As the yen strengthens, does India have to worry?

9 Aug 2024 , 10:43 AM

HOW STRONG IS THE JAPANESE CURRENCY?

Indian markets have been often subjected to global vagaries. Normally, it is cues from the US, UK, Europe, China, or the Middle East. You rarely find Indian investors overtly worrying about what is happening in Japan. However, this time it is different. The sudden strength in the Japanese Yen has caused a lot of problems for Indian investors and Indian businesses. Let us first understand how much the Japanese Yen has strengthened against the Indian rupee. We look at the INRJPY table below.

Date	Price	Open	High	Low
Aug 07, 2024	1.7470	1.7245	1.7543	1.7228
Aug 06, 2024	1.7242	1.7355	1.7423	1.7167
Aug 05, 2024	1.7355	1.7525	1.7565	1.6861
Aug 02, 2024	1.7486	1.7842	1.7883	1.7473
Aug 01, 2024	1.7838	1.7918	1.8022	1.7747
Jul 31, 2024	1.7915	1.8250	1.8363	1.7871
Jul 30, 2024	1.8242	1.8389	1.8541	1.8232
Jul 29, 2024	1.8386	1.8369	1.8434	1.8278
Jul 26, 2024	1.8353	1.8385	1.8481	1.8290
Jul 25, 2024	1.8380	1.8383	1.8431	1.8154
Jul 24, 2024	1.8379	1.8593	1.8633	1.8290
Jul 23, 2024	1.8589	1.8770	1.8780	1.8589
Jul 22, 2024	1.8765	1.8804	1.8836	1.8676
Jul 19, 2024	1.8808	1.8827	1.8880	1.8769
Jul 18, 2024	1.8823	1.8681	1.8831	1.8591
Jul 17, 2024	1.8679	1.8957	1.8987	1.8670
Jul 16, 2024	1.8953	1.8917	1.9008	1.8908
Jul 15, 2024	1.8908	1.8903	1.8970	1.8808
Jul 12, 2024	1.8904	1.9016	1.9095	1.8844
Jul 11, 2024	1.9011	1.9354	1.9372	1.8853
Jul 10, 2024	1.9355	1.9325	1.9381	1.9311
Jul 09, 2024	1.9314	1.9259	1.9347	1.9251
Jul 08, 2024	1.9254	1.9244	1.9305	1.9200

Data Source: Investor.Com

Remember, Japan is one of the few developed currencies that is cheaper than India. Exactly a month ago, you needed ¥1.9314 to buy an Indian Rupee, but by August 07, 2024, you need just ¥1.747 to buy one Indian rupee. In short, in the last one month, the rupee has weakened by -9.27% against the Japanese yen, or you can say the Yen has strengthened against the rupee. If you take the full move from lows to highs, then the Indian rupee has actually weakened by -13.00% against the Japanese Yen. However, the story is not about rupee weakness but about Yen strength. The Japanese currency has appreciated against most major currencies globally, including the US Dollar.

WHY IS THE JAPANESE YEN HARDENING?

The hardening of the Japanese Yen was part of a major policy shift undertaken by the Bank of Japan, under its new governor, Kazuo Ueda. First a quick background. For almost more than a decade, the Japanese central bank had kept rates in the negative and had fuelled liquidity in the system through bond purchases. However, that also had the impact of distorting the markets. What actually urged the Bank of Japan to change its stance was the spike in inflation in the Japanese economy. The persistently weak Yen and higher wages led to a spike in inflation. The Bank of Japan had not choice but to tighten the money bags. Earlier this year, the Bank of Japan had announced its intent to tighten the economy. Apart from the rate hikes, the Bank of Japan is also cutting its asset purchase program by half.

The rate hike was undertaken on July 31, 2024 when the benchmark rates in Japan were raised from -0.10% to +0.25%. This is the largest rate hike since 2007 and it is not surprising. Against, the inflation long term target of 2%, the Japanese inflation had spiked to above 4% by 2023. At a time when central banks across the world were hiking rates to control inflation, Japan held status quo on rates. Even after the rate hike, the rate of inflation stands at 2.6%, which is 60 bps above the long term average. The governor Kazuo Ueda has said that the Bank of Japan would continue to raise rates till inflation was reined in. He also said that the upper limit now may not be 0.50% but 1.00%. More than the rate hike, it is this hawkish outlook that has spooked global currency and the global markets. The Yen strength is not good news for India for a variety of reasons.

IMPACT ON THE JAPANESE YEN CARRY TRADE

Indians have been hearing about this yen carry trade a lot in the last few days. The reasons are not far to seek. Japanese Yen has been one of the most preferred currencies for carry trade. In a carry trade, the trader borrows money in the market with the lowest interest rates and then deploys the funds in other more aggressive markets for alpha. The Japanese Yen carry trade has worked seamlessly for another reason. Apart from being a hard currency, the Japanese Yen has generally been stable due to the large current account surplus that Japan runs. According to the NSDL data, close to ₹2.05 Trillion of Japanese FPI investments are there in India. However, it is not just these monies that will be impacted. Many of the proprietary books based out of Singapore and Hong Kong also borrowing in Japan and deploy the funds in arbitrage trades in India. Hence it will be a double whammy.

The problem is that the economics of carry trade change drastically if there is a sudden hardening of the Yen. That is because the borrowing has to be repaid in Yen and you now need to shell out more of other currencies for the same amount of Yen. Just consider this example. If an investor borrows at under 1% in Japan and deploys it at 5% in another market, it is a great arbitrage. However, if the Yen appreciates by more than 4% in the meantime, then the trade is left with negative returns. That is why, the moment the yen starts to appreciate beyond its normal range, there is a rush to unwind the Yen carry trades. That was one of the major reasons impacting the stock markets across Asia, including India.

HOW WILL THE STRONGER YEN IMPACT INDIAN BUSINESS?

The impact is likely to be there, although it is likely to be limited. Let us look at some of the obvious implications of a 13% stronger yen in the last one month.

• Let us look at the trade impact first. For FY24, India’s merchandise imports from Japan were to the tune of $17.70 Billion, accounting for 2.62% of the total imports of India. For the same period, India’s merchandise exports to Japan was to the tune of $5.16 Billion or 1.18% of total Indian exports. India does run a merchandise trade deficit of over $12.50 Billion with Japan and that is likely to get impacted by the stronger yen. While the impact may be limited, the 13% appreciation in the Yen versus the rupee will contribute towards imported inflation into India.
• We did speak about the Japanese Yen carry trade in the previous paragraph. Japanese FPIs have about ₹2.05 Trillion invested in India and they are not among the top FPI sources into India. However, the Yen trade is likely to have a sentimental impact, not only on Japanese FPI flows, but even on other hot money flows into India that are based on the Yen carry trade. That has surely had an impact on the markets in terms of its correction from the peak levels.
• One area of concern is the Japanese yen denominated loans taken by Indian companies and other lending agencies in India. According to the RBI data, the total Indian borrowing in Japanese Yen is at about the equivalent of $36 Billion. While that is a substantial amount to impact the risk of these borrowings, reports suggest that most of these yen borrowings are based on fixed interest model, where the currency risk is already hedged, and hence may post only a limited risk to India.
• How about the impact of loans from the JICA and borrowings by government sponsored NBFCs? Here again the impact would be there, but would still be limited. If one looks at projects like the Dedicated Freight Corridor or the Bullet Train project; both come from the Japan International Cooperation Agency (JICA). However, such loans are under the overseas development assistance (ODA) program which again has a fixed liability to avoid any escalation of costs. The impact could be a little harder on the government backed NBFCs, which have borrowed in Yen. However, even in their case, most of these borrowers take a 5-year hedge, so any short term volatility risks are substantially covered. Here again the risks may not be too serious for India.

Clearly the macro risks at an economy level or at the level of financial markets is likely to be limited. However, one must keep a watch on companies with an exposure to Japan for their regular business.

INDIAN COMPANIES EXPOSED TO JAPAN

The exposure of Indian companies to the Japanese economy and the Japanese currency comes in different ways. Here is a quick sampler.

• Firstly, there are the companies with Japanese promoters. This includes a lot of blue chip companies like Maruti Suzuki, Samvardhana Motherson, Nippon Life AMC, Asahi India Glass, Hitachi Energy etc. Here the Japanese ownership ranges from 10% in the case of Samvardhana to 75% in the case of Hitachi Energy. The impact is likely to be felt where there is royalties payable to the Japanese parent.
• Secondly, there are Indian companies with joint ventures with Japanese companies. This could either be to access the Japanese market or to use the technology of the Japanese company. Some of the top rung companies with JVs in Japan include big names like JSW Steel, Dixon Technologies, Aether Industries, and Mukand Ltd. While inputs may get expensive, that should be largely hedged with yen sales.
• Thirdly, the real X-factor would be the company that have a significant revenue exposure to Japan. This includes companies like defence player Azad Engineering, which gets close to 40% of its revenues from Japan. Ion Exchange and Anupam Rasayan are two other companies that have revenue exposure of over 20% to Japan and these could see some impact.

Apart from these there are the government sponsored NBFCs that have borrowed in Yen, but we have talked about that in detail.

The bottom line is that if this is just a one-off appreciation in the Yen, it may not impact Indian businesses too much. However, if this is going to be a secular trend with the Yen consistently hardening, then it could create challenges in the future. For now, the impact appears to be limited; in scope and intensity.