Japanese Prime Minister Junichiro Koizumi returned to Tokyo yesterday from his first official trip abroad. Investors in the yen may wish he'd stayed home.
Koizumi won support from President Bush and other world leaders for his plan to clean up bad loans at banks and cap spending. The strategy has been criticized because it runs the risk of deepening a recession and damping demand for assets before it's likely to fuel any growth. To traders and investors, the meetings provided reason to send the currency lower.
"The more support Koizumi gets from his overseas counterparts, the more people in the market will believe world leaders are condoning a weaker yen," said Naoto Ohnuma, senior manager of the foreign-exchange unit at Mitsubishi Corp, Japan's largest international trade company with businesses including aerospace, energy, machinery and food.
Japan's currency is already down 3.5 percent against the US dollar in the past month, trading at ?124.54. It has been falling on concern that Koizumi, who took office in April, will increase bankruptcies and unemployment in the second-biggest economy. He plans to prod banks to admit to loans that will never be repaid, getting lenders to force bankruptcies and reorganizations to get their money back.
Japan's biggest banks have until March 2003 to write off their worst loans, estimated at ?13 trillion (US$104.4 billion), the government said.
A falling yen spells losses for overseas investors.
Japanese government bonds maturing in a year and longer have handed buyers in the US a loss of 4 percent in the past month, the worst performance of 26 indexes compiled by the European Federation of Financial Analysts' Societies. Dollar investors in the Nikkei 225 stock index have lost 8 percent.
At the Dollar Yen Strategy Fund in Tokyo, they're also betting Koizumi's plans will prolong the recession.
"We have been gradually buying dollars," said Kazuyuki Harada, a senior fund manager at Sumitomo Marine Asset Management Co, which handles the ?2.5 billion (US$20 million) fund. The tack marks a switch because the fund had been selling the US currency since May.
Japan's economy already shrank 0.2 percent in the three months ended March 31. A survey of economists by Bloomberg News shows the average forecast for the second quarter is for a contraction of another 0.2 percent.
"Koizumi's plans would result in an accelerated slowdown," said Hideaki Inoue, a foreign exchange manager at Mitsubishi Trust & Banking Corp, Japan's second largest trust bank by sales.
To his thinking, Japan has two choices: the central bank will need to add more money to the banking system or the government will need to increase debt sales and spend the money with an extra budget. Either would hurt the yen, which will probably weaken to ?127 against the dollar this month, Inoue said.
Koizumi may be gaining support. His Liberal Democratic Party and their coalition partners will probably maintain control of Japan's upper house of the lawmaking Diet in an election July 29, analysts said. The likelihood of an LDP victory grew after the party increased its seats in Tokyo city elections last month.
Though LDP re-election would strengthen Koizumi's plan to limit government spending, it may also prompt the Bank of Japan to pump more money into the economy, diluting the value of the yen.
"As voters show they will embrace Koizumi's call to accept the pain his plans will bring, pressure on the Bank of Japan to ease monetary policy would heighten," said Tsutomu Shirafuji, a fund manager at Mitsui Life Global Asset Management Co.
In their meetings, Bush and Koizumi steered away from any announcements on currency policy. Any suggestion that Koizumi favors a weaker yen and that Bush sympathizes would anger US manufacturers who are complaining that the strengthening dollar hurts overseas demand for their products.
Declines in manufacturing helped limit US economic growth to a 1.2 percent annual rate in the first quarter of 2001. For the second quarter, the economy probably grew 0.5 percent, according to a Bloomberg News survey of analysts.
"Voices against a strong dollar may intensify so much in the US that the Bush administration may need to change its strong-dollar policy," said Masafumi Tsuchida, manager for the Finance Group at Toshiba Corp.
Japan may also seek to keep the yen out of freefall to avoid panic among investors that might lead to capital flight. The yen's decline toward ?125 per dollar will probably prompt government officials to signal the nation is ready to buy the currency to slow the decline.
Finance Minister Masajuro Shiokawa already acted by announcing on Friday that a rapid decline in the yen is "troublesome." For now, analysts say Koizumi's economic program is a necessary, if unpleasant, strategy for Japan. And it's not even a strategy that's sure to succeed.
"If Koizumi fails, disappointed investors will sell Japanese bonds, stocks and yen," said Mitsubishi Trust & Banking's Inoue.
"In that case, the yen's decline may go far beyond ?130 per dollar."
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