Depreciating yen is an opportunity and a risk for Japan

Photo: Reuters

Investors in Japan are at least being presented with a consistent picture. The risks there have been increasing during the past five and 10 years, and so far this year a similar pattern is emerging, according to Euromoney’s crowd-sourcing survey.

Indeed, those risks would appear to be coming home to roost thanks to widening interest-rate differentials courtesy of divergent monetary policies.

By maintaining its ultra-loose stance, guided by the fact the country has endured decades of very low inflation and extensive periods of deflation – and current inflation is seen as a temporary hit to commodity prices – the yen has hit a 24-year low against the US dollar.

If this reflects changes in investor perceptions of doing business in the Japanese market … they should be addressed in earnest, and not only by the central bank 

 - Kenji Sekiguchi

Also driving the pairing is the contrasting approach adopted by the US Federal Reserve, which has continued its tightening cycle with the latest 75-basis-point hike in the federal funds target, pushing it up to a range of 1.5% to 1.75%, with further increases expected.

Country-risk experts were anticipating the yen’s depreciation, with scores for the monetary policy/currency stability indicator downgraded in the first quarter.

It is one of several economic risk factors presently scoring less than half the points available, while contributing to the fact that Japan remains rooted to 43rd spot in Euromoney’s global risk rankings of 174 countries, well behind the US in 20th, and the second-worst performing member of the G10; only to Italy. In 2016, Japan had climbed to a high of 23rd.

That puts the country in tier three (of five), on a similar ranking to Kuwait, Cyprus, Dominican Republic and South Korea.

Kenji Sekiguchi, chief analyst at Rating and Investment Information, is one of Euromoney’s survey contributors who says it is understandable that central banks such as the Bank of Japan (BoJ) do not act hastily against supply-side inflation, unless it leads to higher inflation expectations and resulting wage increases (second-round effects).

“Besides, it is in a sense the situation that the BoJ, or more broadly, the Japanese economy, has been striving for over the past decade,” he says.

To some extent, the increase in savings due to reduced expenditure during the Covid-19 pandemic has provided a cushion to households to bear the rise in prices 

 - Prachi Gupta

The substantial interest-rate differential between Japan and the US means that the yen has fallen even after the Russian invasion of Ukraine, which would have triggered a flight to safety in the past, bearing in mind the balance-of-payments current-account surplus.

“If this reflects changes in investor perceptions of doing business in the Japanese market, be it due to regulatory bottlenecks or chronically weak domestic demand, they should be addressed in earnest, and not only by the central bank,” says Sekiguchi.

Another survey contributor, Prachi Gupta, assistant professor of economics at Temple University, Japan, notes the fact the weak yen is favourable for exports, so sectors such as automobile manufacturing and tourism will most likely gain from it, supporting economic growth.

However, the rise in the cost of food, fuel and raw materials is also affecting households and producers that rely heavily on imports.

Japan imports almost two-thirds of its food requirements and virtually all of its energy. Consequently, consumer price inflation accelerated from 1.2% in March to 2.4% in April, and with the core inflation rate rising to 2.1%, it moved above the BoJ’s 2% target rate for the first time in seven years.

“To some extent, the increase in savings due to reduced expenditure during the Covid-19 pandemic has provided a cushion to households to bear the rise in prices,” Gupta notes.

Japanese voters also seem unperturbed for now. Prime minister Fumio Kishida’s approval ratings are soaring ahead of the partial elections for the upper house in July. A decisive victory for the incumbent Liberal Democratic Party would provide a mandate to revise Japan’s pacifist constitution, but voters will also be looking for more as the economy turns.

Recession in key export markets and the prospect of inflation worsening domestically will combine to constrain Japan’s economic growth. It cannot rely on monetary-policy expansion alone.

As Gupta says, Japan needs to invest in productivity-boosting technology, such as digitalization, encourage innovation and reduce the gender wage gap to achieve economic recovery.

In the meantime – also bearing in mind the fiscal gap and the longer-term impact of high debt, given the ageing population – it represents a medium risk.