Yen Weakness A Cause For Asian Concern

As the economic prowess of Japan in Asia is irreplaceable at the moment, the movement of the yen would continue to exert immense influence on its Asian neighbours, according to the latest issue of the Hang Seng Economic Monthly.

As Japan's prolonged economic stagnation arises from its domestic sector rather than its external sector, the effectiveness of a weak yen in stimulating the domestic economy is doubtful, the report states. The impact of yen fluctuations on China would become more evident in the future as it would be more vulnerable to global economic volatility following its World Trade Organization entry. Despite a decade of economic stagnation, Japan has remained the region's greatest investor, creditor, trader and technology-provider. Owing to its dominance in the regional production network, the dollar/yen rate has been an important factor in shaping Asia's business cycle since the mid-1980s. A weak yen would result in declining export revenue for many Asian countries, slow Japan's capital outflow and place great competitive pressure on regional producers with the ability to compete directly with Japanese firms. A vicious cycle of deflation, the weak balance sheet of the banking sector and the failure of expansionary monetary and fiscal policies have underpinned Japan's sluggish economy for some time. Recently, lack of public confidence in Japan's economic outlook and the government's tolerance of a weak yen in the hope of boosting exports have exacerbated the yen's weakness. The yen dropped from 116 to the US dollar last August to the current 133-135 level. However, the crux of Japan's stagnation does not lie in its external sector. The export sector has performed well in the past decade, maintaining decent export growth and a huge current account balance. The Japanese economy has to undergo fundamental reform in its domestic sector in a bid to revive itself, the report states. Due to the deepening of Sino-Japanese economic relations, the Mainland economy would inevitably be affected by yen volatility. The Mainland economy started receiving massive foreign investment and technology transfer from Japan in the early 1990s. In 2001, Japan was the Mainland's largest import origin and third largest export destination. During the Asian financial crisis in 1997-98, when the yen fell from 111 to 147 to the US dollar, the Mainland suffered from shrinking external demand from Japan in terms of exports, tourist arrivals and foreign direct investment (FDI). Mainland producers would find themselves increasingly susceptible to foreign currency fluctuations as the protection they enjoyed would be reduced after the country's WTO entry. All import quotas will be phased out by 2005. A Tariff Rate Quota system, offering protection to local peasants, is also undergoing gradual liberalisation. The recent yen weakness could also accentuate the pressure on the Mainland's domestic economy. Through depressing the intra-regional investment and trade flows and thus weakening the economies in the rest of Asia, a depreciated yen would mean slower growth, rising unemployment and a worsened balance of payment position for the Mainland. As the Mainland would probably respond to the waning external demand with a substantial increase in public spending, a weak yen would also translate into a larger fiscal deficit, which was already about 3% of GDP in 2000. A weak yen would remain a source of uncertainty in Asia and exchange rate stability is likely to be a major concern for the region, the report states.