The downgrading of Japan's government debt by Moody's Investor Services on Wednesday was in the making for quite some time. The revised rating, down by one notch to ‘Aa3', carries a stable outlook and brings it on a par with the ratings by its two main rivals, Standard & Poor's and Fitch. Now, Japan is on the same level as China, which surpassed it last year to become the world's second largest economy. The action of Moody's has not caused, nor is it likely to cause, a turmoil in the markets because the rating agency is only seen as catching up with its peers. Moreover, Moody's themselves have said that taking into account Japan's credit strengths they do not see a funding crisis arising in the next 12 to 18 months. A key dampening factor is that the bulk of Japan's public debt is owned internally; there would have been much commotion if overseas creditors had been dominant. Inevitably, comparisons will be made with S&P's historic downgrade of U.S. sovereign debt earlier this month, for both are a verdict on the deterioration in the public finances of two of the top industrialised countries.
Of course, political factors also weighed in the downgrades in both cases. In the U.S., the absence of a smooth working arrangement between the two political parties almost forced the federal government to default and left the administration with very few options to tackle the debt crisis. In the case of Japan, “revolving door politics” — the country is preparing to elect its sixth leader in five years — have stood in the way of effective long-term fiscal and growth strategies. But the economics are more stark: Japan's financial position is in a miserable shape, with nearly half of the central government budget funded by bond issuance. Its gross debt now exceeds 200 per cent of the GDP, a dubious record unmatched by any industrialised country. In addition to its structural debt problems, Japan faces a bill amounting to ¥15-20 trillion for recovery work following the March 11 earthquake and tsunami. Given the weak growth prospects, it is obvious that Japan will find the servicing of its burgeoning public debt very difficult. To crank up its usually efficient manufacturing sector, Japan has decided to tackle head-on the problems arising from the sharp appreciation in the yen, which is now at its highest levels since World War II. The yen's rise has blunted Japan's much-vaunted export competitiveness and threatens to derail its main growth engine. The $100 billion war chest announced on Wednesday to help small and medium enterprises cope with the surging yen might be too little in relation to Japan's problems and, perhaps, even too late.
