Unlike S&P, Moody's didn't wait for the weekend to announce the latest sovereign debt earthquake:
Moody's has just announced a downgrade of Japan from Aa2 to Aa3, outlook stable.
Perhaps Moody's has now realized that an over 200% debt to GDP ratio is unsustainable?
Singapore, August 24, 2011 -- Moody's Investors Service today lowered the Government of Japan's rating to Aa3 from Aa2, concluding the rating review that began on May 31. The outlook is stable.
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.
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.
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.
The rating action does not affect the Aaa country and bank deposit ceilings, the outlooks for which remain stable. Those ceilings act as a cap on ratings that can be assigned to the obligations of other entities domiciled in the country. Japan's short-term rating is unaffected and remains unchanged at P-1.
The global financial crisis has had a severe effect on Japan's economy.
The current government now forecasts a primary budget surplus (excluding interest payments on government liabilities) by 2020, versus the former Koizumi government's target of a budget surplus by 2012. Headline general government budget deficits will remain approximately at or above 7% of GDP through 2015, according to the Cabinet Office's "prudent" projection, well exceeding nominal GDP growth rates and thereby contributing to the inexorable rise in the debt-to-GDP ratio.
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. That assessment holds true based on either the International Monetary Fund's (IMF) 2011 projection of 233% of GDP or the Cabinet Office's projection of 181% (the IMF has a broader accounting definition). Moreover, neither the IMF nor the Cabinet Office foresees containing or reducing the debt burden over the next decade under the current policy framework.
The March earthquake and nuclear disaster may make it difficult for the government to stay under its JPY44 trillion annual budget borrowing ceiling (which excludes special reconstruction bonds) in the current or next fiscal year, though the government's new Medium-Term Fiscal Framework for 2012-14 repeats its commitment to adhering to that target.
The government estimates that the total fiscal cost will be 5% of the current year's GDP, but that will be spread over 10 years.
The March earthquake also undermined Japan's recovery from the 2009 global recession. Consumer spending has softened further and deflationary pressures have intensified. Also, the strength of future investment growth is more uncertain even though supply chain disruptions are normalizing. This is because power capacity will be reduced from the loss or suspension of supply from nuclear power plants in Fukushima and elsewhere in the country. Japan's economy has been in recession for three consecutive quarters from October 2010 through June 2011.
In particular, the consequences of the Fukushima Daiichi Nuclear Power Station disaster have not fully played out, and it is not yet possible to precisely quantify its impact. The government may be exposed to contingent liabilities even after it establishes a special compensation entity that places the burden on the nuclear power industry. Furthermore, reductions in the national power supply from a crippled and suspect nuclear power sector would intensify headwinds against economic growth.
These developments further hamper the economy's ability to achieve a growth rate strong enough to steadily reduce 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. In addition, a divided Diet and tensions within the ruling Democratic Party of Japan risk both the timing and implementation of the reform plan. Indeed, the imminent change in the party's presidency and the election of a new prime minister reflect the factious nature of the country's politics.
While the government sees as feasible its medium-term policy target of a halving of the primary budget deficit (excluding interest payments) to approximately 3% of GDP by 2015, assuming the government doubles the consumption tax to 10% by the middle of the decade, its ultimate goal of achieving a primary surplus by 2020 would require additional, and yet unidentified, fiscal measures. Moreover, even under the government's more vigorous and optimistic economic growth scenario, a decline in the debt-burden trajectory would remain elusive.
CREDIT SUPPORT FACTORS
Japan's very large economy and very deep financial markets provide the wherewithal to absorb economic shocks. Its dependable domestic funding base provides an exceptional home bias for the government, which can fund itself at a lower nominal cost than any other advanced economy.
Furthermore, throughout the global financial crisis, in the months after the March earthquake, and in recent days with renewed turmoil in global markets, JGBs continue to demonstrate exceptionally strong safe-haven features.
Related to Japan's home bias is its strong external payments position, which insulates the country from global financial market shocks. In addition to a seemingly structural current account surplus on the balance of payments, its net international investment position at more than 50% of GDP is the largest of any industrialized advanced country, and is almost twice as large as that of Germany. In fact, net income receipts from overseas assets provide a bigger contribution to the current account surplus than the trade balance.
The steady appreciation of the yen to post-war highs is a headwind against export competitiveness, although the lack of price and wage inflation in Japan somewhat offsets this effect. Even if exports falter as a source of economic growth, we expect Japan's external position will retain its strengths.
And although the government's June 30 Comprehensive Tax and Social Security Reform plan is not fully worked out, it will help to sustain market confidence if, in the not-too-distant future, the government executes policies on a timely basis and economic growth recovers to support the fiscal adjustment process.
CREDIT TRIGGERS FOR A FUTURE RATING ACTION
Credit-positive factors that could lead to a positive ratings outlook and could eventually lead to a ratings upgrade:
1. Well-established progress in achieving fiscal consolidation targets
2. A robust and sustainable recovery from the recession
Credit-negative factors that could lead to a negative ratings outlook or prompt a ratings downgrade include:
1. A delay in implementing the comprehensive tax and social security reform plan
2. The economy's inability to recover from the lingering effects of the global recession and the ongoing consequences of the March earthquake, tsunami and nuclear power plant disaster
3. A diminished home bias in the government bond market or substantial erosion in Japan's external strengths, which at some point would cause the market to price in a risk premium to government debt, making sizable annual refinancing requirements significantly more costly
PREVIOUS RATING ACTION & METHODOLOGY
The last rating action on the Government of Japan was on May 31, when its government bond ratings were placed on review for downgrade.
The principal methodology used in this rating was Sovereign Bond Ratings published in September 2008. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.
Press releases of other ratings affected by this action will follow separately.