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Apr. 23. The store clerks sit waiting for Japanese tourists

By Kwon Eun-jung and Noh Hyun-woong, staff reporters

The Japanese yen is falling hard against the US dollar.

Early this month, Goldman Sachs raised its projected exchange rate for one year from now from 95 to 105 yen to the dollar. It also predicted the value may rise as high as 120 yen to the dollar in one year’s time. The current rate is about 99 yen to the dollar.

The steep drop began last September after Prime Minister Shinzo Abe became leader of the Liberal Democratic Party. He promptly announced plans to take aggressive monetary action by printing more yen. The central bank, the Bank of Japan, began buying up assets en masse in January. The yen weakened sharply amid a ballooning trade deficit - 5.8 trillion yen (US$58.3 billion) last year - and negative economic growth.

According to Bank of Korea figures, the yen had lost 29.7% of its average January 2012 value as of Apr. 22. The decline has been precipitous: the exchange rate was down 4.5 percentage points from its Apr. 5 level. The currency now looks poised for a prolonged low, with Bank of Japan governor Haruhiko Kuroda announcing at the House of Representatives on Apr. 4 that the institution “is doing all it can and will not hesitate to take additional steps as needed.”

Meanwhile, the won-to-dollar exchange rate was up 2.4% from its January 2012 level as of Apr. 22.

The weak yen stands to have a major impact on the South Korean economy, with Japanese companies using it to boost the competitiveness of their exports. In a report early this month, the Hyundai Research Institute predicted that if the yen reaches 100 or 110 to the dollar, South Korean exports will fall by 3.4% in the first case and 11.4% in the second.

The problem is the large degree of overlap with Japan in terms of major exports, which account for 60% of South Korea’s GDP. An analysis by the Korea International Trade Association showed an overlap of about 50% between South Korea’s top 100 export items and Japan’s.

Indeed, Ministry of Trade, Industry and Energy (MTIE) figures on the first quarter growth rate for export items where South Korea competes with Japan showed an 11.3% drop from the previous quarter for steel and a 3.5% drop for automobiles. With respective ratings of 0.63 and 0.58, they were the second and third most competitive industries behind shipbuilding (0.75).

The so-called “J-curve effect” could make matters worse. This term refers to a phenomenon in which exports drop for the first three to six months after a country’s exchange rate is devalued, before improving thereafter. Data from the MTIE showed a 1.2% rise in first quarter exports for Japan, compared to just 0.5% for South Korea. Given that Japan’s exports for December 2012 were down 6.9% from the same month in 2011 and experiencing negative growth for seven straight months, this could be taken as evidence of the J-curve effect.

Some analysts are fretting that SMEs could feel a much harder pinch than larger corporations. In a report published early this month, the Korea Automotive Research Institute found SMEs to be more vulnerable to exchange rate volatility. It calculated a break-even point of 1,290 won to 100 yen for large South Korean exporters, but 1,343 won for smaller businesses. The weak yen also stands to add a further disproportionate burden on SMEs as corporations lower unit prices to recover some of the lost competitiveness.

Meanwhile, the news is good for Japanese companies. Toyota reversed a five-year operating profit deficit in the 2012 fiscal year (April 2012 to March 2013). The Korea Trade Promotion Corporation (KOTRA) reported in March figures that the difference in US prices between South Korean and Japanese machinery had fallen from the 10% to 20% range to between 5% and 10%, with automobile sales rising. It also noted that Japanese cosmetics and consumer goods were attracting attention in China and Europe.

This may be the main the South Korean economy’s main weakness that is caused by the cheap yen strategy. As corporate profitability weakens, an increasing number of marginal businesses could lead to an excess and volatility for macroeconomic indicators.

“The cheap yen doesn’t just affect exports,” said a source with the Ministry of Strategy and Finance. “It has a lot of different effects, including a weaker financial market due to a rise in the number of marginal businesses. That’s why the weak yen has always been the prelude to a financial crisis in the past.”

Some analysts are speculating that the strategy could have a salutary effect on the world’s advanced economies as Japan, which like the US and EU has suffered from protracted economic downturn, strives to overcome its financial and trade deficits.

The International Monetary Fund recently raised its economic growth rate estimate for Japan to 1.6% - up 0.4 percentage points from January - and called the government’s ambitious monetary easing program “welcome” and “a positive step.”

“At a time when both the US and Europe have been doing major quantitative easing since 2008, they could hardly object to Japan doing it,” said HRI research fellow Lee Joon-hyup.

South Korean companies have long adopted a strategy of reducing exchange rate risks by moving production bases overseas. With their greater export competitiveness, some are now saying their immunity to the weak yen is as strong as it’s ever been.

“South Korean companies’ exports have been putting up a strong defense, if you consider that the yen-to-dollar exchange rate has gone up by more than 20% since last August,” said a MTIE official.

“The yen-to-dollar exchange rate is worse, but the won-to-dollar exchange rate has gotten better, which has led to another rise in exports,” the official added. “It’s too soon to say for certain that there’s a connection between the weak yen and a drop in South Korean exports.”

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