Who's afraid of a weaker yen?

Jennifer Chen, Reuters, Singapore

The prospect of ever more forceful action by Japanese authorities to weaken the yen may be good news for Japan's economy but, analysts say, other countries in the region are worried they may suffer as a result.

For months monetary officials in Japan, the U.S. and Asia have been debating whether a weaker yen is needed to revive Japan's economy -- a policy that would amount to exporting its way back to economic health.

That debate took a new turn on Thursday with a Financial Times report that the Bush administration had signaled it would not object if Japanese monetary authorities tried to drive the yen lower by buying foreign bonds.

The report impacted on the yen and brought to light a discussion within the inner circles of the Bank of Japan and the Ministry of Finance, analysts said.

In early Asian trade on Friday, the yen slipped past the 124 level against the dollar for the first time since August 7.

Analysts say Japanese officials are doing their best to encourage a weaker yen without drawing the ire of other Asian governments.

"What they don't want to see is a sharp four to five yen fall to 130," said Kamal Sharma, a currency strategist at Commerzbank in Singapore, adding that the Japanese were particularly keen not to irk China and Korea in particular.

"They are trying to talk it down. They are trying their best to weaken it via proposals for foreign bonds buying. They're thinking about inflation targeting. The end point is to drive the yen lower."

But Japanese efforts to guide the yen lower will require skilled diplomatic handling of concerned neighbours.

"The only way a weaker yen would solve Japan's problems is by allowing them to steal growth from the rest of the region," said Ron Leven, currency strategist at Lehman Brothers in Tokyo.

That view has driven Asian officials, especially in Korea and China, to repeatedly express alarm over recent sharp downward moves in the yen because it affects the relative competitiveness of their exports, and therefore, exchange rates.

In the case of China, a much weaker yen could threaten its currency peg to the dollar.

Rebecca Patterson at JP Morgan Chase in Singapore noted that the correlations between the yen and other regional currencies were consistently high.

In her view, the Philippine peso followed the yen 84 percent of the time during the second half of 2001, the Thai baht 87 percent of the time, and the S$71 percent.

Other analysts say the currencies of Taiwan and Korea, which both compete with Japan on electronics exports, track the yen's movement's 80 percent of the time.

Asian monetary officials are also concerned that the yen may need to weaken considerably more than many are now prepared to contemplate in order to stimulate a Japanese recovery.

"If you really want to create an impact from a weak yen, it has to be massively weaker. A yen at 130 to the dollar is meaningless. It has to be 160," said Lehman Brothers' Leven.

Echoing many other analysts Leven added that such a level was unlikely in the near term because it would be politically unpalatable and would require a huge drop in confidence among Japanese investors.

However, some analysts say Japan might be unable to prevent a massively weaker yen in three to four years time because of its growing public debt.

Ken Courtis, vice chairman of Goldman Sachs Asia in Tokyo, said the country's current stance of easy fiscal policy and relatively tight monetary policy -- with real interest rates high amid deflation -- could not last because public debt was soaring to unsustainable levels.

"The line of least resistance will be at some point for politicians to crack the Bank of Japan, and force them to monetize the debt, to print money like there is no tomorrow. So you move into tight fiscal and easy monetary policy. And any country that is there will have an extraordinarily weak currency."

Courtis said that would be a destabilizing force in Asia.

"The two economies that could play the biggest role in promoting stability are the U.S. and China. And my advice to them is they should be preparing how to prevent the consequences of a major devaluation of the yen, and they should start working on this now rather than when it happens," he said.