FX COLUMN-Policy, not M&A, is key to yen weakness

Fri Oct 19, 2012 7:25am EDT

-- Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own --

By Neal Kimberley

LONDON, Oct 19 (Reuters) - If the Japanese yen is to weaken further against the dollar, as the Tokyo authorities hope, it will need more of a driver than just offshore acquisition activity by Japanese corporates.

The authorities will have to do some of the heavy lifting through more monetary easing or foreign exchange intervention.

Japanese mobile operator Softbank's proposed $20.1 billion purchase of U.S. wireless carrier Sprint Nextel Corp is not alone enough to turn the tide of yen strength.

The deal has contributed to the yen's softer tone against the dollar. The foreign exchange market expects it to result in dollar demand and pre-positions itself accordingly.

That is the case even though only banks directly involved in the deal can actually know the size of any cash component that would necessitate the purchase of dollars for yen.

Corporate Japan has been very active acquiring overseas companies this year, a process that should overall be yen-negative. The Softbank/Sprint transaction takes outbound deals by Japanese firms to a record $75 billion this year, according to Thomson Reuters data.

However, the FX impact is more complicated than would first appear.

For example, Softbank is said to be raising loans totalling 1.65 trillion yen ($21.1 billion) from four banks.

If those loans are in dollars, Softbank would not need to buy the greenback against the yen in the spot market.

If the loans are in yen, some buying of dollars against yen might be needed, but some or all of the yen could be swapped into greenbacks, lessening any outright need to buy dollars.

The key point, however, is that money is being borrowed.

In the case of Softbank that is because the sums involved are just too large.

In other cases there is perhaps a more subtle explanation.

In March the Bank of Japan announced a 1 trillion yen ($12.8 billion) loan facility that Japanese companies could tap in order to borrow dollars from the central bank to invest overseas.

That facility arguably reduced the need for Japanese companies, looking to invest overseas, to buy greenbacks on the foreign exchange market and so weaken the yen.

Why buy dollars if you can borrow them cheaply from the BOJ?

Some might consider the BOJ move odd given the Japanese authorities' opposition to further yen appreciation.

Perhaps, in truth, the Tokyo authorities would prefer to see Japanese companies leave their cash piles broadly untouched.

Currently, Japan's corporate yen cash reserve is either invested in low yielding Japanese Government Bonds or held with banks who then re-invest those deposits into those same JGBs, thereby financing the government at very low cost.

If companies raid that nest egg to finance an offshore spending spree, that could make a dent in the deposit base used to buy JGBs, and could, just could, end up pushing up Japan's debt servicing cost.

Not good for the fiscally straitened government.

The BOJ also acknowledged on Friday that Japan's financial sector faces increased interest rate risk due to banks' large holdings of JGBs.

But if borrowing is the way to go for Japanese firms investing offshore, there is less reason to buy dollars against yen and the impetus for a higher dollar/yen exchange rate is lessened.

The onus then falls back on the Tokyo authorities if they wish to see the Japanese currency fall.

Friday's comments from Bank of Japan Governor Masaaki Shirakawa signalled a readiness to expand monetary stimulus further to support the fragile economy.

The argument for selling the yen against the dollar remains solid but it owes more to likely policy developments in Japan than to acquisition-related selling of the currency by Japanese companies. (Editing by Nigel Stephenson)

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