With a GDP of about one-and-a-half times as the rest of Asia combined $4.5 trillion versus $3 trillion, in 2000 Japan is a heavyweight with much influence over the region. In 1999, Japanese exports and imports accounted for 7.5% and 5.3% of world trade. The percentage share is likely to be larger in the case of manufactured goods.
A weak yen will, according to the report, amplify deflationary pressures currently bearing down on Asia, including slowing external trade, weak domestic demand and declining prices. A key assumption to this is that a weaker yen means Japanese exporters can charge a lower price in US dollars without also lowering their profit margin in yen terms. A cheaper product, all things being equal, means a rise in the number of exports for Japan. This weaker export price charged by Japanese producers translates into a margin compression for the rest of the region as well as a loss in market share to the more competitive Japanese export.
Two sets of implications will arise, according to Goldman Sachs economists. Firstly, during periods of yen weakening, deflationary pressure in Asian countries outside of Japan will be the greatest in products that compete more closely with Japan.
Secondly, these countries with a greater degree of overlap in industrial structure in relation to Japan will experience the greatest degree of deflationary pressure on export prices. Goldman expects industries such as automobile, semi-conductor and chemical industry to be most effected. Therefore, China and Thailand, which are countries with the least degree of overlap in exports with Japan, will face little risk of deflationary pressure.
Meanwhile, Korea, Taiwan and Singapore, which have a similar export structure to Japan, will be most at risk. On the other hand, for low value added, labour intensive products like textile and clothing; Goldman economists expect little exchange movement. "On a relative basis, the greater degree of overlap in industrial structure vis-a-vis Japan of a NJA [non-Japan Asia] country, the higher the deflationary pressure yen weakness would exert on export prices, and the bigger exchange rate adjustment the country would need to cushion against the adverse shock," say Goldman economists in the report.
The investment implication from this line of logic for equity markets, the report concludes, is that countries with the greatest currency flexibility will be at an advantage to those countries that have fixed exchange rates.