Japan Downgrade Risk Seen Rising as Default Swaps Climb

Updated on
  • Nation’s sovereign credit-default swaps rise to 15-month high
  • Abe plans to use sales-tax hike to fund economic package

Japan’s credit rating could be in the cross hairs after Prime Minister Shinzo Abe indicated the nation may abandon its goal of covering key expenditures through taxes.

The cost of insuring Japan’s government debt against default rose to a 15-month high on Tuesday, with policy uncertainty adding to concerns about tensions with North Korea. On Monday, Abe said he would dissolve parliament later this week and he’d pay for economic measures with funds from a consumption-tax increase originally intended to rein in the nation’s swollen debt.

Japanese government bonds extended declines Wednesday after S&P Global Ratings said it expects “material” fiscal deficits to continue through 2020. S&P’s ratings assume fiscal improvements will be gradual over the next few years, sovereign analyst Craig Michaels said in an emailed response to questions from Bloomberg.

“The prospect for extra revenue to be spent rather than being used to pay down Japan’s debt is a factor of higher bond yields,” said Shuichi Ohsaki, chief rates strategist for Japan at Bank of America Merrill Lynch. “There also appears to be some speculation that such a policy move will lead to a sovereign downgrade.”

Yield on Japan’s five-year note added 2.5 basis points to minus 0.090 percent Wednesday, which would be the steepest increase since March 9. The benchmark 10-year yield climbed 2.5 basis points to 0.055 percent, a level unseen since early August.

The challenges in meeting the long-standing objective of achieving a primary balance surplus, add to concerns about Japan’s debt load, which is the world’s heaviest. Getting to that goal would allow the government to pay for programs including social security and public works projects from tax revenue, rather than through new debt financing.

Abe is betting he can crush a weak opposition in next month’s election, which he has framed in part as a vote on his plans to use revenue from the upcoming consumption-tax hike to fund an $18 billion economic package aimed at tackling the challenges of an aging society.

READ: Japan tax hike? Not so fast, focus on inflation target, S&P says

Japan carries an A+ rating from S&P, AAA from Japan Credit Rating Agency and AA+ from Rating & Investment Information.

JCR had said in June that "attaining a primary surplus by FY2020 is considered to be a pivotal goal for restoring fiscal discipline." The rating firm "will closely examine the possible impact the announced postponement may have on Japan’s fiscal position, and have them reflected on its ratings," it said in a statement dated Sept. 26.

R&I couldn’t immediately comment. The credit assessor changed its outlook on Japan’s sovereign rating to negative from stable in June last year after the government delayed a tax hike. R&I said at that time the postponement of the tax increase made the primary balance goal more difficult and such a situation "cannot be overlooked in terms of fiscal discipline."

The snap elections aren’t likely to have immediate implications for Japan’s credit profile, according to Moody’s Investors Service, which rates the country at A1.

“The pace of nominal gross domestic product growth and the effectiveness of government measures in raising revenues and/or restraining spending will be key drivers of Japan’s credit profile," Moody’s said.

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