The boom in Japan’s inbound tourism is arguably the most tangible success story of Abenomics. Propelled by a steady stream of visa-rule deregulation that started right in the first week of Team Abe moving into the Prime Minister’s Office in December 2012, inbound tourist arrivals have risen almost fourfold, from a 2012 monthly average of 697,000 to 2.6 million recently. That’s real change, with deep-rooted positive structural dynamics and economic follow-through.

Money makes the world go round and money is exactly what the inbound tourism boom has brought to Japan. Consider this: Since 2012 inbound tourists spending has accounted for the equivalent of almost 20 percent of the growth in Japan’s consumer spending (excluding spending on rent). Although in absolute terms the amount of tourist spending is still small at less than 2 percent of all consumption, going from basically zero to 2 percent of all consumption in six years is an exceptional growth rate. Positive impact is not just on Tokyo, Osaka or Fukuoka, but the beneficial multipliers are extraordinarily high in Japan’s regional economies.

Japan’s tourism strategy is arguably the most successful top-down regional growth policy implemented in an advanced economy in recent years. At first, Abe’s progressive deregulation of visa rules for Chinese and ASEAN tourists released structural pent-up demand — a new travel destination for Asia’s rising middle class.

At the same time, the government pushed through supply-side deregulation — more airport landing slots, easier hotel building codes and so on. The result: After decades of “hollowing out,” Japan’s regional economies are now re-building and re-inventing themselves as tourist destinations. This is not so because of one-off big government spending programs, but because of genuine private sector profit opportunities created by deregulation. It takes both positive demand and positive supply side dynamics to create a virtuous economic cycle.

Team Abe deserves credit not only for kick-starting the cycle, but also for seeking to anchor demand-growth expectations for private hospitality entrepreneurs by setting aggressive long-term goals: Japan wants 40 million visitors by 2020 and then 60 million by 2030, a massive jump from last year’s 28.7 million. These seem to make sense because of Asia’s population — and economic growth dynamics. The boom turns into a structural growth upcycle.

However, there is no room for complacency: Despite all the positive structural tailwinds, already the exchange rate plays an important role in determining the spending habits of inbound tourists. A strong yen immediately cuts their purchasing power, while a weak yen raises it. How much? My analysis suggests that yen appreciation cuts both visitor arrivals and average amount spent in Japan: An appreciation of the yen of 10 against the dollar appears to reduce monthly arrivals by approximately 1.2 percent, and cut money spent per tourist by approximately 10 percent.

While the impact on tourist volume appears negligible, the negative impact of money spent is significant. This has important negative implications for hospitality entrepreneurs for their price point and profit strategies. The stronger the yen, the stronger the pressure to offer discounts, which in turn means lower profits for regional hospitality entrepreneurs.

From here, an important consequence of the success of Abe’s tourism strategy will make it even more imperative for Japan to have a weaker, rather than stronger, yen. In fact, weak-yen advocacy is poised to spread from the manufacturing export lobby to the regional development lobby. In the past, many regional and local politicians viewed yen depreciation as negative for their constituents because a weak yen meant higher import prices and the cost push depressed further local business and regional economies. In contrast, yen depreciation is becoming viewed as a positive policy tool for driving domestic growth in general, regional growth in particular. Just like Toyota and Hitachi, local businesses have now become exporters of the services and goods to the world. The inbound tourism boom has aligned the interests of both global and local Japan Inc.

In coming years, the impact of the structural change that kick-started the tourism boom will fade and the importance of the yen as a driver for inbound purchasing power is poised to grow. To keep tourism strong, Japan will need a weaker yen. Before long, local political leaders, i.e., the backbone of the ruling Liberal Democratic Party, are bound to become vocal advocates for yen depreciation, in my view.

Of course, from a purist analysts’ perspective, it is still too early for statistically sound conclusions on the exact factor contributions driving inbound tourist spending. The structural break forced by visa deregulation is still too recent — in fact in early 2017 visa rules for Chinese nationals were eased further; and currency cycles have been relatively limited between 2012 and 2017.

However, the fact that forex sensitivity already registers as a force of significant impact — despite powerful structural tailwinds still at work — suggests that, from here, the importance of the yen exchange rate as a key to the success of Japan’s inbound strategy will only grow.

Make no mistake. To keep the tourism boom growing, Japan does need a weaker yen. Japan’s policy advocacy for yen depreciation is poised to get stronger. Importantly, the key exchange rate to watch here will be the yen-yuan (i.e., Japan-China) exchange rate: a yuan devaluation could quickly translate into very bad economic news for Japan’s regional economies.

Based in Tokyo, Jesper Koll is WisdomTree’s Head of Japan. Researching and investing in Japan since 1986, he’s been consistently ranked as a top Japan strategist/economist. He blogs at www.wisdomtree.com/blog .

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