UPSC Mapping

This topic is important for GS Paper III (Indian Economy), covering exchange rate management, monetary policy, external sector, capital flows, foreign portfolio investment and financial stability.

Article

Japanese yen intervention is in the news after reports highlighted joint action by the United States and Japan to support the Japanese Yen and stabilise financial markets. The move explains how a stronger yen could influence global capital flows, the carry trade and emerging markets such as India.

Why in News

The US and Japan have jointly intervened in the foreign exchange market to strengthen the Japanese Yen. The move aims to improve financial stability by addressing excessive weakness in the yen and reducing volatility in currency markets.

Quick Facts

Countries Involved	United States and Japan
Objective	Support the Japanese Yen through foreign exchange market intervention
UPSC Themes	Exchange rates, central banking, capital flows and external sector

What is Japanese Yen Intervention?

The intervention is coordinated action by monetary authorities to increase demand for the Japanese Yen. Authorities sell US Dollars and purchase Japanese Yen in the foreign exchange market, leading to appreciation of the Japanese currency. The measure seeks to reduce excessive currency depreciation and improve stability in global financial markets.

Why Was Intervention Needed?

• Weak Yen: Prolonged depreciation increased financial risks.
• Imported Inflation: A weaker yen raised the cost of imported goods.
• Capital Outflows: Currency weakness affected investor confidence.
• Global Financial Stability: The intervention aimed to reduce volatility.

How Did Japan Strengthen the Yen?

1. Japan sold US Dollars.
2. It purchased Japanese Yen.
3. Demand for the yen increased.
4. The Japanese Yen appreciated.

Basic Concept: Exchange Rate

An exchange rate represents the price of one currency in terms of another. Exchange rates are influenced by demand and supply, interest rates, inflation, trade and capital flows, and central bank intervention.

Appreciation vs Depreciation

• Appreciation: A currency becomes stronger relative to another currency.
• Depreciation: A currency loses value relative to another currency.

What is Central Bank Intervention?

A central bank can influence exchange rates by buying or selling foreign currencies. Selling US Dollars and buying Japanese Yen increases demand for the domestic currency and supports its value.

What is the Yen Carry Trade?

The carry trade involves borrowing money in Japanese Yen at very low interest rates and investing those funds in countries offering higher returns. Investors earn the difference between borrowing costs and investment returns.

Why is Japan the Centre of the Carry Trade?

• Near-zero interest rates.
• Abundant liquidity.
• Accommodative monetary policy.

What Happens When the Yen Strengthens?

A stronger yen raises borrowing costs for investors using the carry trade. Investors may withdraw funds from emerging markets, repay loans and reduce overseas investments. This process is described as unwinding the carry trade.

Impact on India

• Short-term Risks: FPI outflows, market volatility, pressure on the rupee and higher bond yields.
• Positive Factors: Strong domestic growth, healthy forex reserves, resilient macroeconomic fundamentals and continued long-term FPI interest.

Role of RBI and Government

• RBI: Foreign exchange market intervention and management of exchange rate volatility.
• Government: Inflation management, macroeconomic stability, encouraging long-term foreign investment and deepening capital markets.

Prelims Practice Questions

1. Q1. Exchange rates are primarily determined by: (a) Demand and supply of currencies (b) Rainfall only (c) Population only (d) Agricultural output only.
   Answer: (a).
2. Q2. In a currency intervention to strengthen the yen, authorities generally: (a) Sell Yen and buy Dollars (b) Sell Dollars and buy Yen (c) Print more Yen only (d) Reduce exports.
   Answer: (b).
3. Q3. The carry trade generally involves: (a) Borrowing at low interest rates and investing where returns are higher (b) Export promotion (c) Gold imports (d) Currency substitution.
   Answer: (a).
4. Q4. A stronger Japanese Yen may lead to: (a) Carry trade unwinding (b) Lower demand for Yen (c) Higher inflation everywhere automatically (d) Elimination of exchange rate risk.
   Answer: (a).
5. Q5. According to the reports, one possible short-term impact on India is: (a) FPI outflows and market volatility (b) Elimination of imports (c) Fixed exchange rates (d) Removal of RBI’s role.
   Answer: (a).

Mains Practice Questions

1. Q1 (10 Marks): Explain the concept of currency intervention and discuss how exchange rate movements affect emerging economies such as India.
2. Q2 (15 Marks): Discuss the significance of the yen carry trade and evaluate its implications for global capital flows and the Indian economy.

FAQs

Why did the US and Japan intervene in currency markets? According to reports, they sought to support the Japanese Yen and improve financial stability.

What is the yen carry trade? It involves borrowing in Japanese Yen at low interest rates and investing in higher-yielding assets elsewhere.

How can a stronger yen affect India? It may trigger capital outflows, increase market volatility and influence the rupee, although India’s macroeconomic fundamentals remain supportive.

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