The yen has risen by a sharp 11.27 per cent since June 2007 to 109.29 a dollar, which is seen as a case of dollar depreciation rather than appreciation of the Japanese currency.

A large part of the incremental overseas borrowings by Indian companies in over more than a year has been in yen-denominated loans and the foreign currency risk is hedged at around yen 111-112 to a dollar.

"A lot of ECBs (external commercial borrowings) has been in yen, based on the assumption that yen would not appreciate beyond 111-112. These companies would be adversely affected if not fully hedged. At least 30-40 per cent of incremental ECBs over the last year or so have been in yen, said Abheek Barua, chief economist at HDFC Bank [Get Quote].

Indian companies and banks borrowed about $25 billion overseas in 2006-07 and $7 billion in the first three months of 2007-08.

The yen appreciation is a fallout of increased apprehension about global liquidity conditions. "A lot of appreciation of the yen is because of unwinding of yen carry trade positions. This then further feeds into it," Barua pointed out.

According to BIS Quarterly Review, September 2007, statistics available provide some evidence consistent with a rising role of the yen and the Swiss franc as funding currencies.

Global claims denominated in these currencies have, in absolute terms, been on the rise in recent years, although they remain a small (and declining) portion of reporting banks' total claims. Total yen-denominated claims reached $1.05 trillion in the first quarter of 2007, just shy of their most recent peak in the fourth quarter of 2005.

In contrast, the Swiss franc-denominated claims have grown more steadily in recent years, reaching $678 billion in the first quarter of 2007, though the near-exact measurement of the size of carry trade positions is difficult.

A currency carry trade is usually defined as a leveraged cross-currency position designed to take advantage of interest rate differentials and low volatility.

The strategy involves borrowing funds at a low interest rate in one currency (the funding currency) and buying a higher-yielding asset in another (the target currency). Ex-ante, the strategy is only profitable as long as the gains from interest rate differentials are not expected to be overwhelmed by exchange rate movements in the short to medium term. The use of leverage makes these positions particularly sensitive to changes in exchange rates or interest differentials.

Barua said the kind of leveraged trades in Japan on yen borrowing will tend to moderate and all other asset classes, which were gaining because of it would also be impacted. The yen carry trade does not necessarily flow into credit. In case of India, a lot of it is into the equity market. The non-credit markets would also be adversely impacted, affecting liquidity, with the appreciation of the yen.

"In the case of India, in the last one-and-a-half years or so, a lot of Japanese funds were investing directly or hedge funds were dipping into these funds," he added.