By Leika Kihara and Tetsushi Kajimoto

TOKYO (Reuters – Japanese policymakers stepped up their warning about sharp yen fall, with Japan’s top currency diplomat saying Tokyo had reached an agreement to “communicate closely” on currencies while the third-largest economy struggles to regain it footing.

Masato, the vice-finance minister for international affairs Masato Kanada said that excessive volatility and “disorderly” currency moves are undesirable. It was a signal of Tokyo’s anger at the steep decline in the yen’s value compared to the dollar.

Japan can also use verbal intervention to limit yen drops. There are several options. One is to intervene directly in the currency markets and purchase large amounts of Japanese yen.

We have provided details below on the possible outcomes of a yen buying intervention, as well as some challenges.

WHAT YEAR DID JAPAN FINALLY CONDUCT A YEN-BUYING INTEVENTION?

Japan is heavily dependent on exports so it has traditionally focused its efforts on stopping sharp yen increases and not taking any action on falling yen.

Rarely has Japan intervened to purchase yen. Japan has not intervened in support of its currency since 1998 when it was hit by the Asian financial crisis. This triggered a sell-off in yen and an outflow of capital from that region. Tokyo had intervened before to prevent yen drops in 1991-1992.

What would prompt TOKYO to BUY YEN AGAIN

Intervention in currency is very costly. It could also fail if it’s not possible to influence its value on the large global foreign exchange market.

This is why it’s considered an emergency move. Tokyo would only approve the plan if verbal intervention is not enough to stop a free falling of the yen. In deciding when and how to intervene, authorities will consider not only the level but also the rate of yen’s decline.

Former high-ranking currency diplomat Eisuke Saakibara said to Reuters that a yen drop below 130 could trigger intervention.

Intervention would not be possible if Japan experiences a triple selling of its yen, stocks, and bonds. This would mirror the sharp capital outflows seen in other emerging countries.

HOW DOES IT WORK

Japan may intervene in order to curb yen increases. The Ministry of Finance will issue short-term bills to increase yen that can be sold on the Japanese exchange to lower the currency’s value.

Authorities must access Japan’s foreign reserves to purchase dollars for intervention in order to stop the yen from falling.

Both cases will see the financial minister issue the final order for intervention. Bank of Japan acts as agent for the Market and will implement the Order.

What are the challenges?

It is harder to buy yen than selling yen.

Japan needs to draw on its foreign reserves for dollars that it can exchange for yen in order for dollar-selling and yen buying intervention.

This means that it cannot keep intervening for too long, as opposed to yen-selling interventions – in which Tokyo can issue bills to increase yen.

Japan’s foreign reserves totalled $1.38 trillion. This is second only to China’s. They likely mainly consisted of dollars. The size of Japan’s foreign reserves is not insignificant, but it could shrink quickly if large sums of money are needed to change rates every time Tokyo intervenes.

In order to conduct currency intervention against the dollar/yen it will also need the informal consent of Japan’s G7 counterparts. This is difficult because Washington has always been opposed to currency intervention.