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Yen for a change? | 24th February 2014

Why devaluation of the Yen is unlikely to boost exportsShinzō Abe could not have been clearer in 2012: reversing the appreciation of the Yen since the start of the financial crisis in mid 2007 would stimulate export-led growth and assist a general objective of reflating the economy through higher import prices. Assuming a J-Curve effect, where the trade deficit would close after a short time-lag following a currency depreciation his view was that the policy would change Japan’s economic fortunes sustainably for the better.

Last week’s news that Japan’s trade deficit had widened was a confirmation that the J-Curve effect is not happening in Japan. In fact, the Yen has been depreciating against the US Dollar since October 2012, before Abenomics, and there is no sign in the Delta Economics forecast that there will be any pick-up in exports for the foreseeable future. Our forecast for Japan’s imports in 2014 has fallen slightly from 0.77% growth to 0.75% growth since September, but our forecast for export growth in 2014 has dropped from 0.14% growth in September last year to 0.01% growth now.

Some of this is because of the general failure of world trade to pick up pace in 2014. Japan is being particularly severely affected by this. Figure 1 shows Japan’s largest export partners and its forecast growth in 2014 with each.

 

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Figure 1 | Top ten largest export partners: forecast growth in exports 2014

Source | DeltaMetrics 2014

 

Trade with developed world partners is forecast largely to fall back this year with a particularly severe drop in trade with the US (-5.66%) and Germany (-1.31%). Even trade with its emerging economy partners in the Asia-Pacific region is not forecast to grow as quickly as we were forecasting in September 2013. For example, we were then forecasting that export trade with China would grow by 2.53% and we are now predicting somewhat slower growth at 2.42%.

The existence (or not) of a J-curve means that link between Japan’s trade and the value of the Yen per US Dollar exchange rate must be strong. Over the whole period, the correlation between the Yen in US Dollar terms and trade has been negative, at -0.48 which suggests both that imports may not always fall in line with expectations (rising when the currency depreciates) and that the relationship may not be strong enough for a J-curve effect. Figure 2 shows the trade ratio relative to the Yen-US Dollar exchange rate and demonstrates that the J-curve effect has not been working since April 2010.

 

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Figure 2 | Japan’s exports and imports against Yen-USD exchange rate, 2001-2014 (Yen per 1 USD)

Source | DeltaMetrics 2014, Bloomberg

 

Between June 2001 and January 2004 the Yen appreciated and exports declined relative to imports. A mild depreciation of the currency in Q1 2004 led to an increase in the ratio which continued until mid 2007 when the Yen started its more than five-year appreciation relative to the US Dollar. Exports fell relative to imports during this period. The rapid increase in trade in 2010 explains the sharp increase in the ratio from Q2 2010, despite sustained appreciation of the Yen, and was a consequence of catch-up after the global trade collapse in 2009.

 

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Figure 3 | Japan’s trade ratio (Exports divided by imports) against Yen USD exchange rate, 2001-2014 (Yen per USD)

Source | DeltaMetrics 2014, Bloomberg

However, what is really clear from Figure 2 is the sharp drop in the ratio after May 2011. This date is significant because it is 2 months after the Fukushima disaster. Exports relative to imports have not recovered since, despite mild depreciation of the currency from May 2011 and strong and sustained depreciation, arguably, since August 2011. In other words, the relationship between the Yen’s value and trade started to break down as early as 2010 when trade recovered from its global collapse.

The other striking observation from this chart is that the currency and trade are not especially correlated. There are few lags evident between a change in the currency’s value and a change in either exports or imports and over the period since the financial crisis, the correlation is relatively weak (-0.173) for imports and even weaker (-0.057) for exports. The negative correlation between imports and the Yen per US Dollar exchange rate points to a fact that as the Yen depreciates, imports will increase. Since 2011, this trend has become more obvious with the negative correlation strengthening to -0.606.

What might be behind this strengthening of the negative correlation with imports? Since Fukushima, Japan’s energy demand has been met increasingly by imports, particularly of Petroleum Gas, as illustrated in Figure 4. What this suggests is greater dependency on outside supply of energy and this is evidenced, not only in the increased imports of gas, coal and refined oil, but also in the fact that imports from Australia are forecast to grow by over 3% and from the Netherlands (which is a major oil and gas exporter) are forecast to grow by nearly 9% in 2014.

 

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Figure 4 | Largest exports and import products: forecast growth in trade 2014

Source | DeltaMetrics 2014

 

A steady increase in mineral fuel and iron and steel imports has been evident in the data since before the Fukishima disaster, however. Since the post-trade collapse recovery, it is imports of iron and steel, not energy, into Japan that have grown most strongly. Although demand for mineral fuels did rise after June 2011, the acceleration was not actually as fast as the previous two-year period from mid 2009, as illustrated in Figure 5. And, as the graph also shows, since December 2012, imports overall of mineral fuels have remained relatively static with a slight dip towards the end of 2013.

 

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Figure 5 | Top three import sectors relative to Yen-USD exchange rate, June 2001-Jan 2014

Source | DeltaMetrics 2014, Bloomberg

So is there any chance of export-led growth and a J-Curve effect? The decline in exports of Japanese cars of nearly 4% shown in Figure 4 is replicated at a sectoral level. Sector-level exports of vehicles, electronics and machinery, boilers and nuclear reactors seem impervious to changes in the exchange rate, as illustrated in Figure 6. Even during a period of strong currency appreciation exports rose and, since the depreciation in Q4 2012 exports have fallen.

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Figure 6 | Japan’s Top 3 export sectors against Yen per USD exchange rate, June 2001-January 2014

Source DeltaMetrics 2014, Bloomberg

 

Assumptions about the J-curve and its impact on trade rest on a belief that policy can over-ride the power of markets to influence the value of a currency. Since the financial crisis, currency markets have sought a reserve currency alongside the US dollar and, until October 2012, the effect was the appreciation of the Yen versus the dollar. Abenomics has been successful in convincing markets that it is on a course to reflate the Japanese economy and set it back on a path of export-led growth. Recent data on the deficit suggest that the policy has had little effect so far. The ability of Japanese policy makers to over-ride the market will only last as long as the market belief in the policy is sustained. Delta Economics forecasts suggest that this might not be for very long and that any further depreciation, however desirable, might be because of lack of faith in Japan rather than a direct consequence of policy.