Asia's Yen Problem.

• Author: ALAPAT, PAUL

If later this year the yen-dollar rate reaches 140, watch for all hell to break loose.

Asian economies are being buffeted this year by deepening slump in global demand for information technology. With crude oil prices proving to be relatively sticky, the more than two-year-old deterioration in terms of trade for Asia does not look like it will abate anytime soon. Bad as these developments may be, things could get worse were the yen to enter into a trend decline. The economic downturn in Asia then could prove to be much more severe.

Last year was marked by one of the narrowest ranges for the Japanese yen in over a decade. Through most of 2000, the yen hugged a tight range between 100 and 110, and provided a stable neighborhood for currencies and exporters in the rest of Asia. However, since November 2000 the Japanese yen has weakened to its lowest level since the middle of 1999. The anemic Japanese recovery, its moribund political landscape, its unsustainable fiscal position amid a rapidly aging population, present the perfect recipe for a trend decline in the yen over the medium term. After range trading close to Yen 125/US$1 through most of this year, the chances of a sharp slide towards Yen140/US$1 into the turn of the year are high.

The damage from a weak lien. A weakening in Japanese growth prospects will be telegraphed by a trend weakening of the yen, and the pressures on Asia will first arise from that front. There are three major avenues through which a weak yen will hurt the rest of Asia.

* Competitive pressure on rival exports that compete directly with Japan, particularly in Korea, Taiwan, and Singapore. Erode export-pricing power in the rest of Asia, and undermine the terms of trade.

* Slow the pace of production outsourced from Japanese MNCs and/or domestic producers located outside of Japan.

* Weaken recycling of Japanese capital and increase pressures to repatriate financial savings back to support restructuring activities in Japan.

Competitive pressures on rival exporters. Unlike the U.S. economy that is a net importer from Asia, Japan is a net exporter to the rest of Asia barring Indonesia and Malaysia. Hence, growth in Japan does not directly feed into final demand for Asia, and conversely weakness in Japan should not directly undermine final demand in Asia except for the two countries aforementioned. However, at the margin, reliance on external demand versus domestic demand to fuel GDP growth in Japan means that the net...