Fall in yen is really a 'correction'

The yen has depreciated nearly 10 per cent against the US dollar since late last year, a fact that has drawn considerable international attention and not a little criticism.

In view of the events, I should like to present my personal view on foreign exchange markets and policy, and perhaps convince the sceptics that the falling yen has not been a result of deliberate Japanese policy.

A review of recent foreign exchange developments shows the US dollar started to depreciate from about 125 yen to 120 yen last summer. After the terrorist attacks of September 11th, dollar-yen rates weakened further, at one point hitting 115 yen to the dollar.

Because of recognition that such a sharp appreciation of the yen was inconsistent with Japanese economic fundamentals, and that such movement could have a negative impact on an already struggling economy, the Japanese monetary authorities intervened in the foreign exchange markets on a significant scale.

As the initial shock of September 11th abated, dollar-yen rates returned above the 120 yen level and remained stable in the 120 to 125 yen range for a while. But in early December, the Japanese currency began to depreciate and is now below 130 yen to the dollar, even though no market intervention has been undertaken.

In my view, the depreciation of the yen is broadly in line with the economic fundamentals of Japan relative to other big economies. Although the September shock forced major economies to revise forecasts downwards, signs are appearing that these economies, especially the US, are more resilient than many people believed.

Unfortunately, the same cannot be said of Japan, which has been mired in deflation for more than two years. It may take greater efforts to get the country back on the path of sustainable growth. Japan needs to tackle structural reform in three areas: the banking sector, deregulation (to spur investment in new business), and fiscal consolidation.

The administration of Prime Minister Junichiro Koizumi is making strenuous efforts to tackle all three issues. But the country may face tough challenges and need more time before these efforts bear fruit. In this sense, the depreciation of the yen since last year should be seen as a correction from its previous overvaluation, followed by natural depreciation reflecting economic fundamentals.

There is a view that Japanese government policy has been the driving force behind recent weakening of the yen, which is wrong. The Japanese government has never used a weaker currency as a macroeconomic policy tool. A persistently strong current account surplus has helped to keep the yen strong for more than a decade.

It is sometimes argued that a weaker yen could be the last resort for a country desperate to haul its economy out of recession. It is true that some sectors could benefit from a weaker currency.

But the effect of a weaker yen on the economy is not so straightforward. A falling currency would not be a panacea for the economy, as some have said. Rather, it is essential that the exchange rate reflects economic fundamentals. Some are concerned about an impact of a weaker yen on other Asian economies. But after the financial crises in the region in 1997/98, most Asian countries have adopted more flexible exchange rate policies, and strengthened foreign reserve positions.

It is therefore highly unlikely that the yen's recent depreciation will have a significantly negative impact on other Asian economies. Progress on structural reform in Japan and ensuing economic recovery would be beneficial for Asian economies, not least because of the size of Japan's market. Appropriate movements of exchange rates will help to lay the foundation for that sustained recovery.

On a different note, the smooth introduction of the euro is very welcome. Considering the scale of the European economy, such an introduction was remarkable. However, in contrast to this, the foreign exchange performance of the euro has so far been very disappointing.

I share the views expressed by many European leaders that the euro is undervalued, and hope the introduction of a physical currency will quickly lead to a more appropriate evaluation.

The writer is Japan's vice-minister of finance for international affairs