Moody's Downgrades Japan Over Debt And Deficit

by Mary Swire, Tax-News.com, Hong Kong

26 August 2011

Moody's Investors Service has reduced Japan's sovereign long-term credit rating, partly as a result of the government's ongoing inability to agree a comprehensive tax reform plan.

Moody's reduced Japan's sovereign long-term credit rating from Aa2 to Aa3 – the same level as its rating by Standard & Poor’s, and the same rating as is enjoyed, for example, by China

Moody’s rating action is a conclusion to the review that began in May this year, and the agency has confirmed that, in its opinion, the rating outlook is now stable.

In a statement, Moody’s said that “the rating downgrade is prompted by large budget deficits and the build-up in Japanese government debt since the 2009 global recession. Several factors make it difficult for Japan to slow the growth of debt-to-GDP and thus drive this rating action.”

It points out that, “over the past five years, frequent changes in administrations have prevented the government from implementing long-term economic and fiscal strategies into effective and durable policies. The March 11 earthquake and tsunami, and the subsequent disaster at the Fukushima Daiichi Nuclear Power Station, have delayed recovery from the 2009 global recession and aggravated deflationary conditions. Prospects for economic growth are weak, making it more difficult for the government to achieve deficit reduction targets and implement its comprehensive tax and social security reform plan.”

Moody’s thinks that “government budget deficits will remain approximately at or above 7% of gross domestic product (GDP) through 2015… well exceeding nominal GDP growth rates and thereby contributing to the inexorable rise in the debt-to-GDP ratio.” Japan has “an overhang of government debt that is by far the largest among the major advanced economies,” Moody's added.

The agency has also considered the lack of a definitive fiscal reform plan to address the budget deficit. “Although the government and ruling party unveiled a comprehensive fiscal reform plan on June 30, which identifies a broad range of measures to be taken, it lacks precision,” Moody’s adds. “In addition, a divided Diet and tensions within the ruling Democratic Party of Japan risk both the timing and implementation of the reform plan.” This has been reinforced by the confirmation, on the same day as the downgrade by Moody's, of the impending resignation of Prime Minister Naoto Kan.

While Japan's medium-term policy target of a halving of the primary budget deficit (excluding interest payments) to approximately 3% of GDP by 2015 is seen as feasible, assuming the government doubles the consumption tax to 10% by the middle of the decade, Moody's concludes that its ultimate goal of achieving a primary surplus by 2020 "would require additional, and yet unidentified, fiscal measures”.

However, Moody’s, in placing the rating on a stable outlook, does conclude that there are various credit supportive elements, particularly Japan's “very large economy and very deep financial markets” which provide the means to absorb economic shocks, and its “dependable domestic funding base (which) provides an exceptional home bias for the government, which can fund itself at a lower nominal cost than any other advanced economy.”

It adds that “support for the stable outlook comes from the undiminished home bias of Japanese investors and their preference for government bonds, which allows the government's fiscal deficits to be funded at the lowest nominal rates globally. We believe that this funding cost advantage will be sustained by considerable institutional and structural strengths, which will prevail even with large budget deficits in 2011 and 2012.”

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