S&P cuts Japan rating; warning to rich world

Reuters/Tokyo

The agency reduced Japan’s long-term sovereign debt rating by one notch to AA minus, three levels below the highest possible rating. It said Japan’s fast-ageing population, persistent deflation and the loss of the coalition’s upper house majority had compounded the government’s fiscal challenge.

Politicians and credit ratings agencies have been warning for years that Japan needs to lower its public debt, by far the worst among rich nations at double the size of its $5tn economy, but progress has proved elusive.

The ratings cut is a forceful reminder of the fragile financial state some rich nations are in following the global credit crisis.

The US budget deficit is expected to blow out to a record $1.5tn this year and debt worries in Europe have already prompted financial rescues of Greece and Ireland.

Japanese Prime Minister Naoto Kan has made tax and social security reform top priorities and the S&P downgrade adds pressure on him to galvanise a divided parliament.

Julian Jessop, chief international economist at Capital Economics in London, warned of the consequences if Tokyo failed to get its fiscal house in order.

"If it looks like making a mess of this, further downgrades will surely follow. Given the size of Japan’s economy and the current sensitivity of global financial markets to sovereign debt concerns, the impact would be felt worldwide,” he said.

"It supports our fear that 2011 could be the year when Japan’s dire fiscal position finally impacts markets both at home and internationally.”

The yen and Japanese government bond prices fell and the credit default swaps spread on Japan widened after the announcement.

But markets in the past have not worried too much about the country’s high debt because it is well serviced by ample domestic savings and few foreign investors hold Japanese government bonds (JGBs).

However, Japan’s society is ageing quickly, so social welfare costs will take up an increasing proportion of the budget in the absence of reforms, which S&P said reduces Japan’s already weak fiscal flexibility. S&P’s downgrade leaves its credit rating on Japan one notch below both Fitch and Moody’s and on a par with countries including China and Saudi Arabia. The new level is one notch below Spain.

"The downgrade reflects our appraisal that Japan’s government debt ratios—already among the highest for rated sovereigns—will continue to rise further than we envisaged before the global economic recession hit the country and will peak only in the mid-2020s,” S&P said in a statement.

"In our opinion, the Democratic Party of Japan-led government lacks a coherent strategy to address these negative aspects of the country’s debt dynamics, in part due to the coalition having lost its majority in the upper house of parliament last summer.”

Analysts say a Japanese debt default is unlikely because of Japanese household assets of some ¥1,400tn, which at three times the size of economic output provide a healthy pool of savings to fund the borrowing.

Fitch Ratings said Japan’s rating was supported by its ability to fund itself, although a failure to make progress to reduce the fiscal burden could put pressure on its ratings.

Moody’s Investors Service reiterated its ratings, a spokesman said. Both Fitch and Moody’s have a stable outlook on Japan.

S&P warned a year ago it might cut Japan’s credit rating unless it came up with a plan to deal with its debt.

Japan’s outstanding long-term government debt is set to reach ¥869tn ($10.57tn) at the end of March this year, or 181% of gross domestic product (GDP), Japan’s Ministry of Finance says.

If short-term debt is added, Japan’s liabilities will hit 204% of GDP this calendar year, larger than 137% for Greece and 113% for Ireland, OECD figures show.

The government plans to issue a record ¥144.9tn in bonds in the fiscal year that starts on April 1.

After Thursday’s cut, S&P said the outlook on the long-term rating was stable, reflecting its view that Japan’s strong external balance sheet and monetary flexibility partially offset the pressures stemming from the fiscal side.