Tokyo, August 24, 2011 -- Moody's Japan K.K. today downgraded the ratings on 12 regional
and local governments (RLGs) in Japan to Aa3 with a stable outlook from
The rating action follows Moody's decision to downgrade the Japanese Government
Bond (JGB) rating to Aa3 with a stable outlook from Aa2.
Today's rating actions conclude the review for downgrade initiated
in May 2011.
The 12 RLGs are:
Kyoto, City of
Nagoya, City of
Osaka City Government
Sapporo, City of
The downgrade reflects Moody's view that RLGs are closely tied to
the Japanese central government as a result of the nature of the country's
public sector system, which is highly integrated, and Japan's
historical tradition of risk socialization.
These features indicate there should be no distinction between the JGB
rating and RLG ratings. Therefore, a downgrade of the JGB
rating will inevitably result in a downgrade of the RLG ratings.
RLGs are closely linked to the central government due to Japan's
highly developed institutional framework for local governments,
which includes effective monitoring of all RLG activities, a system
of fiscal transfers that aims to reduce disparities among RLGs and ensure
a national minimum level of services, and strong policies providing
ongoing support for financially weak RLGs.
The considerable level of oversight and supervision of RLGs exercised
by the central government ensures that any credit issues at the RLG level
are uncovered and addressed early.
A well-developed equalization system of transfers, or the
Local Allocation Tax (LAT) system, makes certain that if any individual
entity begins to experience fiscal difficulties related to declines in
own source revenues, it will receive offsetting increases in LAT
Under this program, it is unlikely that any RLG's overall
income would fall to a level that would require emergency assistance.
Finally, the probability of extraordinary support—in the unlikely
event that a RLG experienced a liquidity crisis—is at the highest
level, reflecting again the very tight oversight mechanisms and
the perceived risk to Japan's reputation, should a regional
or local government default.
In the wake of the global economic crisis and the March 11 earthquake,
the central government's provision of significant assistance to
RLGs -- including larger LAT transfers, the provision
of government funds to underwrite RLGs' new debt at low interest
rates, and other subsidies -- is clear evidence of
the highly supportive government policy framework for RLGs.
As a consequence of the importance of the Japanese government's
role as the ultimate supporter of RLGs, as well as its powers to
unilaterally modify intergovernmental arrangements and intervene in a
local government's operations, it is Moody's view that
the rating of any RLG cannot be higher than that of the sovereign bond
Therefore, as indicated, a downgrade in the JGB rating results
in a downgrade of the RLG ratings.
Moody's also downgraded the standalone credit quality (or baseline
credit assessment or BCA) of all RLGs by one notch to reflect a less supportive
operating environment and a potential for lower transfers, both
of which could affect the financial performance of local governments.
Those BCAs that were formerly 4 (Aa3) have been revised to 5 (A1),
and those that were previously 5 (A1) have been revised to 6 (A2).
This BCA downgrade reflects our view that the key determinants of the
standalone quality of RLGs — that is the operating environment,
which is largely determined by national macro-economic conditions,
and the institutional framework, which determines the powers and
responsibilities of local governments within a country — while remaining
strong in Japan compared to its international peers, have weakened
with respect to their historical position. This trend is reflected
in Japan's downgrade to Aa3.
Principally, the less supportive macro-economic conditions
that have persisted in Japan in the wake of the global financial crisis,
earthquake and nuclear accident have correspondingly dampened the short-term
economic prospects for all RLGs in the country.
The resultant slowdown in local tax revenues and expected upward pressures
on social spending over the medium term are likely to challenge RLG budget
operations, bringing them closer to requiring additional assistance
from the central government.
In addition, while we do not foresee any substantial reduction in
the supportive institutional framework, there are clear pressures
to reform and potentially reduce the high level of transfers to RLGs,
given the government's own substantial fiscal challenges and high
debt burden. A potentially less generous funding framework would
similarly increase pressure on RLGs' financial operations.
With regard to individual characteristics that determine the standalone
BCAs -- such as debt, financial performance and governance
-- Moody's notes that these features have not deteriorated
to the same extent, largely due to significant additional assistance
provided by the central government subsequent to the global financial
crisis and March 11 earthquake.
WHAT COULD CHANGE THE RATING
Given the strong linkages between the sovereign and Japanese RLGs,
Moody's would likely downgrade the RLGs further if the sovereign
rating were downgraded again. Furthermore, any policy changes
that would result in a weakening of the highly centralized system,
with its high level of oversight and supervision, would apply downward
pressure on the ratings. However, recent history suggests
that policy changes of this direction are highly unlikely.
Conditions that would lead to a sovereign rating upgrade would also likely
lead to an upgrade of the Japanese RLG ratings. This is because
we assign -- as indicated -- an extremely high probability
of extraordinary support, such as liquidity assistance, from
the central government, if ever required, due to the unique
history of risk socialization and the highly centralized system in Japan.
The principal methodologies used in this rating were Moody's "Regional
and Local Governments Outside the US", and "The Application of Joint
Default Analysis to Regional and Local Governments". Both were
published on September 30, 2010, and are available on www.moodys.co.jp.
Information sources used to prepare the credit rating are the following:
parties involved in the ratings, parties not involved in the ratings,
public information, confidential and proprietary Moody's information.
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Vice President - Senior Analyst
Moody's Japan K.K.
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MD - Sub-Sovereigns
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Moody's Japan K.K.
Moody's downgrades 12 Japanese regional/local governments to Aa3 following sovereign downgrade
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