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KOO Bon-Kwan

Japanese Companies Turn High Yen into Opportunity

KOO Bon-Kwan

Jan. 17, 2011

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On September 15 last year, the Japanese government and central bank unexpectedly poured 2 trillion yen into the foreign exchange market to pull down the value of the yen, marking the first official intervention since April 2004. Nevertheless, the value of the Japanese yen continued to rise, posting a 15-year high of 80.5 per US dollar on November 1. The yen has now remained in the 80-90 per dollar range longer than the four months it sat there in 1995 and shows no sign of weakening soon.

Some Japanese are expressing concerns about the impact the strong yen will have on their export-driven economy. However, some say that high yen is actually good for Japan, in spite of the pain it is inflicting on the country's exporters. In fact, some in the Japanese media and elsewhere, say appreciation of the yen is an opportunity for pumping up growth. Why is there a less than expected sense of pessimism?

In nominal terms, the monthly average yen/dollar exchange rate currently hovers at around 81-82, lower than in April 1995, when the the rate last peaked. But based on the effective exchange rate, which takes into account purchasing power and inflation of trading partners, the yen is approximately 30% undervalued against the dollar compared to April 1995.

The muted pessimism about the high yen is attributable to corporate earnings rapidly recovering to levels seen before the global financial crisis amid the country's trade surplus returning to pre-crisis level. In the first quarter of 2009, Japanese manufacturers recorded their first-ever ordinary losses. But in 2010, when the yen appreciated further, their average ordinary profit to sales pushed above pre-crisis levels. As for listed companies, they saw ordinary profit recover to 96% of pre-crisis levels in the first half of 2010. Major export industries, including electronics and automobiles that were in red in the first half of 2009, turned to the black.

How have Japanese companies overcome the yen's appreciation to achieve sustained growth?

First, they never stopped expanding overseas production. In spite of the strengthening yen, Japanese companies continued to increase overseas direct investment. Seven out of 10 Japanese manufacturers have overseas production bases, and thus have secured the ability to cope with any decline in price competitiveness coming from the strong yen. Robust earnings of overseas business units based in Asia have become a major source of profits for Japanese companies. Among the composition of profits by region of Japanese listed companies whose fiscal year end in March, the share of profits from branches in emerging countries in 2010 were 30% higher than those in 2000.

Second, based on high price bargaining power on the back of competitiveness of their products and domination in global markets, more Japanese companies have been able to receive export payments in yen, with the weight rising to 41% in 2010 from 36.2% in 2000. The yen has historically remained high, and thus price bargaining power is important to receive payments in yen.

Third, Japanese companies have aggressively slashed expenses by re-engineering their operations. Processes have been eliminated and labor costs reduced. As they did in the past when Toyota Motor's slogan was "Squeeze the dry towel," Japanese companies in the wake of the global financial crisis continued with extreme cost cutting, creating a business structure that enabled huge profits with lower sales.

Through these efforts, Japanese exporting companies were able to offset much of operating losses from falling unit prices or high value of yen. In the first half of 2010, carmakers Toyota, Nissan and Honda, and electronics companies Hitachi and Toshiba, saw an increase in operating profit through cost reduction that offset the net operating losses they had posted through strong yen. Indeed, Japanese companies have secured a system to create profitability against any level of foreign exchange rate.

Japanese companies may now become more aggressive. As of September 2010, Japanese companies had 206 trillion yen in currency and deposits, a record-high. Though they are more defensive due to uncertain economic prospects, they are poised to act more assertive when opportunities arise. With Hitachi, Toshiba and Sharp embarking on liquid crystal display panel plants, Japanese companies will make facilities investment where high client demand is expected.

They will also promote acquisitions to take advantage of the strong yen. In 2010, takeover of foreign companies by Japanese companies increased noticeably, signaling their future appetite for M&As.

The movement of the Korean won has not paralleled the yen. Historically, amid a weakening trend in normal times, the Korean sharply depreciated at the outset of a crisis and appreciated moderately afterwards. Amid the sharp gyrations of the won, Korean companies have not had enough time to gain the ability to cope with the strong won. The won will likely to appreciate going forward unless global financial conditions deteriorate dramatically.

Korean companies need to devise mid- to long-term contingencies to cope with this situation. In the mid-term, cost reduction through rationalization and pursuit for high value-added will raise their ability to transfer losses coming from a strong won. In the long-term, a global production network should be established to secure the ability to cope with increasing currency volatility.

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