Moody's warns of Japan rating cut

Moody's Investors Service today warned that it may cut Japan's sovereign rating if government policies fall short of a comprehensive tax reform needed to bring ballooning public debt under control.

The dollar blipped up against the yen after Moody's changed the outlook on Japan's Aa2 rating to negative from stable, although government bond futures showed little reaction and maintained earlier gains.

Japan's struggle to put a lid on the ever-rising public debt, which has ballooned to double the size of its $5 trillion economy, has triggered a Standard & Poor's rating cut and a slew of warnings from other rating agencies.

Prime minister Naoto Kan, who took office last June as Japan's fifth premier since 2006, has staked his career on fiscal reforms including a rise in the 5 per cent sales tax to fund bulging social security costs and urged the opposition to join talks on the topic.

But the opposition has refused to come to the table and is instead piling pressure on the unpopular Mr Kan to call a snap election by threatening to block budget-related bills, including one allowing the government to issue new bonds.

Analysts point out that Japan's reliance on domestic investors who hold about 95 per cent of its debt shields it from the sort of turmoil that has rattled high-debt euro zone economies and explains the subdued market response to rating agencies' stern messages.

Moody's acknowledged that a funding crisis was unlikely in the medium-run, but warned that without urgent government action debt pressures would pile up over time to reach a dangerous tipping point. "Although a JGB funding crisis is unlikely in the near to medium term, pressures could build up over the longer term which should be taken into account in the rating, even at this high end of the scale," it said in a statement.

Neither Japan's economics minister Kaoru Yosano nor finance minister Yoshihiko Noda would comment on the Moody's move.

Some analysts say that Moody's outlook cut and last month's rating downgrade by S&P's may play into the hands of Kan and his allies by highlighting the dire state of Japan's finances. "Credit downgrades by international rating agencies will raise awareness among the Japanese population on the seriousness of the Japanese public sector finance. Such perception by the Japanese population may help Japanese politicians get their act together in fixing fiscal problem," said Takuji Okubo, chief Japan economist at Societe Generale.

One concern of rating agencies and economists alike is that a political deadlock in the divided parliament may stump Mr Kan's efforts to get public finances in order. Another worry is that even if the government manages to overcome the impasse its action may prove not ambitious enough.

Moody's said the rating action was prompted by heightened concern that the government's economic and fiscal policies may get bogged down in political squabbles and prove not strong enough to achieve its deficit reduction targets.

Standard & Poor's downgraded its rating on Japanese debt last month, its first cut in nine years, citing similar reasons. That brought S&P's rating for Japan one notch below Moody's but to the same level as Fitch, another ratings agency.

Moody's said that if the government managed to present comprehensive tax reform proposals in June as promised it would monitor its effectiveness in stabilising public finances.

It also said that while the sheer size of the world's third-largest economy and the depth of its financial markets allowed it to absorb economic shocks, the rise in government debt could not continue unchecked.

It listed a lack of tax reform, a possible decline in household savings and the shift to a current account deficit from a surplus as possible tipping points that could put severe downward pressure on ratings.

Reuters