Continued yen depreciation could pose concerns for Asia
THE Japanese yen's dramatic depreciation over the last week - which looks set to continue - could potentially have a serious impact, not only on Japan but also on Asian and other emerging-market economies.
The yen has gone from 105 against the dollar to near 115 since Oct 16, with most of the move coming since Nov 1, after Bank of Japan (BOJ) governor Haruhiko Kuroda stunned the markets by announcing a major acceleration of quantitative easing.
If the BOJ continues with its ambitious asset-purchase programme, its balance sheet could soar to the equivalent of about 70 per cent of gross domestic product by the end of next year, more than double that of the US Federal Reserve, as a proportion of the economy. Mr Kuroda seems determined to stay the course. Speaking at a seminar on Wednesday, he reiterated that there is no change to the Bank's policy of trying to achieve 2 per cent inflation "at the earliest date possible" and that there are "no limits to our policy tools, including purchases of Japanese government bonds".
A yen depreciation is arguably the easiest and fastest way to engineer a rise in inflation, and by stressing he will keep the expansion going, Mr Kuroda is no doubt also trying to stoke inflationary expectations among a populace that has long been mired in a deflationary mindset. The BOJ's move to raise the ante in the battle against deflation - which it views as the single biggest obstacle to economic recovery - could have been prompted by the recent sharp falls in the prices of oil and other commodities, of which Japan is a major importer. How soon the yen depreciation will slay the deflation beast is an open question, but it stands to reason that at some level it will, and the BOJ will keep going until that level is reached.
The price effects of a cheaper yen on Japan will be mixed. Importers, households and large parts of the service sector, which cater to the domestic market, will be losers, while big exporters will gain. However, their gains are likely to be limited; first, because they too are significant importers of intermediate inputs and, second, because many large Japanese companies have already moved a lot of their production offshore.
If a yen depreciation does eventually produce a Japanese recovery (although this is by no means a sure bet), this would of course be good for the region. But meanwhile, Asian countries have reason to be concerned about possible collateral damage, especially if the yen continues to slide. During past episodes - for example, during the first quarter of 2013 - China among others voiced concerns about competitive currency depreciations. Companies from South Korea and Taiwan which also compete against Japanese manufacturers will, too, be watching the slide of the yen with some apprehension and sooner or later will lobby their governments to take countervailing action.
A potentially more serious problem could be the portfolio effects of a cheaper yen and the associated monetary expansion by the BOJ. It could lead to outflows of funds from Japan, at least some of which will find their way into Asian asset markets where Japanese investors are already active. If some Asian economies were beginning to think that with the Federal Reserve winding down its quantitative easing, they could start to relax some of their safeguards against capital inflows - Singapore's property cooling measures being a prime example - they will now need to think again.
