietnam, and Australia are the "losers" from a weaker yen, given that they run net surpluses with Japan,
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mainly due to their commodity exports.
Chart 3
Competitiveness: The Yen's Big Retracement
A commonly expressed concern is that the Bank of Japan's quantitative easing has resulted in a weaker yen, which will
have negative effects on neighboring economies' export competitiveness. The countries most likely to be affected, so
the argument goes, are Korea, China, and Taiwan (and to a lesser extent Singapore), whose exports compete with
Japanese goods in third markets, for example, the U.S., in sectors such as electronics and automobiles.
But does this charge hold up to closer scrutiny? The usual way to measure competitiveness is by looking at real
effective exchange rates across economies. This is the broadest measure of a currency, taking into account the
weighted average of trading partner currencies (making it "effective") and adjusting for inflation differences (making it
"real").
We also want to make sure that we choose a defensible time frame. Focusing on the sharp depreciation of the yen over
the past few quarters might make for a stunning chart, but it's unlikely to shed much light on the competitiveness issue.
To address this, we have elected to go back to before the outbreak of the Global Financial Crisis. This is to capture the
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Economic Research: Is A Weak Japanese Yen A Problem For The Rest Of Asia?
sharp appreciation of the yen in 2008 and 2009, when the financial markets treated it as a safe haven currency.
Chart 4
Looking at real effective exchange rates since mid-2008 puts the yen's recent decline in a new light (see chart 4). Our
word of choice is "retracement." While the depreciation of the yen since the third quarter of 2012 has been stunning, it
has basically retraced the sharp appreciation in late 2008 and 2009. As a result, the yen is broadly unchanged in real
effective terms since mid-2008.
What about the currencies of key trading partners? We can split these into two groups. The Korean won and the New
Taiwan dollar both remain weaker against the yen compared with mid-2008. The Korean won benefited from a
particularly large wedge in late 2008 and early 2009 as it moved in sharp opposition to the yen, while Taiwan's
currency has been much more stable in real effective terms. A second group contains the Chinese yuan and the
Singapore dollar, which are now both 20% stronger than the yen in real effective terms compared with mid-2008.
China has enjoyed the highest total factor productivity growth in Asia over the past decade, which would help to offset
a stronger currency by lowering real labor costs. Also of interest, the Chinese yuan has very closely tracked the
Singapore dollar in real effective terms over the past three years, providing some insight into the objectives of Chinese
exchange rate policy (1).
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Economic Research: Is A Weak Japanese Yen A Problem For The Rest Of Asia?
Two other factors might dampen the competitiveness effects suggested by the real effective exchange rate. The first is
the extent to which Japan's exports are price sensitive. Most of Japan's export products are near the high end of the
spectrum for value added, where factors such as brand loyalty and non-price competition play a more prominent role
in final demand. As a result, demand for Japanese exports may prove fairly unresponsive to changes in exchange rates.
(In contrast, we would expect the more commoditized products at the lower end of the spectrum to be more price
sensitive.) The second factor would be the extent to which companies hedge or absorb internally exchange rate
changes. This would tend to mute the effect of exchange rate changes on prices faced by final consumers.
Portfolio Flows: Push Or Pull?
Our final possible transmission channel from a weak yen to the rest of Asia is portfolio flows. This is the most complex
of our channels. The expectation of a weaker yen and a revival of Japanese growth (nominal and real) could lead to
both net outflows from or net inflows into Japan.
The direction of flows will be driven by various factors. If an investor does not want to be long a weakening
currency—the yen in this case—then she will sell claims on Japan and invest elsewhere. Depending on who does these
sales, they will show up in the data as lower net inflows by foreigners or higher net outflows by Japanese. However, if
a weaker yen and Abenomics cause growth and returns to pick up, then we will see higher foreign inflows or fewer
outflows out of Japan. Also, Japanese investors will experience wealth rises due to a higher value of their foreign
assets (since there are now more yen per unit of other currencies) and therefore investors may choose to lock in gains
by selling these assets and repatriating funds back to Japan.
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Charts 5
Which of these factors dominate? The data show that, on a net basis, portfolio flows have been going into Japan over
the past few quarters (see chart 5). The main reason for the portfolio flows has been international investors buying
Japanese equities, which have climbed steadily higher since the third quarter of 2012 (this implies that the recent
sell-off in the Nikkei index was driven by domestic investors). Foreign purchases of Japanese bonds have turned
positive as well. Japanese investors initially sold foreign portfolio assets on a net basis, but this has turned around in
recent months with the flows close to neutral.
As for flows to and from Asia, here we have to rely on indirect evidence since the available higher frequency data do
not include Asia-specific flows. What we do know is that Japanese investors put the vast majority of their international
portfolio assets (stocks and bonds together) in other advanced economies (see chart 6). Over one-half of their portfolio
assets represent claims on the U.S. or in the eurozone (European Economic and Monetary Union). In contrast, only
about 6.5% of their international portfolio assets represent claims on the rest of Asia, split roughly evenly between
Emerging Asia and Australasia. From these data, we can infer that outward investment from Japan is likely to be
heavily concentrated outside of the region, which squares with recent comments made by senior Japanese officials. All
of this suggests that any portfolio impact from a weakening yen on the rest of the region will be limited.
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Economic Research: Is A Weak Japanese Yen A Problem For The Rest Of Asia?
Chart 6
Positive On Balance, But What To Watch?
Putting it all together, our analysis shows that, on balance, the recent decline of the yen should be positive for the rest
of Asia, at least at the macro level. First, most of the economies in the region are net importers from Japan, so a
weaker yen means cheaper imports. Net exporters to Japan, however, will lose out. Second, while the recent steep
decline in the yen has negative connotations for neighboring economies' export competitiveness, we see the recent
weakness of the yen as retracing the sharp gains seen during the depths of the 2008 global financial crisis, when the
yen appreciated sharply due to its status as a safe haven currency. Third, any portfolio effects of a weak yen on the rest
of Asia look to be minor at this juncture. Japan has mostly seen net inflows from foreign equity investors, and
historically most outflows from Japan have traveled outside of the Asia region.
What can go wrong with this relatively sanguine picture? Another round of sharp yen depreciation could heighten the
downside risks to the rest of Asia. These risks would be concentrated in our second and third channels. On
competitiveness, another round of yen weakness would take the real effective exchange rate of the currency below
that of Korea and further below that of China, and would likely be contentious at a time when global trade flows
remain weak as demand from the U.S. and European economies remains soft. On portfolio flows, the risk is that
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another bout of yen weakness could trigger a round of outflows from Japan. If these outflows were destined more
heavily toward emerging economies, including in Asia (a plausible assumption given lower growth and returns in the
advanced world), they may well put unwanted pressure on currencies and further complicate policy and financial
stability, given the effects on monetary aggregates, interest rates, and asset prices.
Notes
(1) The Monetary Authority of Singapore targets the nominal effective exchange rate of the Singapore dollar, and
currently has the currency on an appreciation path estimated at 2% to 3% per year (the actual slope, mid-point, and
width of the path are not disclosed but guidance is given to the market).
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