Yen Set To Continue Weakening Throughout 2001

We expect the yen to weaken over the course of 2001, but the approach of the end of this financial year on March 31 brings the possibility of a temporary yen strengthening. The fall in the Nikkei may force Japanese banks to report unrealised losses at the end of the financial year.

To offset these losses, they may realise profits that they have made on overseas assets and repatriate the funds. But some analysts believe that yen repatriation will not be as strong this year, as Japanese financial institutions have already sharply cut back their overseas asset holdings. The view is partly based on the fact that when life insurer Kyoei collapsed, its overseas exposure was found to be much smaller than the previous year.

Diminishing confidence in the economic recovery has led to a broad-based weakening of the yen. It has also combined with weakness in international stock markets to bring about another downturn in the Nikkei, which has been in a downtrend since April 2000. Even when optimism over economic growth was high, bankruptcies and the unwinding of the shareholdings that Japanese companies hold in one another dragged the Nikkei lower.

Unwinding of cross shareholdings is likely to remain a negative influence on the Nikkei in the next few months, as Japan introduces mark-to-market accounting rules on cross-held shares when the new financial year begins in April.

A strong rise in corporate profitability led to a surge in investment spending on high-tech products in Japan during the year 2000. The hope was that this would have knock-on effects, which would lead to a rise in personal incomes and bring about a recovery in consumer spending.

But by mid-December, fewer and fewer analysts remained optimistic that the high-tech stimulus could overcome what are frequently known as Japan's "structural headwinds". The Bank of Japan's quarterly Tankan survey showed that sentiment among Japanese corporations had improved only very slightly since September 2000, and the Bank's December monthly report said the economy was likely to grow at a slower pace than had previously been expected.

The term "headwind" is used to describe the problems of overcapacity in Japanese companies, which need to be removed before the economy can recover strongly.

Apart from the high-tech sector, firms have excessive stocks of capital, and a survey conducted in 2000 by the Economic Planning Agency (EPA) showed that most of the managers in major companies believe it will take two or more years to reduce their capacity to optimal levels. This is likely to keep a cap on investment spending over that period.

Japanese companies also have excess labour costs. Some 45% of respondents to the EPA survey said it could take over two years before labour costs are reduced to optimal levels. Nearly 50% said that current employment costs are 5--10% above optimum levels. So fear of redundancy is likely to prevent a large rise in consumer spending.

Japanese banks still hold large amounts of shares in other Japanese companies, and a falling equity market means they have lower assets against which they can write off bad loans.

The current collapse in the Nikkei has led to fears of another financial system crisis in Japan, and has prompted some members of the LDP party to call for public money to be used to shore up the equity market.

We do not expect this to happen, but believe the Japanese authorities will encourage a weakening of the yen. Such a strategy would allow the shares of exporters to recover some ground and, going by recent comments from Finance Minister Muiyazawa, it is a policy that already appears to have been adopted.