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Japan might not like the yen’s rise but cannot easily reverse it

Abenomics needs to be reloaded with measures to raise wages and structural reforms to raise growth prospects

PUBLISHED : Tuesday, 28 June, 2016, 3:08pm
UPDATED : Tuesday, 28 June, 2016, 3:18pm

“Abenomics has made progress in revitalising the Japanese economy but sustained higher growth and inflation remains elusive,” said the International Monetary Fund (IMF) on June 20 adding that “ambitious targets will therefore require a more substantial, coordinated policy upgrade.”

Be that as it may, Japan’s policymakers are not operating in a policy vacuum and Japan is not the sole master of its own fate. Nowhere is this more apparent than when it comes to the yen.

“Strong coordination between the Bank of Japan’s unprecedented quantitative and qualitative easing programme and fiscal stimulus combined with ambitious structural reforms helped narrow the large output gap” and “reversed the undue appreciation of the yen,” said the IMF.

Japan’s Abenomics programme lies in tatters

Whether the Abenomics-related slide in the yen reversed prior undue appreciation or was an unacknowledged, but targeted, attempt to devalue the Japanese currency in order to generate inflation through the import of more expensive foreign currency-denominated goods and energy depends on your point of view.

But one man’s imported inflation is another man’s imported deflation.

While a devalued yen undoubtedly made imports into Japan dearer it also made Japanese-manufactured exports to the rest of the world cheaper. Japan imported inflation but exported deflation.

That’s why other countries have more than a passing interest in Japanese policy and specifically what that means for the yen.

Japan’s Abenomics seen failing badly as markets signal disillusion with missed targets

Despite the yen already having risen some 15 per cent versus the dollar in 2016, ex-Ministry of Finance official Eisuke Sakakibara said on June 20 he still sees the possibility of the Japanese currency rising beyond 100 to the dollar at which point “Bank of Japan intervention is possible.”

That level was actually breached on Friday following the UK referendum that saw the British electorate vote to leave the European Union.

But it would surely be unrealistic to expect others to tolerate sustained Japanese intervention in the currency markets to weaken the yen when that yen strength was essentially a reflection of a post-referendum sell-off in sterling.

'Abenomics' is paying dividends

And as Sakakibara said on June 20, “in order to intervene in the markets” Japan has to “get agreement from the United States” and, in reference to the rate of the yen versus the dollar at that time, he said “and at this level – 104, 105 – I don’t think the US would agree.”

And why would Washington, particularly in a US presidential election year, be inclined to see a material weakening of the yen? Such action would disadvantage US manufacturers competing with Japanese firms.

US exporters aside, if Japan exports deflation to the United States via a weaker yen, the task of the US Federal Reserve, which is trying to normalise US monetary policy, is complicated further as lower US inflation would make existing, let alone higher, real yields on US Treasuries more attractive.

That would likely result in a yet stronger dollar and more disinflation in the US economy.

Of course, if the yen were to fall as a consequence of global dollar strength, that would be a different matter but that is not something that domestic Japanese monetary and fiscal policies can engineer.

But Japan has an added problem in that although the first phases of Abenomics resulted in a slide in the yen, the IMF notes “sluggish global growth and overcapacity in the traded goods sector prevented the weaker yen from materially boosting exports.”

Indeed, Japan’s finance ministry released data on June 20 that showed Japanese exports fell 11.3 per cent in May compared to the same month in 2015, following a 10.1 per cent fall year-on-year in April.

Japan economy shrinks in Q2 in setback for ‘Abenomics’

Japan consequently posted a May trade deficit of 40.7 billion yen rather than the surplus forecasters had predicted.

Of course reduced exports can translate into a weaker yen as Japan’s exporters need to convert smaller foreign currency revenues into yen but that’s not the type of yen weakness Japan needs.

Japan needs yen weakness to generate imported inflation but linked to rising exports not falling ones.

“Abenomics needs to be reloaded,” believes the IMF, with measures to raise wages, structural reforms to raise growth prospects and “a credible fiscal consolidation course…including a pre-announced path of gradual consumption tax hikes.” That may be politically unpalatable in Tokyo.

The IMF is concerned that “without bolder structural reforms and credible fiscal consolidation, [Japanese] domestic demand could remain sluggish, and any further monetary easing could lead to overreliance on depreciation of the yen.”

If Japan opts for the latter course anyway, the question would still remain as to how tolerant other countries would be of a weaker yen.

Japanese policymakers might have to heed the IMF’s advice and adopt bolder structural reforms as relying on a-weaker yen to help solve Japan’s problems no longer seems an internationally acceptable strategy.