Abe must drive yen lower to avoid 'nasty growth shock', says Japan star

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Polar Capital Japan manager James Salter has called on prime minister Shinzo Abe to make renewed efforts to talk down the yen to avoid 'nasty growth shocks' early next year.

With the yen currently hovering at around 100 to the US dollar, Salter warns that if the currency does not weaken, further pressure will be heaped on Japan’s exporters, which could in turn jeopardise the country's nascent recovery.

Rivals feeling the pinch

Efforts to weaken the yen began last November when Abe hit the campaign trail, but this came to a halt three months later as exporters in some of its rival trade partners started to feel the pinch.

Salter believes fair value for the currency is around 110 to the US dollar and expects this to subsequently fall even further to 115 or even 120.

Salter told Citywire Global: ‘The yen has been overly strong against the dollar for the last four years as a result of risk aversion. If you go back to the pre-Lehmans period, the currency was hovering around 110. The Koreans and the Germans have bleated a lot about the weakness of the yen recently.'

‘That loosening talk stopped in February and March when the Koreans and Germans started to complain very bitterly but the fact is, if the currency gets back to 110, that is only where it was before the Lehmans debacle.’

Salter believes that Abe’s so-called ‘first arrow’ – monetary policy – is the most crucial of all of his reforms, if the country is to finally achieve a meaningful and long lasting recovery.

‘It is absolutely critical for the Japanese economy at this point to ensure that the yen is driven weaker to ensure the VAT rise has a muted impact on the economy because it is far from clear [at this stage] that we will definitely see a much stronger economy over the next 18  months.’

Further QE likely from BoJ

He also anticipates further monetary policy will be required early next year.

‘There are significant risks in the first quarter of 2014 that there will be some very nasty GDP numbers so I would like to see a renewed effort to talk down the yen. I would think further Bank of Japan (BoJ) action in February and March is highly likely.’

Salter believes the third arrow, structural reform, will be a lot more drawn out.

‘[The third arrow] is much more contentious. Labour reform, women’s participation in the workforce and [joining] the Trans-Pacific Partnership are all admirable things to be doing but will take a long time. If I were Abe I would be focusing on weakening the yen off.’

Salter also called on the government to increase its tax take dramatically as part of the reform process. ‘We need to see tax take as a proportion of GDP rise dramatically as it is a very inefficient tax system.’

VAT rise

He is relatively unconcerned by Japan’s impending VAT rise next April and argues that the country is far better placed than in 1997 to deal with it.

‘It had a very negative impact back in 1997. This time Abe and the BoJ will ensure the effect is not nearly as draconian. Although VAT will increase from 5% to 8% there will also be a supplementary package of about ¥5 trillion which should negate some of the negative impact of the rise,' he said.

'In addition, compared to 1997 there is a much more robust policy framework now and a banking system that was resuscitated back in 2003.’

He believes some areas of the small and mid cap market still offer compelling value, despite the meteoric rise that small caps have experienced over the past year.

‘Some people have been saying small caps represent very poor value compared to large caps but I completely disagree. Some areas such as internet companies have seen ridiculous growth, but the smaller end of the Topix [in areas such as] housing or food offers very good value.'

‘They have very robust balance sheets, very good management and strong visibility of earnings – and they are the ones we are focusing on.’ 

Over the five years to the end of September, the fund has returned 82.6% compared to 45.2% by the Topix index, according to Lipper.