Singapore, February 22, 2011 -- Moody's Investors Service has today changed the outlook on the Government
of Japan's Aa2 rating to negative from stable.
The rating action was prompted by heightened concern that economic and
fiscal policies may not prove strong enough to achieve the government's
deficit reduction target and contain the inexorable rise in debt,
which already is well above levels in other advanced economies.
Although a JGB funding crisis is unlikely in the near- to medium-term,
pressures could build up over the longer term which should be taken into
account in the rating, even at this high end of the scale.
More specifically, factors driving the decision are:
1. The severity and persistence of the shock that the global financial
crisis imparted on Japan's government finances and on aggravating
pre-existing deflationary pressures,
2. As a result, the current policy framework will not be
capable of overcoming hurdles blocking a return to a path of fiscal deficit
reduction,
3. Increasing uncertainty over the ability of the ruling and opposition
parties to fashion an effective policy reform response to the debt and
growth challenges, and
4. Vulnerability inherent in the long-time horizon of Japan's
gradual fiscal consolidation strategy to worsening domestic demographic
pressures, as well as to possible, renewed shocks in a fragile
and uncertain, post-crisis global economic environment.
The rating action does not affect the Aaa foreign currency bond and bank
deposit ceilings, the outlooks for which remain stable. Nor
does the rating action affect the Aaa local currency bond and bank deposit
ceilings. The ceilings act as a cap on ratings that can be assigned
to the domestic or foreign currency obligations of other entities domiciled
in the country.
RATIONALE FOR THE CHANGE IN OUTLOOK
The global financial crisis has had a deep effect on Japan's economy.
It has significantly raised the hurdles which policy efforts must overcome
to reach the government's 2020 balanced primary budget target (excluding
interest expenditure). While Japan's real GDP growth of 3.9%
in 2010 may prove to be the strongest among the major advanced economies,
the apparent rebound was actually weaker in nominal terms.
Nominal GDP growth was a modest 1.8% on account of chronic
deflationary pressures, which were aggravated by the global financial
crisis. Over the long term through to 2020, the government
does not envisage growth breaking out of the 1-2% real and
nominal range in its baseline, "Prudent" scenario.
Moreover, even under the government's more optimistic "Growth
Strategy" scenario, the envisaged rise in nominal GDP to 3.8%
by 2020 will by itself not be strong enough to eliminate the primary budget
deficit—thus the importance of policy reform. While a more
buoyant global economy and a higher domestic labor force participation
rate would boost growth under this scenario, new fiscal measures
are unavoidably necessary to close the primary deficit.
To that end, the government intends to introduce a comprehensive
tax reform program in June. However, the divided Diet --
in which the opposition Liberal Democratic Party controls the Upper House
-- and the intensifying level of political challenges to
Prime Minister Kan together threaten to bog down such efforts.
By contrast, we note that under that stable government of Prime
Minister Koizumi from 2001-2006, confidence in the economy
improved and policies gained traction. Were it not for the global
financial crisis, the Koizumi target for a primary budget balance
may have already been achieved.
While we do not see the government encountering a funding crisis in the
near- to medium-term, we agree with Bank of Japan
Governor Masaaki Shirakawa's view that "as history shows,
no country can continue to run (large) fiscal deficits forever"
(7 Feb 2011 speech, "Toward a Revitalization of Japan's
Economy").
Large deficits and the collapse of growth since the early 1990s have led
to an overhang of government debt that is by far the largest among the
major advanced economies -- whether projected at 226%
of GDP by the IMF, or at 174% of GDP by the Cabinet Office
for 2010 (accounting practices explain the difference). Moreover,
both sources project an inexorable rise in debt over the long term under
current policy and growth assumptions.
RATING OUTLOOK DYNAMICS AND CREDIT SUPPORT FACTORS
Should the government of Japan put into place a comprehensive package
of fiscal and supply-side economic reforms in June, we would
monitor developments to assess their efficacy in stabilizing the government's
credit fundamentals.
Japan's credit strengths lie mainly in its deep financial markets
from which spring an exceptional home bias. The government can
fund itself at a lower nominal cost than any other advanced economy.
Moreover, throughout the global financial crisis, JGBs demonstrated
sounder and more stable safe haven features than even US Treasuries,
as the government relies on a domestic funding base buttressed by an ample
stock of household savings equal to three times GDP and relatively moderate
indebtedness.
Related to Japan's home bias is its strong external payments position
which insulates the country from external shocks. In addition to
a seemingly structural current account surplus on the balance of payments,
its net international investment position, at 58% of GDP
in 2009, was the largest of any industrialized advanced country
— larger than Germany's 28% of GDP, while Aa-rated
Spain and Italy had net liability positions. In fact, net
income receipts from overseas assets provide a bigger contribution to
the current account surplus than net merchandise trade.
Lastly, the strong external payments position is a reflection of
the continuing competitiveness of Japan's large, export-oriented
companies. Despite the recent appreciation of the yen, we
see this sector continuing to support growth and the external position
over the long term.
CREDIT TRIGGERS FOR A FUTURE RATING ACTIONS
Japan's very large economy and very deep financial markets provide
the wherewithal to absorb economic shocks. Nevertheless,
the inexorable rise in government debt suggests that actions are urgently
needed to regain a path of fiscal consolidation. Moreover,
the government's large refinancing needs introduce susceptibility
to financial tipping points, which could lead to abrupt, downward
rating pressures. These may include:
1. An inability by the government to put into place its comprehensive
tax reform program, or its adoption of weak measures that postpone
action into the indefinite future.
2. A depletion of the domestic funding base to a level that is
insufficient to meet government refinancing requirements. This
could arise from a drop in the household savings rate into negative territory.
3. A shift in the current account on the external balance of payments
into deficit. This would reflect a downshift in national savings
and would raise government funding costs to a level on par with those
in foreign government debt markets. It could also sharply raise
the risk premium for JGBs.
On the upside, policies which help revitalize the economy and which
lead to a clear and sustainable reduction in fiscal deficits would support
the current Aa2 rating.
We expect the outlook horizon to extend over the next year or two,
depending on developments.
PREVIOUS RATING ACTION & METHODOLOGY
The last rating action was on the Government of Japan on 18 May 2009,
when Moody's unified Japan's public sector ratings at Aa2 with a
stable outlook.
The principal methodology used in rating the government of Japan is "Moody's
Sovereign Bond Methodology", which was published in September 2008.
Press releases of other ratings affected by this action will follow separately.
Singapore
Thomas J. Byrne
Senior Vice President - Regional Credit Officer
Sovereign Risk Group
Moody's Investors Service Singapore Pte. Ltd.
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (65) 6398-8308
New York
Bart Oosterveld
MD-CCO Pub, Proj and Infra Fin
Sovereign Risk Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (65) 6398-8308
Moody's changes Japan's Aa2 government rating outlook to negative
