Yen Fragile Five Membership Risks Losses Backfiring
Japan’s encouragement of yen depreciation to boost the economy threatens to backfire by making the country dependent on foreign investors for funding.
That’s the very same economic weakness that prompted Morgan Stanley to describe emerging-market currencies from South Africa’s rand to Turkey’s lira last year as the “fragile five.” While the yen is still regarded by investors as a safer bet than any of those developing currencies, the prospect of 33 years of current-account surpluses coming to an end may dent its appeal as a haven, according to Brown Brothers Harriman & Co.
“As Japan’s current account continues to deteriorate, we may see bad currency weakness, just like the fragile five,” Masashi Murata, a Tokyo-based currency at strategist Brown Brothers Harriman, said in a March 26 phone interview. “Japan may enter the fragile list as early as this year.”
The yen has weakened 16 percent since December 2012, when Prime Minister Shinzo Abe was elected on a pledge to flood markets with cheap money and end 15 years of crippling deflation by keeping the currency in check. Those losses have pushed up the costs of imports, increasing the current-account deficit to a record 1.59 trillion yen ($15.5 billion) in January.
Economy Minister Akira Amari warned on March 3 that a permanent current-account deficit would have an immediate impact on the credibility of government bonds. Speaking in parliament today, Abe said he will monitor the current-account balance with interest and that he will keep working toward maintaining trust in Japan’s bonds.
The yen tumbled to a more than five-year low of 105.44 yen per dollar on Jan. 2. It has rallied 2.8 percent this year amid a selloff in emerging markets and growing tensions in Crimea, and was at 102.83 as of 1:18 p.m. in New York.
Japan is one of just five nations to have posted annual current-account surpluses every year since 1981, enabling it to become the world’s largest creditor, with overseas assets worth a net $3.42 trillion as of 2012. This month, the Ministry of Finance flagged the risk of twin current-account and fiscal shortfalls for the first time in at least three decades, as exports failed to keep pace with imports and more Japanese companies moved their manufacturing operations overseas.
“The structural change in Japan’s current account is the main driver of our weaker yen call,” Peter Dragicevich, a currency strategist at Commonwealth Bank of Australia in Sydney, said by phone on March 21. “The collapse in Japan’s current-account surplus reflects reduced saving by Japanese households and businesses. We expect these trends to continue in 2014.”
CBA, Australia’s biggest lender by market value, predicted the yen will weaken 16 percent to 119 per dollar by year-end. The median estimate of 60 strategists surveyed by Bloomberg puts the currency at 110.
Japan may have a better chance of maintaining a current-account surplus this year after imports fell 18 percent in February from the previous month’s record 8.04 trillion yen. The nation has been buying in more goods since the earthquake that led to the nuclear reactor meltdown at Fukushima in March 2011.
“Imports have little room to increase from here,” Takahiro Sekido, who worked at the Bank of Japan before joining the Bank of Tokyo-Mitsubishi UFJ Ltd., said March 26 by phone. “The current-account deficits are short-term phenomena and the balance is more likely to turn to surplus.”
The only other nations to have achieved uninterrupted annual current-account surpluses since 1981 are Taiwan, the Netherlands, United Arab Emirates and Switzerland, according to the International Monetary Fund.
Should Japan be forced to leave that distinguished club, it may find its currency lumped in by investors with another group -- one that no nation wants to join.
Morgan Stanley dubbed the rand, lira, Brazilian real, Indian rupee and Indonesian rupiah the “fragile five” in August because of their reliance on foreign capital to finance deficits in their current accounts. Indonesia and India have improved their trade balances and raised interest rates since then, helping their currencies shrug off the tag and rally 7.1 percent and 3.2 percent respectively this year.
Japan’s deteriorating trade position also risks the unstoppable “avalanche” of yen losses that billionaire investor George Soros warned about a year ago, as well as calling into doubt the nation’s capacity to service a debt pile almost 2 1/2 times the size of its economy.
While the unprecedented 60 trillion yen to 70 trillion yen a year that the BOJ is pumping into Japanese markets through bond purchases has succeeded in depreciating the currency, it’s failing to buoy gross domestic product. Expansion slowed to an annualized 0.7 percent in the fourth quarter, from 0.9 percent in the previous period, official data showed March 10.
The Topix index of Japanese shares surged 51 percent last year, the most since 1999, on speculation a weaker yen would help exporters. With the trade position offsetting the effects of the lower exchange rate, the gauge dropped 8.9 percent since Dec. 31, the biggest loss in developed markets.
“The history of the strong yen is the history of current-account surpluses,” Daisuke Karakama, a markets economist at Mizuho Bank Ltd., a unit of Japan’s third-biggest financial group by market value, said by phone on March 24. “Yen depreciation was regarded as a good thing because it would boost the trade surplus, corporate earnings and stock prices. But I’m worried we’re nearing the situation where a weak yen benefits nobody.”
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