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The challenge of yen
appreciation
By Hussain Khan
TOKYO - Japanese manufacturers, who are only
starting to see light at the end of a dark and winding
economic tunnel, now must confront the specter of a
rising yen that, if it goes very much higher, could
snuff out the country's nascent recovery. They are
growing increasingly confident that that won't happen,
and that the strength of the recovery will overcome the
effect of the rising currency. Nonetheless, a
dramatically rising yen would have profound effects on
the rest of Asia, driving more of Japan's manufacturing
plant offshore as the relative price of their exports
rises in other countries.
The changes in world
economics wrought by currency fluctuations can be
stunning and often produce effects that their engineers
never expected. For instance the previous surge in the
yen, known in Japan as endaka, or high yen,
kicked off a Japanese economic prosperity bubble that,
when it finally broke in 1990, plunged the country into
13 years of stagnation from which it is only now
emerging.
The story began in the mid-1980s, when
Japanese export prowess created what then was thought to
be a huge trade deficit with the United States. At that
time, the finance ministers and central bank governors
of France, Germany, Japan, the United Kingdom, and the
United States put together the Plaza Accord to drive
down the value of the US dollar, particularly against
the yen, which rose from 240:$1 in 1985 until it reached
80 in April 1995.
As the price of Japanese
exports increased, competitiveness overseas fell, but
not nearly as much as the United States had assumed or
hoped. In fact, US manufacturers, particularly auto
makers, discovered to their dismay that now they were
competing on the basis of quality, not price, and they
weren't very good at that either. The rising yen did
create a rising tide of prosperity in Japan. Government
financial measures increased demand domestically.
Corporate investment zoomed. Equities prices soared,
becoming an important source of financing for
corporations, which then overexpanded. Banks went crazy
lending for real-estate development and equities. In
turn, corporations used their real-estate holdings as
collateral to speculate in equities. Land prices soared
so high that famously the land under the Imperial Palace
was worth more than all the real estate in the United
States. The Nikkei rose by 180 percent.
But at
the same time, to escape the rising yen, Japan's
exporters moved an enormous amount of the country's
industrial base to Southeast Asian countries, kicking
off an ancillary export boom that lasted more than a
decade in Singapore, Malaysia, Thailand and other
economies. Factories that had been up and running in
Japan were dismantled and shipped to Southeast Asia,
reassembled and put back into production within months.
As a result today, according to the Ministry of Economy,
Trade and Industry ((METI), overseas production
comprises 37.2 percent of total output by Japanese
manufacturers that have operations abroad in fiscal
2002. A decade earlier, that figure stood at 17.4
percent.
While most companies don't see the
yen's surge adversely affecting the recovery or the
recent rebound of Japanese stocks, some say they would
be forced to move their operations overseas at a faster
pace or shut plants in Japan if the yen were to remain
strong for an extended period. Sixty percent of
export-oriented Japanese companies said a strong yen
would not have a serious impact on their business
performance in the short term because they have hedged
against currency movements by establishing forward
yen-dollar exchange contracts.
None of this
uncertainty has been helped by President George W Bush,
whose mangled syntax often leaves his audiences
open-mouthed and his advisers cringing. At a Tokyo
stopover during his just-concluded trip to Asia, he
confused the currency markets by pleading for a strong
dollar and thus a weaker yen. But in the same speech, he
called for currencies to find their own levels under
market forces - which inevitably means a stronger yen.
Commenting on this contradictory position, one senior US
official deeply involved in the issue said, "It's a
combination of statements that make no sense, when you
think about it. Either you want a strong dollar or you
want the markets to determine the rate, but you can't
pray at both altars."
Previous jawboning this
year by John Snow, the US treasury secretary, and market
forces have pushed the dollar down by 10 percent against
the yen, which has gone from above 120:$1 to 109,
briefly flirting with 108, a 35-month high. The US twin
fiscal and trade deficits are beginning to take their
toll, and the recovering Japanese economy is also
driving up the yen's value.
The question is when
the tipping point comes - when the rising economy drives
the yen higher and Japanese exports start to lose their
competitiveness. According to a METI survey, 80 percent
of Japanese manufacturers would be negatively affected
if the yen were to stay below 110 into 2004. The firms
that responded to the survey said they expect their
operating profits to fall by an average 3 percent with a
1-yen advance against the US currency. The average
make-or-break exchange rate is 113:$1 for most Japanese
exporters, according to the survey.
While
concerns about the economic impact of the strengthening
yen persist, companies are much better equipped to
handle the rise than in the past because of increased
overseas production and the use of financial
arrangements to reduce risks associated with currency
volatility.
Major electronics companies that
generate nearly half of their sales in overseas markets
are also bolstering their efforts to reduce their
exposure to currency risks. For instance, Sanyo Electric
Co has accelerated its shift of production overseas. As
a result, about half of its audiovisual products are
made outside of Japan. In fiscal 1998, a 1-yen rise
against the dollar would have translated to a decline of
roughly 1.2 billion yen in parent-only operating profit.
But now, the profit drop is about 900 million yen. On a
consolidated basis, the loss is only about 200 million
to 300 million yen, according to the company.
Similarly, Matsushita Electric Industrial Co has
been able to reduce the impact of currency fluctuations
on its earnings by about 20 percent from the level of
five years ago through such measures as having a higher
proportion of transactions settled in local currencies.
The company has also moved up its use of forward
contracts to convert overseas sales income into yen.
Matsushita Electric set up contracts setting the dollar
at 115-120 yen through December. For these reasons, the
rise in the yen is expected to have only a slight impact
on these firms' earnings for the time being.
Furthermore, advanced financial techniques
linked to information technology are allowing an
increasing number of small and midsize firms to manage
currency risk. In April, UFJ Bank, a core unit of UFJ
Holdings Inc, rolled out a 5 million yen product that
enables even small and midsize companies to manage their
currency risks, including those at overseas site, in a
unified manner. Similar products for major firms can
carry a price tag of several tens of millions of yen,
but by offering a standard product, UFJ Bank was able to
keep the price down. The software enables companies to
track their foreign-currency account balances and
forward contracts. And because it enables them to
construct a system at lower cost than in-house
development, it has proved popular.
Some
worrisome factors are cited from some quarters that a
strong yen could cool off domestic demand at a time when
there are finally some signs of an economic turnaround.
Even if the stronger yen has little impact on corporate
management, its psychological impact could be large. A
further rise in the yen could prompt a sell-off of
exporter stocks. However, a Nihon Keizai Shimbun report
says a surprising number of Tokyo market participants
replied that they were not worried about yen
appreciation in the medium to long term.
The
usual market trend that has appeared during yen
appreciation is that investors take profit by selling
the shares of firms with a high percentage of exports
and shift their investments to construction stocks and
other issues tied to domestic demand, as well as oil
companies, which benefit from a strong yen. On such
occasions usually their thinking is reflected in the
phrase: "The market was overheated anyway, so this was a
perfect opportunity for a correction." Other market pros
say the chances of the rising yen sending stocks down
further are small.
The overall sense of optimism
is not groundless. In fact, past market trends show that
since the late 1990s, stock prices have risen when the
yen has strengthened and fallen when it has weakened. In
a report issued two weeks ago, Shoji Hirakawa, chief
strategist at UBS Securities Japan Ltd, argues that when
the yen is rising on economic recovery momentum, firms
are able to maintain profit growth because higher sales
volume more than offsets the reduction in prices caused
by the stronger yen. The basic point is that as long as
the economy is solid, the impact of yen appreciation
will be limited.
Some market analysts point out
that Japanese companies are more insulated from a rising
yen than they were in the past. According to Daiwa
Institute of Research, exports to Asia, which actually
account for the biggest share of Japan's exports, are
often denominated in yen, not dollars. "Setting aside
the auto industry, which has a high percentage of
exports to North America, the impact of yen appreciation
on electrical machinery and other sectors is smaller
than most people would imagine," says Junichi Makino, a
senior economist at the think-tank.
Another view
is that because the latest economic pickup is being
driven by domestic demand, the rising yen will not have
an adverse effect on the recovery. Goldman Sachs (Japan)
Ltd projects that domestic demand will account for 76
percent of gross domestic product growth in fiscal 2003,
compared with a figure of only 24 percent for net
exports. In other words, the main engines of the
recovery are private-sector business investment and
consumer spending. "The recent yen upswing, if anything,
presents a good opportunity to raise portfolio weights
of stocks tied to domestic demand," says Goldman Sachs
chief strategist Kathy Matsui.
And do not ignore
the fact that a higher yen increases the value of
yen-denominated assets in dollar terms. As a result, the
38 percent gain registered by the benchmark Nikkei Stock
Average from its 2003 low through last week translated
into a substantially higher 47.9 percent upturn in
dollar terms.
As of now, foreign investors are
selling auto, technology and other export-related
stocks. But Tetsuo Inoue of UAM Investments Trust
Management Co points out that foreigners are using the
proceeds of these profit-taking sales to shift into
other Japanese stocks. There is no sign that foreign
investors are pulling money out of the market, he says.
Of course, the optimistic mood now prevailing
hinges on the assumption that the yen's upturn does not
become dangerously steep. If yen appreciation
accelerates to the point that it threatens to choke off
economic recovery momentum, the market's view could
change very quickly.
Hussain Khan
holds a master's degree in economics from Tokyo
University and has worked in Japan as an equities
analyst. He is an independent Tokyo-based analyst on
current affairs and economic issues for various
newspapers and magazines. E-mail: hk@ourquran.com.
(Copyright 2003 Asia Times Online Co, Ltd. All
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