A Closer Look at Japanese Yen Depreciation and its Impact on Growth and Equities
Weakness in the Japanese economy has given investors reason for concern. Recently released data showed that GDP grew just 0.2% quarter-over-quarter (qoq) during the last three months of 2013. This worked out to be a qoq annualized rate of merely 0.7%, and marked the second consecutive quarter of weaker growth relative to the preceding periods. Growth in the country has softened despite significant monetary and fiscal stimulus, and it is especially concerning considering that an impending tax increase (April 2014) has pulled some consumption forward.
Yen Depreciation and Economic Growth
A deeper dive into the growth data reveals that currency depreciation may not be having the desired effect on the Japanese economy. The yen has depreciated more than 25% versus the U.S. dollar since the beginning of the third quarter of 2012 and has had a similarly pronounced downward move relative to other major currencies including the euro, British pound, Canadian dollar, Chinese yuan and the South Korean won. Conventional wisdom tells us that a weak yen makes Japanese exports more competitive, and by this logic, exports should have risen markedly since the third quarter of 2012. To be sure, the data confirms that on an absolute basis, exports have risen significantly since the latter half of 2012.
However, it is also important to remember the other side of currency depreciation when considering its impact on the Japanese economy. While a weaker currency increases the relative attractiveness of a country’s exports, it also increases import prices, which is precisely what has happened in Japan. While exports have risen markedly since the currency began to depreciate, the rise in import levels has overwhelmed the gains made on the export front. Given that net exports is a component used in the calculation of GDP, the nation’s widening trade deficit is negatively impacting economic growth. Japan recorded the widest trade deficit in the country’s history in January of this year.
Most of the deterioration in the trade balance has been due to a dramatic increase in energy imports, with Japan now having to import 93% of its domestic energy fuel needs versus 80% prior to the March 2011 Tohoku earthquake and tsunami. The devastating after effects of this traumatic event included a shut-down of all of the country’s nuclear plants, which had contributed as much as 30% of the country’s total energy needs. While Japan’s energy import needs have gone up, Prime Minister Shinzo Abe’s commitment to looser monetary and fiscal policy has also meant that as Japan’s currency has depreciated, individuals and businesses alike have to pay more for the increased energy imports. The nuclear reactor shutdown and its impact on the trade accounts has understandably become a point of serious contention in Japanese political discourse. Restarting the nuclear reactors would go a long way toward helping the country’s trade accounts and GDP growth. The government has recently moved to outline a resumption of nuclear generation, with four reactors expected to come back online in the next few months.
Implications for Equities
While economic growth in Japan has slowed and is likely to be negatively impacted by the coming value-added tax (VAT) hike, we believe that opportunities still exist in the Japanese equity market. To this end, we are focused on identifying world-class companies that sell their products into markets outside of Japan. While a resumption of nuclear power generation may have a positive impact on the trade accounts, GDP growth, and therefore the yen, we believe that the loose monetary and fiscal policies being pursued today by Abe and the Bank of Japan are likely to continue throughout 2014 and into 2015. This should guard against too much yen strength in the near term, and as such, benefit the types of businesses mentioned above. In the longer term, we believe that the path of least resistance for the yen is downward, given the country’s aging population, declining labor force and high levels of debt. In our view, a weaker yen is a positive for the Japanese equity market, and in particular, for companies that stand to benefit from an increase in the competitiveness of Japanese exports.
