Japan – beneficiary of a weaker yen

For every country the level at which its currency trades at is important and especially so for an export dependent nation. Such is the case for Japan, which over the past decade has come to rely on its exports to drive growth. The level of the yen versus the US dollar is central to the profitability of the export sector in Japan as the US currency is used to set prices globally.

The benefits of a weak yen are plain to see. Export related companies record higher profits as overseas earnings are translated back into a depreciating yen. This in turn alleviates pricing pressure within the home market whilst also allowing wages to rise as profitability expands. This process in turn allows for a greater level of personal consumption and stronger economic activity. Why not, then, allow for the currency to persistently depreciate to boost overall activity?

Whilst a weakening currency has its attractions, there are also costs. Notably imports cost more, which in itself is inflationary, while the higher costs may enter the pricing mechanism and force interest rates higher thereby constraining economic activity. So there is a balance to be had in terms of weak currency, strong currency.

For Japan the all-important yen to US dollar (¥/$) rate has fluctuated over the past several years thus bringing fortune and misfortune to the economy. With the strength in the yen over the past number of years the recent weakness in the currency has come as a welcome respite. Profits will be revised up thus improving the outlook for the economy.

So what has caused the sudden weakness in the yen? It is never easy to pinpoint what moves currency levels but it is fair to say that having lagged their western counterparts, the Bank of Japan has become more aggressive in monetary easing than in the past thereby resulting in a weakening yen. There is belief that this trend will continue and even some speculation that with the huge amount of public debt overhanging Japan, the currency is set to collapse. The latter development is improbable given Japan’s vast net overseas assets (ie, Japan is owed a lot of money). On the former point, the Bank of Japan will have a new governor this April whom, it is believed, will adopt a more accommodative stance than the incumbent. Therefore, the relative tightness in monetary policies between Japan and the US should continue to favour a weak yen. How weak is an important question and it is interesting to note that with the yen having fallen by about 10% versus the US dollar to around ¥90, rhetoric is emerging from various countries about the unfair currency advantage that Japanese exporters are now enjoying. A move much weaker than the ¥90 versus the US dollar level would appear challenging. 

The benefits of a weaker currency are immediately seen within the export sector but what is less visible and arguably more powerful are the benefits which flow through to other areas of the economy as the impact of a weaker currency percolates through. The greatest surprises are, therefore, expected within the domestic environment and that is where the portfolio is weighted. Consumption should be a natural beneficiary. Assuming the ¥/$ rate remains around the current level of close to 90 the outlook for the economy in the year ahead is positive. Together with the recent change in government, upcoming fiscal spending and a probable value added tax (VAT) hike early next year, which may frontload consumption, the outlook for activity is encouraging. One would believe that with such a backdrop the equity market can continue to rise.