By Stanley White
TOKYO, Jan 28 Rating agency Standard & Poor's cut
Japan's long-term sovereign debt rating on Thursday for the first
time since 2002, saying the government lacked a coherent plan to
tackle its mounting debt.
It reduced the rating by one notch to AA minus -- three
levels below the highest possible rating.
Prime Minister Naoto Kan has staked his career on overhauling
the social welfare system and raising the sales tax to keep up
with the fiscal burden of an ageing population and prevent public
debt from rising further.
Politicians and ratings agencies have long warned that Japan
needs to lower its debt pile. Japan's debt burden is by far the
worst among industrial economies, but does it face a crisis
similar to what is plaguing Europe's smaller economies?
WILL JAPAN DEFAULT ON ITS GOVERNMENT DEBT?
Unlikely. Japan has a massive pool of domestic deposits to
draw on to fund its debt issuance.
Japanese household assets total some 1,400 trillion yen ($17
trillion), some three times bigger than its economic output,
providing a healthy pool of savings that can be funnelled into
Japanese government bonds.
The government has almost no foreign currency-denominated
debt obligations and domestic investors hold 95.4 percent of
Japanese government bonds (JGBs), according to the Bank of Japan.
For the main story on the credit downgrade: [ID:nTOE70Q02Z]
Graphic on Japan fiscal woes link.reuters.com/qad63r
Graphic on Japan welfare link.reuters.com/mag46r
More stories on the Japanese economy [ID:nECONJP]
More stories on Japanese politics [ID:nPOLJP]
Greece, which sought a bailout due to its high debt, has the
opposite profile. About 70 percent of its sovereign debt is held
by foreign investors.
Japan also has other avenues to raise funds. It is the
world's largest creditor nation, with net external assets of
225.5 trillion yen.
Unlike Greece, it enjoys a steady flow of foreign earnings
from a current account surplus.
The yen's status as an important international currency also
helps Japan to access external liquidity and markets, and the
ratio of Japan's tax burden to national income is one of the
lowest in the OECD, leaving it room to raise taxes.
WHAT MIGHT HAPPEN AND WHAT WILL THE TRIGGER POINTS BE?
Fears are growing that Japan's ageing population will draw
more on their savings, forcing the government to rely on foreign
investors to fund its debt.
The most likely worst-case scenario is a sharp rise in
long-term JGB yields. That could force the central bank to
increase government debt purchases.
A potential trigger point would be if the government were to
lose vital sources of funding its debt. One analyst said the
current account could swing into deficit by 2016/17.
If that is combined with a significant loss of faith among
Japanese in domestic investments, the government would lose its
most important source for funding debt.
Grinding deflation complicates the problem because it means
the government's real borrowing costs are higher than nominal
rates would suggest.
The BOJ's forecast of a slight increase in consumer prices in
the fiscal year starting from April is overly optimistic, many
economists say, because the gap between demand and supply in the
economy is still large.
A significant erosion in the savings rate would force the
government to pay higher yields to lure foreign investors.
The savings rate, or savings divided by disposable income, is
already falling as the population ages. It stands at about 3
percent, down from more than 10 percent a decade ago.
Yields have been rising since late last year, but this
reflects an improving U.S. economic outlook more than concern
about a Japanese debt crisis. Problems would occur several years
in the future if the government failed to reduce its debt as the
ageing population will draw down its savings gradually.
Japanese bond yields rose shortly after S&P's downgrade but
have since recovered.
The 10-year JGB yield JP10YTN=JBTC on Friday fell 1 basis
point to 1.215 percent, which compares with 3.387 percent for
10-year U.S. Treasury yields US10YT=RR. It has held below 2
percent for more than a decade due to deflation and near-zero
Yields on Greece's 10-year debt GR10YT=RR last stood at
11.627 percent. Debt of a similar maturity from Ireland
IE10YT=RR, another country that sought a bailout due to weak
public finances, yields 9.264 percent.
HOW BAD IS JAPAN'S FISCAL POSITION?
By some measures Japan is in a worse mess than Greece and
Japan's outstanding long-term government debt is set to reach
869 trillion yen at the end of March this year, or 181 percent of
gross domestic product (GDP), the Ministry of Finance says.
If short-term debt is added, Japan's liabilities will hit 204
percent of GDP this calendar year, larger than 137 percent for
Greece and 113 percent for Ireland, according to the OECD.
That also puts Japan worse off than countries that investors
speculate will need bailouts in the future, such as Spain,
Portugal and Belgium.
WHY DOES JAPAN HAVE SO MUCH DEBT?
Japan's debt burden is a legacy of massive government
spending in the 1990s to support the economy as it stagnated
following the bursting of a huge property bubble.
An ageing population means rising social welfare costs add
considerably to government spending.
Some analysts say Japan's net debt provides a more accurate
picture of the country's indebtedness. This measures gross debt
minus government assets such as public pension fund reserves and
On that basis, debt will reach 120 percent of GDP in 2011,
the highest among major economies, the OECD says.
Still, some analysts say Japan would not be much worse off by
that measure than Belgium and Italy were in the 1990s, and both
of them avoided a sovereign debt crisis.
WHAT ARE THE GOVERNMENT'S LIKELY POLICY OPTIONS?
The most obvious option is to raise the 5 percent sales tax.
But this is unlikely to happen in the immediate future.
Having seen Greece's debt problems turn into a European
crisis, Prime Minister Kan is determined to avoid a similar fate
The government could raise some 2.5 trillion yen for each 1
percentage point rise in the tax, but a split parliament, low
public approval ratings and divisions within Kan's Democratic
Party make this difficult.
Many voters accept the idea of a sales tax hike in some form
to fund rising social security costs, but the Democrats have so
far failed to convince voters of their vision to cure Japan's
economic ills with a painful tax increase.
Japan has been cutting public works spending for years. The
government will need to get more serious about cutting spending
elsewhere and scale back some welfare benefits to improve public
Since Japan's public debt is mostly yen-denominated, Japan
has the ultimate option of printing money to prevent a debt
(Editing by Michael Watson, Edmund Klamann, Ron Popeski and