Where is the Asian locomotive?

Japan is not providing Asia with the support that North America is providing to Latin America or the EU to emerging Europe. With the US economy slowing down, more support from Japan is needed to maintain the momentum of the Asian recovery.

Prior to the financial crisis, Asian exports to Japan were outperforming overall Asian exports and Japanese exports to Asia were overperforming overall Japanese exports. Exports to Japan represented about one-fifth of total Asian exports and exports to Asia about 40% of total Japanese exports.
With the crisis, the trade relationship between Japan and Asia has become less favourable to Asia. The 1998 output collapse in East Asia resulted in lower demand for Japanese exports. As can be expected, starting in early 1997, Japanese exports to Asia have underperformed total Japanese exports. Asian exports to Japan however have started underperforming overall Asian exports as early as 1997.

Because the Asian recovery has happened sooner and faster than the Japanese recovery, the Japanese current account balance with Asia has been improving since mid-1999. In fact Japanese exports to Asia have outperformed overall Japanese exports since early 1999, while the reverse is not true: Asian exports to Japan, until recently, have continued to underperform overall Asian exports.

In addition, foreign direct investment (FDI) flows from Japan, that had been slowly increasing since the mid-1990s, have declined since mid-1999. Furthermore Japanese banks in 1999 have continued to retrench from Asia: Bank of International Settlement data shows that the proportion of OECD bank lending to Asia originating from Japanese banks fell from 40% in 1994 to 24% at end-1999.

Classic mixed bag

The decrease in foreign exchange inflows from Japan to Asia partly reflects the nature of the Japanese policy mix of loose fiscal policy and overly tight monetary policy (whereby falling money multipliers and high real rates have belied the movement to zero nominal yields), which has resulted in a strong yen and, in our view, prolonged the Japanese recession.

The appreciation of the yen has improved the competitiveness of Asian exports but, because Asian exports in general tend not to compete on the same markets as Japanese exports, the impact does not seem to have been overwhelming. Rather, the impact of depressed output on Japanese demand for Asian exports seems to have been the dominant factor. Output growth in Japan has been negligible over the past decade and was 0.3% in 1999 against 4.2% in the US and 2.3% in the EU. Depressed output in Japan has also affected negatively FDI and bank lending through its impact on corporate and banking profitability and cashflow.

Yen borrowing cheaper

The policy mix has been supportive of Asia in one specific way: the zero interest rate policy has made yen borrowing very cheap (hence EGAT yen syndicated lending and the PhilippinesÆ planned Y50 billion samurai issue). However, most of Asia is currently a net capital exporter, and stands to benefit little from this.

For these reasons, we are not overly concerned about the impact of the abandonment of the zero interest rate policy on the cost of yen borrowing for Asia. Rather, we remain concerned about the sustainability of the Japanese recovery. Aggregate demand in the US has started to slow down, especially investment, durable goods and manufacturing purchases. The May decline in the NAPM index was strongest in electrical and electronic goods. In some Asian countries, electronics represent more than 60% of exports.

Asia needs more support from Japan. Instead, Bank of Japan governor Hayami is laying the ground for ending its zero rate policy, and the government is signposting another supplementary fiscal package, to add to the Y100 trillion worth of packages provided since 1992. This will continue to bias the yen stronger and limit Japanese capital outflows, while the medium-term impact on Japanese demand growth is likely to be negligible.

For those Asian countries most vulnerable to slower global growth due to a lack of domestic demand (Indonesia, Thailand and the Philippines) this policy mix in Japan will be particularly unhelpful at a time when US growth is slipping, and may manifest itself into significant depreciation of the Philippine peso, baht and rupiah against the yen over the short term.