The foreign exchange market is vast, complicated and ruthlessly competitive all over the world, including Bangladesh. Although our forex market is not strong enough, the commercial banks (authorised dealer branches), trading houses and funds still dominate the market and are quick to incorporate new information into the prices. Forex trading, therefore, is not a market for the unprepared or ignorant. For effectively trading it on a fundamental basis, the traders must be knowledgeable when it comes to the major foreign currencies. Relevant knowledge should include not only the current economic statistics of a particular country, but also the underpinnings of the respective economies and the special factors that can influence the currencies. Just seven currencies account for 80 per cent of the forex market. Of these, Japanese yen remains one of the largest in terms of international trade and forex trading. That is only fitting as Japan is one of the largest economies of the world with one of the highest GDP (gross domestic product) among the nations. It is also one of the largest exporters in terms of dollar trading.
All of the major currencies in the forex market have central banks behind them. In the case of yen, it is the Bank of Japan (BoJ). Like most of the central banks in developed countries, the BoJ has a mandate to act in a fashion that encourages growth and minimises inflation. In the case of Japan, however, deflation has been a persistent threat for many years, and the BoJ has pursued a policy of very low rates with hopes of stimulating demand and economic growth. Real rates in Japan were actually slightly negative at various points in the 2000s.
The Japanese economy has some particular and peculiar attributes that yen traders need to understand. Firstly, despite its size Japan has been notably lacking in growth since the collapse of its equity and real estate bubbles in 1990. Writers often refer to the ensuing years as a 'lost decade' in Japan because of this reason. Since then, growth has rarely exceeded 2.0 per cent in Japan between 2001 and 2011 and has contracted to zero or negative rates multiple times. Japan is also notable for inflation, or rather the almost near-absence of it. Japan has actually experienced deflation for much of the last decade. Secondly, Japan is also the oldest major economy in the world and has one of the lowest fertility rates. That suggests an increasingly aging workforce with fewer and fewer younger workers to support the economy through taxation and consumption. Japan is also quite closed to immigration, and that establishes difficult demographics.
Lastly, Japan is also an advanced economy with a well-educated workforce. Although industries like shipbuilding have migrated to countries like South Korea and China, Japan is still a leading manufacturer of consumer electronics, autos and technological components. This has left Japan with significant exposure to the global economy, but also with increasing reliance on China as a trade partner.
There are several theories that attempt to explain foreign exchange rates. Purchasing power parity, interest rate parity, the Fisher effect and balance of payments models - all offer explanations of the 'right' exchange rate based on factors like relative interest rates, price levels and so on. In practice, these models do not work especially well in the real market as real market exchange rates are determined by supply and demand, which includes a variety of market psychology factors.
Major economic data includes the release of GDP, retail sales, industrial production, inflation and trade balances. Investors should also take note of information on employment, interest rates (including scheduled meetings of the central bank) and the daily news flow; natural disasters, elections and new government policies can all have significant impacts on exchange rates.
In the case of Japan and yen traders, the tankan survey (i.e., short-term economic survey of enterprises in Japan) is particularly noteworthy. Many countries report information on business confidence, and the tankan is a quarterly report published by the BoJ. The tankan is seen as a very important report and often moves trading in Japanese stock and currency. Besides, trade flow data is also uncommonly important for the yen.
In many respects, BoJ policy drives carry trades across the world. Carry trades refer to borrowings of money in a low-interest-rate environment, and then investment of that money in higher-yielding assets from other countries. With a stated policy of near-zero interest rates, Japan has long been a major source of capital for that trade. That also means that talk of higher rates in Japan can send ripples throughout the currency markets. While the BoJ has maintained low rates since Japan's property bubble collapsed, the bank has also been involved in currency intervention - selling the yen to help keep Japanese exports more competitive. This intervention, however, has carried political consequences in the past. Hence, the bank is relatively hesitant to intervene in the forex markets.
Japan's trade balance also impacts BoJ policy and forex rates. Japan has large trade surpluses, but a very large public debt and an aging population. A large percentage of that debt is held domestically, though, and Japanese investors seem willing to accept low rates of returns. The yen is the signature currency for Asia and it is one of the topmost frequently traded currencies across the world. And its relative stability has made it a significant reserve currency for many Asian countries. While the significance of yen could be at risk if the Chinese yuan becomes more liquid, that would likely be a multi-year process.
While Japan has very high debt levels, traders tend to be more comfortable with Japan's debt balance as so much of it is domestically owned. Moreover, traders often balance the high debt level of Japan with its high trade surplus, although the devaluation of the dollar and the 'safe haven' status of the yen have led the Japanese coin to become so strong that it threatens the very trade surplus that makes it attractive.
Currency rates are notoriously difficult to predict and most of the models seldom work for more than brief periods of time. While economics-based models are seldom useful to the short-term traders, economic conditions do shape long-term trends. Japan's strong trade surplus will likely maintain the country's position as a relatively safe haven for quite some time to come. But the aging workforce, persistently low number of consumers and business confidence as well as the rising significance of China as an economic rival will threaten that position making the Asian forex market vulnerable. Certainly as an emerging Asian country, Bangladesh should monitor the vulnerability to keep pace with the flow in the long run.
Sk. Shamim Iqbal is a banker serving the R&D Division of a private commercial bank after obtaining MBA (Major in Banking) from University of Dhaka. [email protected]
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