Financial Daily from THE HINDU group of publications
Wednesday, May 31, 2006
Financial Daily from THE HINDU group of publications Wednesday, May 31, 2006 |
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Money & Banking
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Forex Markets - Stock Markets Columns - Financial Scan S. Balakrishnan
The yen carry trade. Its latest victim, authoritative sources say, is the Indian stock market. What is the connection, one may ask. In recent times, our shares have been the best performing across global markets. And what better way to fund the investments than borrowing yen. The attraction is obvious. From the mid- and late-1990s, yen interest rates have been near zero. Japan is fighting a war against deflation and its central bank progressively reduced interest rates to nothing in a bid to spur households and businesses to spend and invest, and revive the economy, which was in deep recession. The prolonged zero interest rate policy pushed yields on 10-year Japanese government bonds — popularly called JGBs — to below 0.5 per cent. In other words, money was practically free, both at the short and long ends.
Prolonged slump
Japan's slump was prolonged. Meanwhile, the rest of the world tried to have a good time at its expense. Thus was born the yen carry trade. The strategy was obvious. Borrow zero-cost yen and invest in high yielders. For example, a carry trade in dollar-yen — which means buying dollars using yen and creating a dollar asset and a yen liability — offers a spread of about 5 per cent to the dollar buyer. Is it money for jam? Hardly. Dollar interest rates have invariably been several percentage points higher than those on yen, yet the yen is today close to 100 against the greenback, after starting at 300 in the aftermath of World War II. Japan's spectacular economic growth, its export machine and accumulating foreign exchange reserves overwhelmed the dollar's interest rate advantage. The trick in making money out of the yen carry trade has always been to catch the yen in phases of depreciation, which, unfortunately, have been few and far between. So is the story with other popular carry trades — funding pound sterling, Australian dollar and so on, which are traditionally high interest rate currencies with yen. The latest carry trade application, it is reported, is to buy into Indian stocks using ultra-cheap, near-zero cost yen.
Too many risks
The strategy is unlikely to appeal to a sophisticated investor. For the embedded risks are not confined to a fall of the Indian stock market, but include dollar-yen risk and rupee depreciation. If the yen moves up 10 per cent in double quick time — as happened just weeks ago — or the rupee falls, as is happening now, even a winning stock market bet could vanish. Why add on so many layers of risk to a simple bullish view of India? Thus, to attribute the collapse of the market to the unwinding of yen carry trades seems an oversimplification. The fact is that there were other far more powerful factors — commodity prices, fear of higher US interest rates, volatility in global markets — at play in driving our markets down.
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