Japan's slow economic growth and rapid capital outflow are increasing depreciation pressure on the yen.
Many yen watchers cite the still-wide interest rate gap between Japan and the U.S. as a reason for the yen’s continued weakness, especially given the inflationary policies that may be adopted by President-elect Trump. Less visible but equally influential are trade and investment flows to and from Japan.
Japan posted a current account surplus of 8.97 trillion yen ($57.5 billion) in the third quarter, but that was offset by outflows of direct and portfolio investment. The yen rebounded to a 14-month high against the dollar in September as traders unwound yen carry trades, but has since weakened by about 10%.
Shusuke Yamada, head of Japanese currency and rates strategy at Bank of America in Tokyo, said that “direct investment and securities investment are offsetting the current account surplus,” limiting the yen’s potential gains. Given that a large part of the surplus comes from primary income and is reinvested abroad, “it’s easy to be misled if you only look at the current account balance.”
The current account measures imports and exports as well as other cross-border flows including wages and investment income. Japan posted a record primary income surplus of 12.2 trillion yen in the third quarter, mostly investment income. That offset a deficit in goods and services, boosting the current account surplus.
“The trade deficit has led to selling of the yen to cover demand for foreign exchange. This trend will continue,” said Hideki Shibata, senior fixed income and foreign exchange strategist at Tokai Tokyo Intelligence Laboratory Co., Ltd.
In addition to portfolio flows, the data also reflects direct investment - money that companies bring in to do business in Japan, which has one of the lowest direct investment rates among major economies.
“The barriers to entry for overseas companies are high,” said Tsuyoshi Ueno, senior economist at NLI Research Institute in Tokyo. “The business environment is complicated for overseas companies starting up in Japan, and the market won’t expand because Japan’s growth rate is low.”
Direct investment outflows from Japan have exceeded inflows in nearly every quarter since 1996. Outstanding foreign direct investment in Japan was 8.3% of gross domestic product at the end of June, the lowest among the world’s 20 largest economies, according to a Bloomberg analysis of International Monetary Fund data.
This compares to 99% in the UK and 57% in the US.
Japan’s potential economic growth has stagnated over the past two decades, with the most recent reading at 0.6%, according to the central bank’s estimates, supporting the case for deepening capital outflows.
Japan has attracted more portfolio investment, with outstanding balances accounting for 90% of gross domestic product. However, most of these inflows have not led to yen appreciation because they are currency hedges, said Hirofumi Suzuki, chief foreign exchange strategist at Sumitomo Mitsui Banking Corporation in Tokyo. "Most of these inflows are also speculative, and demand for long-term holdings has not grown."
Because Japan's interest rates are much lower than those in other economies, hedging against a weaker yen can generate positive returns for overseas investors unless the yen appreciates significantly to offset the interest rate differential.
“There are very few investment opportunities in Japan, which means most overseas dividends and redemption proceeds are reinvested,” said Shibata of Tokai Tokyo Research Institute.
Article forwarded from: Jinshi Data
