Is the Weak Yen Benefiting the Japanese Economy?
This year has seen a major drop in the value of the yen against the USD, slipping to a two-decade low but is this a benefit or a disadvantage to the Japanese economy, businesses, and consumers?
Japan has a different view on inflation the other major industrial nations as the Bank of Japan (BOJ) is committed to maintaining very-low interest rates to revive inflation on a sustainable basis after many years of deflation while the US Federal Reserve has chosen to roll back stimulus programs and raise interest rates.
The sharp fall in the yen has the raised the question whether the BOJ needs to intervene as Japan’s post-Covid recovery is moderate while the trade deficit increased to 2.82 trillion yen ($19.7 billion) in August creating further downward pressure on the yen. This trade deficit is expected to increase again in September.
The Japanese government has put in place a series of measures, including higher fuel subsidies, to ease the impact of higher costs for households and businesses and inflation is much lower than in the US and other leading countries. The government has estimated real economic growth of 3.2% in fiscal year 2022-2023, an increase on the prior estimate of 2.2%. But with debt still accounting for 34.3% of the budget, it will remain difficult to achieve the target budget surplus by fiscal year 2025-2026. The current budget deficit, excluding new bond sales and debt servicing will be about 13 trillion yen in fiscal year 2022-2023, a 20 trillion yen improvement on the past year, but still a long way from the government’s target budget surplus.
What does a weaker yen mean for the economy?
In general, a weaker yen helps Japanese companies operating globally because it boosts their exports. This, in part, has caused Japan’s corporate profits to rise to their highest levels since 1954 despite there being no noticeable increase in the quantity of sales.
A weak currency also helps tourism by making everything cost less in yen due to the advantageous exchange rate.
A disadvantage is that all imported items will cost more, rising almost 50% in value from a year ago, leading to an increase in inflation and consumers are affected as salary increases are not keeping up with the cost of living.
In addition, increasing costs of commodities and other goods are squeezing profits of businesses that rely on imports.
Exchange Rate Drop
The yen has fallen below 140 per dollar for the first time in almost a quarter century – a drop of about 20%.
The main reason is the higher interest rates in the US. Yields on US Treasuries have grown while the BOJ has kept a 0.25% cap on Japan’s 10-year government bond yield. The yield on Treasury 10-year notes has climbed above 3%, the highest since 2018, as traders are assuming that the Federal Reserve will continue with further interest rate increases.
The BOJ decided in April to buy as many bonds as necessary to protect the 0.25% ceiling on 10-year debt yields which means that the yen can be expected to fall further if US Treasury yields continue to increase.
The BOJ has been resistant to increasing interest rate as it feels that the ongoing fight against deflation is not yet over. Currently inflation is above 2% but the bank thinks that the current trend is unsustainable and expects the inflation target to be met again by spring 2023. These lower borrowing costs also help the government to keep increasing public spending to help Japan’s economy recover from the pandemic and to stimulate exports, but exports appear to be slowing down compared to a month ago, suggesting growth is already beginning to slow in Japan’s key markets which include the US and Europe.
The Japanese government stepped in to strengthen the yen by selling dollars on 28th September for the first time since 1998 after the currency fell to a 24 year low against the USD. Currency officials stated that this was a one-off move in the FX market, and it caused the yen to increase in value to 140 to the dollar.
The Japanese yen, adjusted for inflation, is at its lowest level since the early 1970s. In the past, the low value of the yen would have caused friction between Japan and the West which would be worried about cheap Japanese imports but now the weakness of the yen is giving issues inside Japan.
Some analysts suggest that to raise interest rates would be a mistake as this is fresh opportunity for the BOJ to achieve its outstanding goal of reflation of the Japanese economy.
Japan holds $1.2tn in foreign currency reserves, which grew when the yen was too strong instead of being too weak. The BOJ could choose to sell some of these reserves and use the proceeds to reduce public debt, but the sentiment is that this action would have little medium-term impact on the exchange rate. Instead, it is better to use the weak yen to stimulate exports and move inflation closer to the 2% target.
In the past, Europe and the US would worry about cheap Japanese exports, but in these inflationary times this is no longer the case, and weak yen suits both Japan and the US in some aspects and the BOJ could just let the yen rate continue to fall.