For all the turmoil over Toyota's wave of recalls, the automaker may face a bigger problem: the surging yen. With the yen at 15-year highs against the dollar, at a nine-year peak versus the euro and still near recent highs against the South Korean won, Toyota, the world's largest automaker, is finding that its cars have become too expensive to compete effectively in the increasingly cutthroat global auto market. That has allowed its foreign rivals to make big inroads around the world. Volkswagen of Germany, Hyundai of South Korea and the Detroit automakers all are benefiting from their relatively weaker currencies. Hyundai is quickly expanding its share in major markets, including China and the United States, using record profits to offer cash rebates, low-interest financing and other aggressive incentives that Toyota is struggling to match. Volkswagen continues to dominate in Europe and across much of the Asia-Pacific region; its chief executive, Martin Winterkorn, has said the company aims to be the world's largest automaker in sales by 2018, up from third place today, behind No.2 General Motors. Analysts say the yen, which started to soar as a refuge currency in late 2008 in response to the global financial crisis, has highlighted a flaw in Toyota's global production setup. The company still depends too heavily on factories and suppliers in its high-cost homeland, they say. While Toyota is acting to improve the ratio, about half its cars are still assembled in Japan, and many of them are shipped overseas on huge tankers. 'Before the yen's surge, Toyota got by with exporting lots of cars even though it was aware that posed a big currency risk,' said Takashi Akiyama, vice president at the Tokyo-based SC-ABeam Automotive Consulting. 'They held out for as long as they could, but now they're seeing the consequences of stalling.' Other big Japanese exporters like Honda, Nissan, Sony and Canon feel the yen's burden, too. Japan's export growth slowed for the fifth consecutive month in July, weighed down by the strong yen. But because those other companies have moved more of their production overseas in recent years, they suffer much less from currency arbitrage. The difference is laid bare in a startling statistic: for every yen to the dollar that the Japanese currency gains beyond the value that Toyota assumes in its planning -- 90 yen to the dollar -- the company says it loses 30 billion yen ($355 million) in operating profit. If the exchange rate stays at the current level, in which a dollar buys only 85 yen, Toyota's operating profit for the year to March could fall by half from the 330 billion yen ($3.91 billion) that the company had forecast. By that measure, Nissan says it loses only half as much for each yen's gain against the dollar -- about 15 billion yen ($178 million). Sony loses but 2 billion yen ($24 million). No matter how much the product recalls have tarnished Toyota's reputation for quality, the foreign exchange rate has probably caused more financial damage, by shaving margins to razor-thin levels and raising the specter of operating losses if the yen continues to rise, said Christopher Richter, a senior analyst for autos at the brokerage firm CLSA. 'Given how fast the yen has strengthened, time is not Toyota's friend,' Richter said. Over the years, Toyota has set up manufacturing in other countries -- including the United States, where it makes cars at four assembly plants. Still, Toyota imports from Japan 35 percent of the cars it sells in North America, compared with Honda's 10 percent. Toyota's share of the American market fell to 15.2 percent in August from 16.6 percent at the start of the year. Next year, Toyota plans to open a plant in Blue Springs, Miss., to build its popular Corolla compact sedan, which has been imported since April, when the company closed the Fremont, Calif., plant that made them. 'Our goal is to produce cars where they're sold,' said Paul Nolasco, a spokesman for Toyota in Tokyo. 'Who knows when, and 100 percent might not be possible. But the idea is to try to make as many cars locally to increase local content. That just makes business sense.' Perhaps nowhere does Toyota need to localize production and slash costs more than in emerging markets, where competitors easily undersell its vehicles. Take China, now the world's biggest auto market, where sales of the Toyota Yaris compact have fallen far short of expectations since its introduction in 2008. Although Toyota assembles the Yaris in China, to take advantage of much cheaper labor there, many of the parts still come from Japanese suppliers like Denso and Aisin. That helps push the price of the Yaris to more than 100,000 renminbi ($14,690), making it hard to compete with Hyundai's new Verna subcompact sedan, priced as low as 73,900 renminbi ($10,856) or General Motors' popular Buick Excelle, which costs slightly more than the Yaris but has a larger, sleeker body that seems to appeal to consumers who have the money to spend. Toyota had only 5.2 percent of China's auto market in 2009, trailing Hyundai, General Motors and the market leader, Volkswagen, whose Jetta family car starts around 75,000 renminbi and is pervasive in China's big cities. In India, another big emerging market, Toyota plans to introduce the Etios compact car late this year. Analysts expect it to cost around 500,000 rupees ($10,680), significantly more than the most popular models in India, including the Alto from Maruti, which starts at 323,000 rupees (about $6,900), or Hyundai's i10, which sells for 350,000 rupees. Toyota's slim market shares in India and China worry the company because emerging markets are expected to account for most of the growth in the global auto industry. IHS Automotive, an Englewood, Colo., research company, predicts car sales in emerging economies like China and India will surge 81 percent -- to almost 47 million units in 2016, up from about 25.8 million units in 2009. During that period, according to IHS Automotive, sales in industrialized economies will grow at only about half that rate, to 45.3 million. To capture a bigger part of these growing markets, Toyota says it is seeking to increase local production and its use of locally supplied parts in India and China. But it takes time and large investments to set up local production networks, analysts say. 'It isn't an easy task to build supplier networks overseas,' said Masatoshi Nishimoto, senior manager at IHS Automotive. 'Then there's the question of what to do with the excess capacity in Japan.' A big beneficiary of Toyota's travails is Germany's Volkswagen. It was an early entrant into the Chinese market and enjoys an almost 20 percent market share there -- the highest among foreign automakers. And Volkswagen continues to dominate in Europe, where Japanese automakers are being squeezed by the high exchange rate against the euro. Meanwhile, Hyundai is reaping the rewards of a weak South Korean won. In China, it leads Japanese automakers, with a 6.2 percent share in 2009. It has also secured 14 percent of the Indian market, where it plans to release by 2012 a car that costs as little as $5,000. For Toyota, moving more manufacturing overseas would inevitably mean cutting capacity and jobs in Japan, something the automaker has long avoided. Exporters are now under immense government pressure to keep jobs in Japan, even though the government has been hesitant to act to weaken the yen through monetary policy or intervention in currency markets. Japanese companies are growing frustrated with the government inaction. In a government survey of 102 exporters, released last week, about 40 percent of them said that they would transfer their factories overseas if the yen stayed at current levels. Some analysts say that it is a good chance for Japan to get over its obsession with manufacturing, move production overseas and make a long-awaited move into services -- a shift highly unlikely for a carmaker like Toyota. 'It would be a tough transition,' said Kazuki Ohara, a senior management consultant at the Tokyo-based Nomura Research Institute. 'But instead of trying to curb the strong yen or ride it out, it would be better for Japan to build an economy that thrives on a strong currency.' 