Japan is experiencing significant capital outflows, escalating the depreciation pressure on the yen. While Japan reported a sizeable current account surplus of 8.97 trillion yen (approximately $57.5 billion) in the third quarter, these gains are offset by capital moving out through direct and securities investments.
The yen had reached a 14-month high against the dollar in September as traders unwound carry trades, but it has since dropped by approximately 10%. Analysts attribute the yen’s continued weakness to the still-wide interest rate gap between Japan and the U.S., especially considering expectations that policies under President Trump could spur inflation, potentially prompting the Federal Reserve to maintain high rates.
Another influential factor is the dynamics of trade and investment flows involving Japan. According to Shusuke Yamada, Head of Japan FX and Rates Strategy at Bank of America in Tokyo, the outflows from direct and securities investments are neutralizing the potential gains from the current account surplus. Most of Japan’s surplus stems from basic income and is reinvested abroad, which can obscure the true picture if one only considers the current account balance.
The current account includes exports, imports, and other cross-border activities like wages and investment returns. Japan's basic income recorded a record surplus of 12.2 trillion yen in the third quarter, mainly from investment returns, which offset the trade deficit and boosted the current account surplus. Hideki Shibata, Senior Fixed Income and FX Strategist at Tokai Tokyo Intelligence Lab, highlighted that trade deficits prompt yen selling to meet foreign currency demand, and this trend is expected to persist.
Despite attracting a higher share of securities investment, equivalent to 90% of GDP, much of these inflows do not lead to yen appreciation since they are currency hedged and largely speculative with no long-term holding increase. Additionally, Japan's interest rates remain low compared to other economies, making it unlikely to attract foreign investment unless the yen strengthens significantly to counteract interest rate differentials.
Shibata noted the lack of domestic investment opportunities in Japan, indicating that most overseas dividends and redemption proceeds are reinvested abroad.
Capital outflows are further influenced by Japan's challenging business environment for foreign companies, characterized by high entry barriers and a complicated market landscape, as noted by Tsuyoshi Ueno, Senior Economist at NLI Research Institute. This scenario, coupled with Japan's stagnant potential economic growth over the past two decades, reinforces the trend of capital leaving the country.
