Asiamoney: What Abenomics means for Asian currencies

Asiamoney, June 2013

When Prime Minister Shinzo Abe and the Bank of Japan set about their audacious bout of quantitative easing to reflate the becalmed Japanese economy, the yen fell far and fell sharply, recent bounces notwithstanding. But what of the impact on other Asian economies and their currencies?

The answer varies considerably depending on the country and the timeframe. “It’s a mixed picture,” says Mitul Kotecha, FX strategist at Credit Agricole CIB. “The obvious conclusion would be to say that a weaker yen would have negative consequences for the competitiveness of other countries because it will hit their exports. But at the same time, a stronger Japanese economy will mean capital outflows into the rest of the region and potentially stronger currencies. There are two conflict views and the impact is not obvious.”

There are several mechanisms through which a weak yen impacts other Asian nations.

“Easing in Japan should affect other countries through three channels,” says Sameer Goel, head of Asia rates and FX research at Deutsche Bank. “The first, the most dominant and the most obvious, is trade, in particular in countries where the export baskets are similar to Japan’s. The second is the portfolio aspect: to the extent that the Bank of Japan is committed to expanding its balance sheet and creating liquidity, it begs the question where that liquidity will get deployed. And the third is the supply chain channel: Asian countries which are linked into the Japanese supply chain.”

The first is the easiest to see – particularly if you’re in Korea. Korea’s economy is the one that looks most like Japan’s from an export perspective, with electronics, automobile and manufacturing industries. “In the first four months of this year, if you look at the performance in Asian currencies the biggest loser was the Korean won, because the export similarity was the highest,” says Tan Teck Leng at UBS in Singapore, adding that the Taiwan dollar was the second worst performer, reflecting the second greatest export similarity. Correspondingly, the Bank of Korea has been the most vocal of Asian central banks in complaining about Japan’s behaviour.

Korea is hit in several different ways, explains Rob Subbaraman, chief economist for ex-Japan Asia at Nomura. “Firstly, Korea’s exports in Japan can lose competitiveness because Japanese local firms suddenly have an advantage over Korean ones. Another way it can hurt Korea is Japanese firms selling into the Korean market: those firms in Korea that compete with Japan are suddenly less competitive. And the third way is indirect: Samsung and Sharp, for example, competing in the US market.”

Numbers clearly show Korean exporters hurting already. Korea’s exports to Japan fell 11.3% year on year in April, and then 22.4% in May. The impact on the overall economy has not yet been keenly felt, because exports to other parts of the world have not yet been demonstrably impacted, and because Korea itself has fought back with stimulus, lower interest rates and efforts to weaken the won. “Our view is Korea’s economy will actually strengthen,” says Subbaraman. “It’s weak at the moment, but we will see a pick-up.”

Beyond the obvious examples of Korea and tech-heavy Taiwan, Singapore deserves scrutiny, although it has not been affected as much. “You can’t disregard the weakness in the yen because it counts for almost 12% of the trade-weighted basket Singapore manages its currency against,” says Tan.

The trade impact most obviously affects the currency through exports, but as an aside, it does also tend to flow through in stocks too. “There is a subset of this trade channel which is that competitiveness clears itself out through earnings expectations for corporates,” says Goel. “If you look at 2004 and 2007 – the last periods of significant yen weakness – a lot of this competitiveness play came through the relative performance of the equity markets, when there was a very clear outperformance of Japanese corporates and the Nikkei versus Korean corporates and Kospi.”

The second theme, around liquidity and portfolio flows, is an interesting one because it isn’t yet playing out as many expected: as the article on the Australian dollar elsewhere notes, easing has not led to an outflow of funds from Japan into the high yielding Australian dollar as one might expect, but a repatriation of capital back to Japan. Similar dynamics may be at work in Asia. “So far there is little evidence in flow data to show that Japanese money is funding its way into the rest of Asia – or anywhere else, for that matter,” says Kotecha. “There is huge expectation that Japanese life insurers and, in particular, the government pension investment fund could be major buyers of overseas assets in coming months. It’s on the cards. But the evidence is not there.”

Goel adds: “In general Asia has not been, and I suspect will not be, a very major part of the shopping basket for Japan. Most Japanese investment historically has either been in developed markets or the high carry market.” Where there are portfolio flows, Goel thinks they will benefit Asean bond markets rather than, for example, North Asian equity markets.

So why isn’t this money flowing out of Japan? Subbaraman at Nomura – which sees plenty of the flows in question first-hand – believes that “local institutions like the big pension and insurance companies are not fully sold that Abenomics is going to work and that there is really going to be much of a change. They haven’t yet become a lot more risk-taking.” Besides that, the weakening of the yen has effectively increased their holding of foreign assets without them doing anything, because domestic assets are decreasing in value in dollar terms. “So there is less need to allocate more overseas as yen depreciation has done it for them.” Thirdly, despite an initial fall in Japanese government bond yields, they have since backed up, as the yen has staged a slight rebound.

Besides, the fact that the money hasn’t flowed out of Japan yet doesn’t mean that it won’t. John Woods at Citi agrees that “reflation in Japan has been almost entirely internalised: invested in domestic assets like the Nikkei and JGBs”. But this may not remain the case, he says. “If you are a sceptical domestic investor and believe the Nikkei has peaked, that liquidity will start exiting Japan and look for earnings opportunities offshore. That is one reason people are becoming a bit more positive towards Asian equities.”

Tan at UBS says that, to the extent that capital movement does eventually leave Japan, “the high yielders in Asia will benefit, the Indonesian rupiah and Indian rupee, assuming the Fed doesn’t taper off too quickly.” And in June the Government Pension Investment Fund stated that it would increase its allocation to foreign bonds, suggesting that it may only be a matter of time before money does start to leave Japan in search of yield. “If Japan really does double its monetary base in two years, that will be unprecedented, and it creates more scope for outflows to foreign bond markets, Tan says.

Then there’s the supply theme. “A stronger, more economically vibrant Japan has a more positive effect on the rest of Asia, particularly those which have a close supply chain relationship,” says Woods at Citi. “In particular I’m talking about Thailand, China and even the Philippines. Obviously it helps them if Japan is on a sustainable growth path.”

Thailand is the classic example of the supply chain theme, as it is responsible for so much of the manufacturing and assembly of Japan’s automotive industry, notably Toyota. Malaysia is another beneficiary, but Thailand has had the most visible improvement: in the first few months of the year, the baht strengthened almost 5% against the dollar.

In aggregate, these themes together “lead you to conclude that North Asia, being more of a competitor to Japan, stands to have more to lose than some parts of southeast Asia which benefit,” Goel says. Still, even in North Asia, there may be a good outcome from all of this. “If Abenomics works,” says Subbaraman, “and the Japanese economy comes out of deflation with stronger growth, ultimately it could be very positive for the rest of Asia. After all, Japan is the third-largest economy in the world, and if it comes back the demand effect will be very good for Asian exports to Japan.”

Naturally, Japan is not the only thing influencing Asian currencies, and as time has gone on developments in the USA have come to be still more influential, as the market attempts to work out just when the tapering off of US quantitative easing will take place. Deutsche, for example, argues that if the falling yen is the defining theme, the currencies most affected are the Korean won, Taiwan dollar and Singapore dollar; if the theme is instead the US treasury one, then those most at risk are the Indonesian rupiah, Indian rupee and Malaysian ringgit. “What could end up happening is a mix of both themes playing out,” says Goel. “They do have a common element:  a strong dollar.”

And all of this presupposes that Japan stays the course on its bold reflation strategy – which is not certain, given the controversy in Japan about whether it is the right way to go. “I do think there are still risks to this policy, in that the next big phase for Japan has to be reform and productivity improvement,” says Kotecha. “I think Japan will get to 2%, though maybe not as quick as it hopes; whether it sustains it depends on these reforms being carried out.” Upper house elections are coming in July, and the market will be looking closely for guidance from their results.

In the meantime, reading the signals is going to be tricky. “The dynamics are quickly changing every single day,” says Tan.