The value of the yen has fallen sharply since Prime Minister Shinzo Abe took office in December on a promise to defeat deflation, while the Bank of Japan’s decision this month to ramp up its asset-buying program has fueled its decline.
In theory, the yen’s depreciation should be positive for Japan’s trade balance.
A weaker currency generally boosts demand for a country’s exports as they become cheaper in international markets, while dampening domestic consumption of imports as their prices increase in local currency terms.
But, paradoxically, the opposite is happening in Japan.
Japan posted a trade deficit of ¥777.5 billion in February – the country’s eighth consecutive monthly trade shortfall – as exports fell 2.9 percent from a year earlier and imports rose 11.9 percent.
The persistent trade deficit confirms a call made earlier this year by Credit Suisse, which forecast the depreciation in the value of the yen would do little to improve Japan’s trade balance, at least in the short term.
“Our analysis thus indicates that a depreciation of the yen will not boost export volume sufficiently over a one-year horizon to offset the negative impact of a deterioration in the terms of trade,” Credit Suisse analysts said in a report entitled “Devaluation of the Yen Would Widen Trade Balance Deficit.”
So, why isn’t the depreciation in the value of the yen translating into stronger demand for Japanese exports and weaker imports?
Part of the reason, according to Credit Suisse economists Hiromichi Shirakawa and Takashi Shiono, is that Japan has a virtual monopoly over some products, such as certain electronic components and high-tech materials, which means fluctuations in the value of the yen have limited impact on overseas demand.
Customers who need these products are buying them, regardless of the value of the yen.
“Given that the ‘average’ Japanese manufactured export can be considered somewhat differentiated in this fashion, there is likely to be a certain threshold (saturation point) beyond which depreciation of the yen has relatively little impact on foreign demand,” the analysts wrote.
“Similarly, if differentiated Japanese-made intermediate products are an essential input into the manufacturing process (meaning that demand is relatively price inelastic), then an appreciation of the yen should have comparatively little impact on export volume in the short term.”
Another reason is the global economic downturn, especially in China.
Shipments to China – one of Japan’s most important export markets – have fallen sharply in recent months largely due to the slowdown in the world’s second-largest economy. A bitter territorial dispute between Tokyo and Beijing over a string of islands in the East China Sea contributed too.
On the other side of the trade balance, Japan is wrestling with a soaring import bill, Credit Suisse noted.
Imports of natural gas and oil have risen sharply since Japanese power generators switched to fossil fuels from nuclear power. The government shuttered nuclear power plants in response to the 2011 Fukushima Daiichi disaster.
The weaker currency has driven up the cost of these energy imports, exacerbating the country’s trade deficit.
Credit Suisse expects Japan’s trade deficit to persist until the end of next year, which the Brookings Institution’s Joshua Meltzer thinks is not such a bad thing as the country seeks to reduce its reliance on exports to drive economic growth.
“Part of what’s going on in Japan at the moment is an attempt to rebalance some of their domestic drivers so they are less dependent on external demand and have more robust domestic demand, which can drive the economy,” Meltzer, a trade policy expert, told The Financialist
But there could be a tipping point.
Over the longer term, a stalled export machine – despite a weakening yen – could cause expectations of further yen depreciation, triggering “an outflow of domestic savings of sufficient magnitude and speed to destabilize financial markets,” Credit Suisse warned in a report entitled “Three years to go for CPI to rise to +2%, but…”
This could ultimately leave policymakers with little option but to start defending the currency by hiking short-term interest rates, which are currently hovering near zero.
If that happens, the value of the yen could start heading north.
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