Takashi Miwa, Nomura's Chief Economist for Japan, explores the impact of Brexit on Japan. In a world where higher barriers to trade and capital flows are expected, Japan occupies a unique position as a creditor nation with current account surplus facing currency appreciation risks.
Japanese economy faces the risk of yen appreciation under higher barriers to trade and capital transfers
The majority of voters in the UK's referendum favored leaving the EU. It would appear that the primary short-term concern for the markets—a credit crunch triggered by a liquidity crisis at financial institutions—has been averted. From a longer-term perspective, however, the Brexit vote may mark a major turning point from the previous overarching trend of increasing economic and market integration, to a prevailing global scepticism regarding such integration. This scepticism brings with it the risk of even higher barriers to trade and to capital flows. We think that Japan, as a net creditor nation with a current account surplus, would face even higher risks of currency appreciation under such conditions.
Undercurrents of dissatisfaction with low growth behind trend away from integration
It would be premature to conclude that the leave outcome of the referendum vote will immediately accelerate the collapse of economic integration in continental Europe and elsewhere. However, we think public support for Brexit among UK voters was driven in part by economic frustration due to slow wage growth and widening income inequality. This was further supported by a latent dissatisfaction with persistently low economic growth, which we see as an indirect cause behind these issues. In our view, this state of affairs should be recognized as an issue for the entire global economy, rather than a problem specific to the UK or to Europe. This is the core reason for our view that Brexit could gradually lead to an increasing global scepticism regarding economic and market integration.
Signs of contraction in trade and capital transfers are already emerging
When assessing the potential impact of higher barriers to trade and capital flows as scepticism regarding economic and market integration gains ground, it could be noted that trade and capital flows have already begun to contract for other reasons. Declines in resource prices in recent years and currency-supportive monetary tightening in some emerging markets (in order to stem capital outflows), have already reduced trade volumes and suppressed capital transfers by forcing the narrowing of external imbalances, and we think this could also be an indirect factor behind yen appreciation since the start of 2016. We think the tendency for market risk avoidance to lead to a stronger yen makes sense if the reduced ability to adjust currency supply-demand is viewed as resulting from reduction in capital flows accompanying risk avoidance, due to the structural issue of Japan's status as a creditor nation with a current account surplus.
Focus on relative strengths of so-called self-sufficient companies
As scepticism toward economic and market integration gains ground in the aftermath of Brexit, higher barriers to trade and capital flows could expose the Japanese economy to risk of yen appreciation. This, in turn, could put the spotlight on the relative strengths of so-called self-sufficient companies, which have traditionally been viewed as likely to be placed in an unfavorable operating environment as they face the consequences of Japan's shrinking population in terms of a smaller domestic market and lower demand.
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