RPT-Fitch Affirms Japan at 'A+'; Outlook Negative
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May 14 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has affirmed Japan's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'A+'. The issue ratings on Japan's senior unsecured foreign and local currency bonds are also affirmed at 'A+'. The Outlooks on the Long-Term IDRs are Negative. The Country Ceiling is affirmed at 'AA+' and the Short-Term Foreign Currency IDR at 'F1+'.
KEY RATING DRIVERS
The affirmation of Japan's 'A+' IDRs with Negative Outlooks reflects the following key rating drivers:
- Japan's public finances are its key credit and rating weakness. Gross general government debt (GGD) was 237.2% of GDP at end-2013, the highest of any Fitch-rated sovereign. Japan's cyclically-adjusted primary deficit was 7% of GDP in 2013 according to data from the International Monetary Fund, much higher than the average of 2% for the Group of -20 advanced countries. The agency expects Japan's gross GGD ratio to peak at 245% in 2020 in its baseline projection. Debt dynamics analysis indicates Japan's public debt sustainability is vulnerable to fiscal slippage or other negative shocks.
- The Japanese sovereign's financial position is less of an outlier compared with advanced-economy peers in net terms because of the sovereign's large stock of assets. However, Japanese general government net financial liabilities of 137.5% of GDP at end-2013 were still the highest among members of the Organisation of Economic Co-operation and Development (OECD), which include Greece (122% of GDP), Italy (116.5%) and the US (81.2%). Japan's liabilities have also risen rapidly from the recent trough of 80.5% of GDP at end-2007.
- Set against these vulnerabilities, the Japanese sovereign retains exceptional funding flexibility. Yields on ten-year Japanese government bonds (JGBs) fell to 0.72% on average over 2013 from 0.86% in 2012. The average maturity of the stock lengthened to 7.5 years at end-2013 from 7.25 years at end-2012. This funding strength partly reflects the role of the broader Japanese public sector in funnelling the deep pool of Japanese private-sector savings into JGBs. The broader public sector held about 46% of the JGB stock at end-2013. The Japanese sovereign has relatively large deposits of about 16% of GDP, although from the perspective of fiscal liquidity, this is offset against a heavy debt maturity burden of about 70% of GDP per year (or 21% excluding short-term bills).
- The Bank of Japan's policy of quantitative and qualitative easing (QQE) since April 2013 is aimed at doubling Japan's monetary base within two years. The Bank of Japan purchased a net JPY62.8trn of JGBs in the financial year to March 2014 (FY14), equal to 45% of gross issuance, taking its holdings to 17.1% of the stock. Japanese QQE is a powerful demonstration of the policy flexibility available to a sovereign issuing one of the world's main reserve currencies. The Bank of Japan will face a challenge in withdrawing monetary accommodation smoothly when macroeconomic conditions warrant, although this is also the case for central banks in other major advanced economies.
- Fiscal consolidation has begun in earnest with the imposition of a 3pp increase in the consumption tax to 8% that took effect on 1 April. A general government budget deficit of 7% in 2014, in line with Fitch's forecast, would be the lowest since 2008. Fitch thinks there is a high chance that the government will achieve its interim fiscal target of a 3.3% primary deficit for the central and local government sectors, excluding earthquake reconstruction spending, in FY15. This assumes the second scheduled consumption-tax increase to 10% takes place in October 2015, as currently legislated, or that equivalent measures are taken. However, further reduction of the deficit to a level consistent with debt ratio stabilisation will require additional spending or revenue measures beyond those currently proposed.
- Japan's economic performance is a credit weakness. Japan's five-year average real GDP growth rate of 0.3% is much weaker than the median for 'A' range peers of 3.3% and marginally weaker than the median for Fitch-rated advanced economies of 0.5%. Most estimates of trend growth for the Japanese economy are between 0.5% and 1% per year. The shrinking working-age population weighs on potential growth. Japan's multifactor productivity growth averaged 0.7% per year over 1992-2011, lagging other major economies including Germany (1%) and the US (1.2%), according to OECD data. Persistent deflation since 1992 has undermined nominal GDP growth and public debt dynamics. Nominal GDP of JPY478.4trn in 2013 was below the 1992 level of JPY480.8trn.
- Aggressive monetary policy action and fiscal accommodation ("Abenomics"), coupled with the global recovery, support GDP growth - Fitch expects a 1.6% expansion in 2014. But Japan's prospects of achieving sustainably higher real and nominal GDP growth remain open to question. A self-sustaining inflationary process is likely to require stronger wage growth, which has yet to take hold unambiguously. Current structural reform plans appear insufficient, in Fitch's judgement, to deliver the government's ambition of raising the real growth rate to 2% per year on average over the decade to 2023, compared with the average of 0.8% per year over 1992-2012.
- Japan's ratings are supported by strong sovereign credit fundamentals. These include one of the world's most advanced, wealthy and diversified economies, high standards of governance and strong public institutions.
- Japan's external finances are a strength. The sovereign's foreign reserves stockpile was USD1,279bn at end-March 2014, the world's second-biggest after China (USD3,948bn). Japan's overall net external creditor position of 55% of GDP at end-2013 was substantially stronger than the 'A' median of 20%. The trade balance moved into deficit in 2011 for the first time since 1980, but Fitch expects income inflows will keep the overall current account in surplus until 2015.
The Negative Outlook reflects the following risk factors that may, individually or collectively, result in a downgrade of the ratings:
- Mounting evidence that the economy had failed to attain sustainably higher nominal and real GDP growth compared with the 1992-2012 record
- Signs that the government had abandoned fiscal consolidation and debt stabilisation as a policy objective, including for example, failure to implement the second consumption tax increase scheduled for October 2015 without compensating measures
The current rating Outlook is Negative. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a material likelihood, individually or collectively, of leading to a rating upgrade. However, future developments that may, individually or collectively, lead to a stabilisation of the Outlook include:
- Articulation of a credible strategy for further consolidation of the budget deficit that leads Fitch to bring forward its forecast for public debt ratio stabilisation
- Growing confidence that the economy's performance had strengthened durably, including for example, expectations for stronger trend GDP growth, and/or sustained modestly positive inflation
The ratings and Outlooks are sensitive to the following assumptions:
- Japanese sovereign funding conditions do not deteriorate substantially and in a lasting way. A sharp and sustained increase in JGB yields would endanger Japan's public solvency and could see the ratings downgraded by more than one notch. However, Fitch considers this to be unlikely. Fitch assumes the eventual exit from the Bank of Japan's policy of QQE will be orderly.
- No significant intensification of regional geopolitical disputes to a level that would significantly disrupt economic behaviour
- The global economic backdrop is broadly in line with the projections in Fitch's March Global Economic Outlook; in particular, China is assumed to proceed along a gradual rebalancing path without a systemic economic or financial crisis.
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