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View all search resultsIndonesia and the yen: What should we expect?
The Japanese yen has depreciated sharply since October last year, falling by an average of around 20 percent in real, inflation-adjusted terms against its main trading partners
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T
he Japanese yen has depreciated sharply since October last year, falling by an average of around 20 percent in real, inflation-adjusted terms against its main trading partners.
Despite a bounce in recent days, the likelihood is that the yen will continue to depreciate over the next year or so, with considerable implications.
All and all, this yen depreciation is likely to be positive for Asia and Indonesia. To understand the yen, we must first understand Abenomics.
The trajectory of the yen is inextricably tied to the dramatic re-orientation of economic policy that Japanese Prime Minister Shinzo Abe initiated when he took office. We need to understand 'Abenomics' if we are to appreciate the full impact of the weaker yen.
Abe's aim is to restore Japan as a leading economic and political power. To this end, he is implementing a major fiscal stimulus, the first 'arrow' of three that he says he will fire at Japan's malaise in order to turn the country around.
The second arrow was the revolutionary change in monetary policy at the Bank of Japan (BOJ) whose management Abe had reshuffled in April. Since then, the BOJ has aggressively injected liquidity into the Japanese economy to achieve a targeted inflation rate of 2 percent, a sea change from the current deflationary situation of falling prices. As the supply of yen is expected to rise sharply, currency markets have pressed down its value substantially.
The third arrow of Abenomics is structural reforms ' the much more painful process of deregulating the economy and opening it up to greater competition by reducing barriers to trade. Since the pain of such reforms is immediately felt by clearly identified groups but the gain from such policies emerges only after many years and is spread thinly across a large number of people, the resistance to structural reforms is likely to be high.
As Abe's Liberal Democrats face Upper House elections in late July, he is not keen to outline the specifics of his third arrow.
Why will the yen fall further? Financial markets have become a tad nervous about Abenomics in recent days with these fears compounded by rising concerns about the Chinese economy and whether the US Federal Reserve might tighten monetary policy. As a result, the Yen has rebounded smartly.
This rebound will probably not last. First, the BOJ is aware of market worries that higher inflation will cause bond yields to rise and so inflate the cost of public debt, which will reach a towering 240 percent of gross Domestic product this year, a level which is larger than even Greece's. The BOJ will soon implement further measures to cap the rise in bond yields ' which will involve further quantitative and qualitative easing that will depress the yen.
Second, with the real shape of structural reforms only likely to be announced later this year, Abe needs to buy time. What is more, when structural reforms are implemented, they will inflict short term losses on sectors that are currently protected. Japan has to cushion the blow so as to contain the inevitable resistance to reforms. The only instrument he has to do this is monetarypolicy and a weaker yen.
Having gone so far, Abe will not sit back and see his new policy lose momentum ' he will pull out all the monetary stops to keep the recovery going. This can only mean a weaker yen.
Should Indonesia fear a weaker Yen?
There are several reasons to believe that Abenomics as a whole, including the weaker yen, will be positive for Indonesia and its neighbors. First, Indonesia's exports are more complementary than competitive with Japan's and this is also the case for the ASEAN economies.
Thus, a weaker yen will not hurt Indonesia's export competitiveness. In fact, as Japan's economy recovers with help from a weaker yen, Japanese demand will grow, supporting Indonesia's exports to Japan.
Second, foreign investment from Japan to Indonesia or Southeast Asia for that matter is unlikely to fall with a weaker yen, as many analysts believe.
These analysts think that a weaker yen makes expanding domestic Japanese production capacity more attractive than expanding overseas production. This ignores the more important determinants of Japanese investment in Indonesia than the yen.
Indonesia's low labor costs, the high rates of return on investment in Indonesia, its better demographics compared to China, the enticement of its huge consumer market potential and the geostrategic imperative of building strong ties with Indonesia, the third largest country in Asia, are too compelling to be offset by a weaker yen.
Third, financial markets will probably become a lot more volatile and this could be potentially damaging to Indonesia, as the ructions in currency, bond and stock markets last week showed. Abenomics is such a hugely innovative experiment with policy that financial markets are unsure about its success or effects. This leads to occasional bouts of unease as financial markets recalibrate their view on Abenomics. Such volatility hurts flows of capital into emerging markets such as Indonesia.
However, as the yen continues to weaken, Japanese investors are likely to push capital out, to take advantage of stronger external currencies. Such inflows of capital can be a double-edged sword, though. At one level, they can inflate asset values in Indonesia and elsewhere, which will boost wealth effects and reduce the cost of capital for businesses. But at another level, large and volatile capital flows could push local currencies up too fast, hurting exports and also causing asset bubbles such as in real estate.
Central banks in emerging economies quite often find it difficult to manage the effects of such inflows given how thin and shallow their financial markets are. It is vital, therefore, for Bank Indonesia to be proactive in employing macro-prudential measures to ensure that asset bubbles do not expand dangerously in Indonesia.
If Abenomics produces a revitalized Japan, that would be an unambiguous positive for Indonesia and ASEAN.
Unlike the northern Asian economies, which compete more directly with Japan, Indonesia and her neighbors will be net beneficiaries ' so long as they manage some of the downsides of volatile capital flows.
The writer is vice chairman of the Indonesian Chamber of Commerce and Industry (Kadin) and president director of PT Gobel International. The views expressed are personal.
