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29 Jun 2010
Tokyo, June 29, 2010 -- Moody's Investors Service says that the plan announced last week
by Japan's new prime minister, Naoto Kan, is supportive
of the country's Aa2 sovereign rating and stable outlook,
but is not without its challenges.
The prime minister's cabinet also announced a new growth strategy
that seeks to pull Japan out its decade-long torpor. Kan
was formally appointed prime minister just short of three weeks ago on
"Mr. Kan's strategy -- which is designed to fix
Japan's deteriorating finances and re-invigorate its economy
-- suggests that the government believes it has time to move gradually
on putting its finances in order and seeks to keep a balance between supporting
economic growth with the imperative of fiscal adjustment. Nonetheless,
the strategy is realistic on in its macroeconomic assumptions,"
says Thomas Byrne, a Senior Vice President in Moody's Sovereign
"The initial market reaction has been positive, and continued
market confidence in the government's management of its large debt
overhang as well as continued recovery in economic growth will be essential
for its success over time," adds Byrne.
"We note that the benchmark 10-year JGB yield fell to a 7-year
low of 1.14% last Thursday, following the release
of the plan, but a fleshing out of its details and demonstrated
progress in performance during the next year will be needed to maintain
market confidence," says Byrne.
In outlining his government's so-called medium- and
long-term "Fiscal Management Strategy," Mr.
Kan, citing the cautionary case of Greece, said that unless
"decisive" action is taken, Japan faces a "collapse."
As a solution, in the medium term, the plan proposes a halving
by 2015 the government's primary deficit, which --
excluding interest expenditure on debt -- equaled about
8-9% of GDP in 2009. He also proposed imposing a
long-deferred increase in the consumption tax before 2015.
Moody's does not know whether that target date will be moved up
after the pledge made by the U.S., Japan and European
nations at the G-20 Summit to halve their fiscal deficits by 2013.
"However, where Mr. Kan's roadmap is weak is
in its lack of specificity in terms of the timing, form and degree
of revenue and expenditure measures, as well as in its long duration,"
"By comparison, other highly rated governments under financial
stress have shown a greater sense of urgency; for example,
the new UK government -- whose fiscal deficit is large like
Japan's -- has also announced a fiscal consolidation target,
but it is more determined than that of Mr. Kan. In the case
of the UK, structural current deficit elimination is to occur over
five years," says Byrne.
The more decisive policy stance on the part of the UK government underscores
a difference in policy strength features of Aaa versus Aa ratings for
governments, adds Byrne.
Nonetheless, a key support factor for Japan is that it does not
have the problem of excessive foreign borrowing nor of highly indebted
households or corporations—residents hold about 94% of government
bonds, the current account balance on the external balance of payments
is in surplus and the country has a large, net asset international
investment position which is more than 50% of GDP. Thus,
the gradual pace of implementation suggests that the government considers
it has some time to balance economic recovery concerns for external pressures
on its fiscal sustainability.
Moody's nevertheless notes that the risk of a gradual approach is
that the challenges are greater now for Japan than previously, and
when former Prime Minister Junichiro Koizumi had initiated a similarly
long-term fiscal consolidation plan. The latter would likely
have achieved the same target of a primary surplus by 2012, if it
were not for the global recession.
By comparison, Japan's budget deficits are larger now than
when Mr. Koizumi was elected prime minister in 2001 and its debt
is twice as high.
In addition, future gains generated from possible lower interest
rates will be negligible even against a background of chronic deflation
and the prospects for a boost to growth from a sustained expansion of
global and regional trade are much dimmer.
One area in which Japan is stronger now than in the past is its banking
sector, which is liquid, of relatively good asset quality
and adequately capitalized. "This will help support Japan's
stable domestic-market funding base and strong home bias for JGB
assets. But, at the same time, there may be little
margin for error in implementation, or for downside surprises from
a fragile global economy," says Byrne.
With the longer-term specifics, Mr. Kan's goal
is to eliminate Japan's deficit by 2020 so as to stabilize the ratio
of debt to GDP; and to get on the path of fiscal balance, the
government will cap the issuance of net new government bonds for fiscal
2011 at this year's level of around JPY44 trillion. Spending
growth would also be frozen.
Moody's considers that supply- and demand-side measures,
including a cut in the corporate income tax rate -- currently
among the highest among the advanced economies -- and an
expansion of a free-trade zone to include the entire Asia-Pacific
region as essential to boosting GDP growth to 3% in nominal terms
and 2% in real terms. Such growth rates, as envisaged
by the plan, are the minimums necessary for success.
Moody's further notes that the central government has outlined its
decentralization policies, which include some reorganization of
local government responsibilities and revenue sources, but within
the former's commitment to not off-load its problem onto
Accordingly, given the close relationship between central and local
government finances, there is nothing in the announced strategy
that would lead Moody's to change its view that the likelihood of
central government action to support a local government facing extreme
financial stress is a near certainty, given the long history of
risk socialization in Japan.
Therefore, Moody's ratings on prefectures and designated cities
in Japan remain closely linked to the sovereign Aa2.
The principal methodology used in rating the government of Japan is "Moody's
Sovereign Bond Methodology", published in September 2008,
which can be found at www.moodys.com in the Rating Methodologies
sub-directory under the Research & Ratings tab. Other
methodologies and factors that may have been considered in the process
of rating this issuer can also be found in the Rating Methodologies sub-directory
on Moody's website.
Thomas J. Byrne
Senior Vice President - Regional Credit Officer
Sovereign Risk Group
Moody's Singapore Pte Ltd.
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (65) 6398-8308
Sovereign Risk Group
Moody's Investors Service
Moody's considers that Japan's new strategy supports the government's rating
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