Fitch downgrades Japan on public finances

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Fitch Ratings has downgraded Japan‘s credit rating because of the rapid deterioration of public finances in the world’s most indebted nation since the global financial crisis.

While the move is unlikely to have much effect on prices of Japanese government bonds, analysts said, it may help to galvanise support within Japan’s parliament for a bill to double the country’s 5 per cent consumption tax. The bill, which Yoshihiko Noda, Japan’s prime minister, hopes to pass before the end of the parliamentary session next month, is the centrepiece of the ruling party’s efforts to put public finances on a firmer footing.

Separately on Tuesday, the Organisation for Economic Co-operation and Development said that lifting the country’s consumption tax in 2014, “if not before,” should be a “top priority” if Japan is to maintain confidence in its fiscal situation.

Government debt is projected to hit 239 per cent of gross domestic product by the end of 2012, Fitch noted – by far the highest of any sovereign under its coverage. Japan’s ratio has risen by 61 percentage points since 2008, compared with a median of 39 percentage points for OECD economies, and just 8 percentage points for A-range sovereigns, it said.

Even if Mr Noda overcomes stubborn opposition to pass the bill as planned, state finances will remain stretched. The government said in January that it would probably miss an earlier goal of balancing its budget by fiscal 2020 as the bill for restoring earthquake-affected areas of north-east Japan added to costs. Government ministries and agencies requested a record Y98.5tn ($1.2tn) for the fiscal 2012 budget, a record high for the third consecutive year.

Andrew Colquhoun, Hong Kong-based head of Asia-Pacific sovereigns at Fitch, said: “Since we assigned the negative outlook last May, progress towards fiscal reform has not really picked up. We’re also concerned that if the tax increase is not authorised, there is no Plan B.”

The New York-based Fitch cut long-term foreign- and local-currency credit ratings to A plus, from double A and double A minus respectively. It said the downgrade did not necessarily imply financing problems in Japanese government bond markets, given the country’s resilient current account surplus and the continued strong bond purchases by domestic investors.

Its decision was announced after the local bond and equity markets had closed, but the reaction in currency markets was muted, as the yen fell slightly against the dollar. Analysts at Capital Economics in London noted that investors had “shrugged off” previous downgrades, including one-notch moves by Standard & Poor’s and R&I, the Japanese agency, last year.

Naka Matsuzawa, chief investment strategist at Nomura, said: “As far as the JGB market is concerned, downgrades are just noise, and relatively low-level noise. The bigger, second-round effect would be if the government uses [Fitch’s decision] as a lever to pass the tax bill, which could be better long-term news for bonds.”

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