Why the weak yen no longer means what it once did for Japan Inc
The Japanese yen has tumbled by a fifth against the dollar this year, but broad shifts in the country’s economy mean its impact on Japan Inc is far more uneven than the last time the currency traded at such weak levels 24 years ago.
Japanese companies had long struggled to match the cost competitiveness of rivals in China and South Korea when manufacturing products in their home market, having historically endured a strong currency as well as high electricity bills and labour costs.
The landscape is now shifting as the yen has tumbled 20 per cent this year against the US dollar, reaching a low of ¥145 on Thursday. The real effective exchange rate, a measure of the currency’s strength against those of trading partners adjusting for price levels, has reached its lowest level since 1970, according to Bank of Japan data.
Japan last week sharpened its verbal intervention against the weakening yen. The Bank of Japan contacted banks to check on currency rates, which has in the past been a precursor to a market intervention, which would be ordered by the country's finance ministry.
While officials may be growing more nervous about a weak yen, its effects are far more nuanced now than in years past.
Historically, a weak yen has been a boon for Japan Inc. It provided a boost to the country’s sprawling export sector by making Japanese goods cheaper for foreign buyers. However, corporate Japan has changed since the last time the yen was this cheap in 1998. Almost a quarter of manufacturing has shifted overseas and the old relationships with an exchange rate that once ruled supreme have now been broken.
“Relative to Asian competitors, it has never on record been as cost-competitive as it is now,” said Nicholas Smith, Japan strategist at CLSA, who added that the Chinese real effective exchange rate has almost doubled since 1994 as Japan’s has been in long-term decline. There has also never been a time when Japan has been as price-competitive as it currently is relative to South Korea.
Here are five case studies showing how the weak yen is now having a more nuanced effect across Japan’s $5tn economy.
Sony: tech and entertainment conglomerate
For Sony, with its diverse range of businesses, the weaker yen is a mixed blessing. The Japanese electronics and gaming group began outsourcing the production of its PlayStation consoles and consumer electronics products in the past few decades. For these businesses, a weaker yen is negative since it increases the dollar-denominated costs of manufacturing as well as the prices of raw materials and components purchased in dollars. This prompted an unprecedented price rise for the PlayStation 5 last month.
But for image sensors that Sony has continued to manufacture in Japan to sell to Apple and other mobile phonemakers, the yen’s decline is a boost for its overseas exports. Overall, the net currency impact is only “slightly positive” for the group’s three businesses.
“The weaker yen impact is still there, but clearly it isn’t what it was,” said long-term Sony analyst Pelham Smithers.
Hoya: world leader in lenses
Optical glass specialist Hoya manufactures almost all of its products outside Japan. With the company generating about 75 per cent of its sales outside its home market, it benefits from the weaker yen when profits made overseas are repatriated and converted into yen. In fact, the gain was significant enough that Hoya announced a ¥60bn share buyback programme after reporting a 17 per cent year-on-year boost in net profit for the April-to-June quarter.
“A lot of our cash is held in foreign currency, so when there was an increase in yen basis, we decided we should be paying back to our shareholders when we can,” its chief financial officer Ryo Hirooka said when asked about the share buyback.
The big question, said Macquarie analyst Damian Thong, was whether companies would continue the repatriation. “If Japanese companies decide not to invest in Japan by bringing the money back to take advantage of Japan’s growing economic competitiveness, and decide to use it for [mergers and acquisitions] or to build factories abroad, then the yen could remain under pressure with no benefit to the Japanese economy,” he said.
The ratio of overseas production for Japan manufacturing companies has risen from average 3.8 per cent in 1990 to 17 per cent in the post-global financial crisis period of 2008-2012 to more than 22 per cent recently. These decisions have been made by manufacturers which, historically, benefited most strongly when a weakening yen improved the competitiveness of their products.
Honda: Japan’s offshoring pioneer
Among carmakers, Honda has been one of the most aggressive companies pursuing offshoring in the Japanese car industry, with the ratio of its overseas production rising from 68 per cent in 2008 to 85 per cent last year. As a result, a depreciation of ¥1 in the yen against the US dollar increases its operating profits by ¥10bn ($70mn), compared with a nearly ¥20bn boost it received 15 years ago.
These offshoring decisions were not, in general, made to chase cheaper labour but to more effectively cater to the demands of customers in foreign markets. As such, the offshoring is likely to continue as Japan’s domestic markets continue to shrink. “[Exchange rates] cannot be a big factor to choose production location. At least 1mn vehicle production is needed for a market to sustain production technology,” said Koichi Sugimoto, analyst at Mitsubishi UFJ Morgan Stanley Securities.
Even with a smaller benefit from the weaker yen, Honda upgraded its annual guidance last month as the currency tailwind helped to offset a rise in raw material costs. Companies are still grappling with supply chain disruptions and a slowdown in the global economy, but analysts say Honda’s case suggests there is more room for upgrades in the coming quarters for corporate Japan.
Fast Retailing: Asia’s biggest clothing brand
Earlier this year in April, Tadashi Yanai, the chief executive of Uniqlo owner Fast Retailing, warned that the weak yen had “no merit whatsoever”. That may have been true 15 years ago when its Uniqlo business was mainly domestic. But with its Uniqlo stores currently generating nearly half of their annual profits outside of Japan, a depreciation of ¥1 against the US dollar increases its profits by ¥1.2bn when repatriated. The costs of imported materials are still higher with a depreciation of ¥1 against the US dollar, wiping ¥4bn in Uniqlo profits.
Since Asia’s largest clothing retailer has used hedging tools called foreign exchange forwards, the weakening yen will only seriously start to bite in 2024. Thus, for the fiscal year that ended in August, the group is forecasting record profits. Going forward, Uniqlo has already announced price hikes for some of its products and its overseas sales are expected to grow further. “It’s a wrong to assume that all retailers will do badly as a result of the weaker yen,” said Credit Suisse analyst Takahiro Kazahaya.
Nitori: Cut-price furniture for a deflationary generation
The discount furnishing group generates most of its sales in Japan so the weaker yen impact is negative due to the rising cost of imported materials. Until the end of this month, the company has foreign exchange forward contracts locking the dollar-yen rate at ¥115. But for the rest of the fiscal year until the end of February, Nitori will be buying materials at market prices since it had assumed that the yen would strengthen by the year-end due to a recession in the US. A depreciation of ¥1 against the US dollar decreases its profits by ¥2bn. Like Uniqlo, it could also raise prices to offset rising import bills.
“A price increase poses two issues: there is the question of whether the products will sell if Nitori transferred the costs to consumers, and there is also a time lag until it can transfer the costs,” said Kazahaya. The lag is especially long for Nitori since it will need to sell all of its old products before it can raise the price of its new furniture. Either way, the company will have no choice but to transfer some of the costs to consumers.