Japan’s Credit Rating Cut to AA- by S&P on Debt Load

Japans Credit Rating Cut to AA- by S&P
Mount Fuji, Japan's highest peak, emerges through buildings in the Shinjuku district at dusk, in Tokyo. Photographer: Tomohiro Ohsumi/Bloomberg

Japan’s credit rating was cut for the first time in nine years by Standard & Poor’s as persistent deflation and political gridlock undermine efforts to reduce a 943 trillion yen ($11 trillion) debt burden.

The world’s most indebted nation is now ranked at AA-, the fourth-highest level, putting the country on a par with China, which likely passed Japan last year to become the second-largest economy. The government lacks a “coherent strategy” to address the nation’s debt, the rating company said in a statement. The outlook for the rating is stable, S&P said.

The yen and bond futures fell on concern the downgrade will push up the cost of borrowing for Japan, where public debt is about twice the size of gross domestic product. Vice Finance Minister Fumihiko Igarashi this week said the government must fix its finances to avoid a debt crisis that could trigger a “global depression.”

“I hope this serves as a warning for the government, they have absolutely no sense of crisis,” said Azusa Kato, an economist at BNP Paribas in Tokyo. “Once bond yields spike and the fire is lit, the amount needed to finance Japan’s borrowing needs is going to jump and it’s going to be too late.”

Credit-Default Swaps

The yen weakened and stocks swung between gains and losses after the announcement. The currency fell against all of its main counterparts and was trading at 82.89 per dollar as of 8:49 a.m. in New York. The Stoxx Europe 600 Index added 0.2 percent, while the MSCI Asia Pacific Index slipped 0.1 percent, erasing a 0.6 percent advance. Ten-year Japanese bond futures for March delivery declined to 139.56 at the Singapore Exchange.

The cost of protection against a default by the Japanese government rose. Credit-default swaps jumped 4 basis points to 84 basis points, according to Deutsche Bank AG, set for the biggest daily increase since Nov. 30, prices from data provider CMA show.

Thirteen Japanese companies included in the benchmark Topix stock index are more highly rated than AA- by S&P, including Toyota Motor Co. Shiori Hashimoto, a spokeswoman for Toyota City, Japan-based Toyota, declined to comment.

It is possible for companies to have higher ratings than the local or foreign currency ratings of their home country, S&P said in a May 2009 report. The best candidates have a robust export base, little reliance on the public sector and sell products with “relatively inelastic” demand. The S&P report said businesses with sales mainly in local currency, subject to regulation and heavily dependent on imports probably won’t pass stress tests without “heavy overcollateralization or reserves.”

Downgrades in Europe

Japan joins developed economies including Portugal and Spain in being downgraded as emerging nations bounce back more strongly from the global recession. The previous change to Japan’s rating by S&P was an upgrade in 2007, before the financial crisis. The nation lost its AAA rating, the highest grade, in 2001 after holding it since 1975.

With domestic investors holding more than 90 percent of Japanese government bonds, the downgrade “probably won’t prompt them to move money out of Japanese bonds into foreign assets because the problem of sovereign debt is worsening worldwide,” said Naomi Hasegawa, a senior debt strategist in Tokyo at Mitsubishi UFJ Morgan Stanley Securities Co., a unit of Japan’s largest lender by assets.

‘Regrettable’ Decision

Economy and Fiscal Policy Minister Kaoru Yosano called the downgrade “regrettable.” He said Prime Minister Naoto Kan’s “commitment to fiscal reform hasn’t been fully understood” and the government needs to step up its efforts to increase revenue and pare debt.

“I’ve just heard about it,” Kan told reporters in Tokyo more than an hour after the news was released. “I’m not familiar with the matter, so please ask me later.”

Chief Cabinet Secretary Yukio Edano said minutes later that he couldn’t confirm when Kan, who spent most of the day in parliament, first heard the news.

Kan, whose approval rating has halved since he took office last year, appointed Yosano this month to help draft a fiscal policy plan and called for a national debate on raising the 5 percent sales tax. The premier’s ability to push through legislation has been weakened by opposition control of the upper house of parliament.

The Democratic Party of Japan-led government “lacks a coherent strategy” to tackle the nation’s debt, S&P said. In addition, government debt ratios are likely to rise “further than we envisaged before the global economic recession hit the country,” the company said.

China Versus Japan

By putting Japan alongside China, the downgrade highlights the rise of the neighbor that has led the global recovery. S&P has upgraded China five times in the past decade, most recently in December when it cited the nation’s world-record foreign-exchange reserves, now $2.85 trillion.

The International Monetary Fund estimated that China’s ratio of debt to GDP would be 20 percent in 2010, a prediction that excluded local-government liabilities. In comparison, it estimates Japan’s burden exceeds 200 percent.

Japan’s bond sales may surpass 50 trillion yen in the year starting April 2013, the Finance Ministry said yesterday. That suggests Kan may not meet a pledge of capping sales at 44.3 trillion yen. Public debt will probably increase 5.8 percent to 997.7 trillion yen in the year starting April 1, from a projected 943.1 trillion yen this year, the ministry said.

Losing Credibility

Finance Minister Yoshihiko Noda said Jan. 24 the debt burden has risen to a point where Japan can’t rely on bond sales to cover revenue shortfalls. Economy Minister Yosano warned the same day that such a reliance on such sales could lead to a jump in borrowing costs.

“If we continue relying on bond sales to make up for spending that exceeds revenue, we could see long-term interest rates increase or a deterioration in our debt ratio, causing Japan to lose credibility globally,” Yosano told parliament.

The Bank of Japan this week kept its benchmark interest rate near zero even as it raised its growth forecast for the year ending March to 3.3 percent from an October estimate of 2.1 percent.

Higher commodity costs will spur a 0.3 percent increase in consumer prices in the year starting April, the central bank said. A gain of that amount would be less than the 1 percent it regards as stable.

‘Within Expectations’

Today’s rating downgrade “was within expectations given the situation with the GDP and outstanding debt,” said Yoshimitsu Goto, general manager at Softbank Corp., Japan’s third-largest wireless carrier. “It won’t hinder our financial operations.”

Moody’s Investors Service today affirmed its Aa2 rank for Japan, the third-highest grade, with a stable outlook. Fitch said it’s “supporting” its local AA- and foreign currency Aa ratings for the nation.

Japan’s borrowing costs are among the lowest in the industrialized world, helping it fund its debt load. The yield on the benchmark 10-year bond slipped 1 basis point to 1.23 percent as of 10:47 p.m. in Tokyo. It touched 1.26 percent in Jan. 19, the highest since Dec. 16.

As a consequence of today’s downgrade, S&P lowered ratings on other entities including four insurers and six government-related institutions including Japan Finance Corp., Japan International Cooperation Agency and Japan Finance Organization for Municipalities, according to a separate statement. All institutions are now graded AA- at the company.

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