'Abenomics' and its implications for Japan's neighbours
Since taking office in December, Shinzo Abe has taken extreme action by forcing the Bank of Japan (BOJ) into more aggressive monetary easing in order to stimulate Japan's economic growth. This is being carried out through an asset-purchasing scheme and yen devaluation. In 2012, the BOJ had already expanded its balance sheet to 101 trillion yen (US$ 1.09 trillion) in order to weaken the yen.In January, the BOJ announced a more aggressive approach through the "price stability target" and the "open-ended asset purchasing method" that will become effective in 2014. The former will be pursued by doubling the inflation target to 2 per cent, whereas the latter will be carried out through unlimited asset purchasing. In order to accommodate this monetary easing, the BOJ has prepared monthly asset purchases of 13 trillion yen.
In Japan, this announcement has caused positive sentiment on the Nikkei. It hit a 33-month closing high on February 1. The BOJ's commitment to more monetary easing also weakened the yen further. On the same day, the yen hit a 32-month low of 92.2 against the US dollar.
Following this sharp depreciation, some economists are worried that this action may lead to a currency war. Moreover, some countries such as Australia, the US and Germany are concerned that the weaker yen may have a negative impact on their economies.
Nevertheless, for East Asian economies, yen depreciation does not necessarily lead to bad things. In fact, the manufacturing sector in the region may benefit from a cheaper yen since most Southeast Asian economies such as Thailand, Malaysia and Indonesia import parts and components from Japan. These parts are then assembled and sold in the local market.
As a consequence, a weaker yen causes import prices to drop and, thus, local companies enjoy higher profit margins due to lower production costs and, to some extent, less severe foreign exchange losses from trading with Japanese companies.
In recent years, the strengthening yen, which led to higher production costs, adversely affected the manufacturing sector in Indonesia, particularly the automotive industry. Therefore, the change in direction of the yen should be considered as momentum to enhance manufacturing in Indonesia since it provides an incentive to produce more goods while production costs reduce.
Despite these benefits, a weakening yen may have some negative implications. One possible short-term adverse impact is Japan's declining purchasing power in Asia. Currently, Japan is a major investor in the region. In Indonesia, Japan is one of the biggest investors, second only to Singapore. A report by CIMB Research shows that Japan's foreign direct investment (FDI) accounts for around 11 per cent of Indonesia's total inward FDI. Hence, as the yen depreciates, Japan's investment in Indonesia and other Asian countries will slow in the short-run due to more expensive outward capital investment. Considering Japan's big FDI influence, this slower investment from Japan, to some extent, will hinder investment growth in the region.
Another possible negative impact is the expected decline in exports from Asian countries to Japan. As the yen weakens, Japan's consumers will buy fewer foreign goods as they become more expensive.
In this regard, data from the CEIC suggest that Indonesia's export share to Japan is around 16 per cent of its total exports. Thus, Indonesia's reliance on exports to the Japanese market may result in a weakened trade balance.
Meanwhile, Indonesia has been experiencing a trade deficit since the fourth quarter of 2012 and, based on government forecasts, will see another deficit in 2013. As a consequence, Indonesia's government has to be careful to prevent its trade balance deteriorating further, following the weaker yen.
In short, however, the depreciating yen will have a positive impact on Asian economies. In particular, this will bring benefits to the manufacturing sector that imports parts from Japan.
Nevertheless, Indonesia's government and central bank has to monitor its effects closely, since it may also have negative results.