Japan must demonstrate a sense of crisis in trying to ease the industrialised world’s biggest debt, analysts say, after the first ratings downgrade for a G7 country since 2006.
The downgrade by Standard & Poor’s of Japan’s sovereign debt offered a tough critique of both the country’s economic health but also of a political system hamstrung by legislative deadlock.
Cutting Japan’s credit rating for the first time since 2002 to AA-, the agency said it doubted the government of Prime Minister Naoto Kan was capable of preventing Japan’s groaning debt burden from increasing further.
A rapidly aging population, entrenched deflation and a feeble economy have made it hard for lawmakers to curb borrowing, with years of pump priming creating a debt load that is well on course to exceed 200 per cent of GDP.
Nearly a third of government spending is being swallowed up by a social security system catering to a rapidly greying society, Standard & Poor’s warned, with that ratio set to rise without reforms as Japan continues to age.
Mr Kan has prioritised social security reform, but his ambivalence on whether he favoured hiking Japan’s five percent consumption tax – seen as a key step to boost revenues – led to a heavy election defeat last July.
Since then, Mr Kan has faced political gridlock as a powerful political opposition obstructs policies in a push for a general election.
“The Democratic Party of Japan-led government lacks a coherent strategy to address these negative aspects of the country’s debt dynamics, in part due to the coalition having lost its majority in the upper house of parliament last summer”, said S&P.
“The Kan administration has to act now,” said Hideki Matsumura, senior economist at Japan Research Institute. “It is a warning to Kan at a time when there is little progress for reforms in this country.”
Yet the downgrade is also an opportunity for Mr Kan’s government to try and bring round its foes to seeing the urgency of the situation, observers say.
“The Kan government must now hurry to show a roadmap for tax and social security reforms,” the Nikkei business daily said in an editorial.
“It would be disastrous if Japan fails to share the sense of crisis and address this problem before financial markets start getting out of control.”
The government has been able to fund its growing fiscal gap by raising money in the domestic market, with around 95 per cent of the country’s huge debt held domestically via banks and pension schemes.
Japan’s ability to finance its debt is therefore seen as sustainable for now, but analysts warn pressures will increase as the population ages and dips into savings to spend in retirement.
The downgrade was the first of a G7 member since Italy in October 2006, and underlined mounting problems with national debts since the 2008 financial crisis.
On Friday Standard and Poor’s affirmed AA ratings on Japanese companies including Toyota and Canon, giving them a higher rating than their home country.
Economists agree Japan’s situation is not on the level of eurozone states that have seen borrowing costs soar on fears for their fiscal integrity, given the concentration of debt at home makes it less vulnerable to market whims.
“Even at AA-, Japan’s rating is one notch above that of Italy, three above Portugal and seven above Greece,” noted Julian Jessop of Capital Economics, citing Japan’s diversified economy and current account surpluses.
But he warned that the clock is ticking on a demographic time bomb.
“Not only will retiring baby boomers want to run down their savings (reducing demand for government bonds) but they will also put a greater burden on government expenditure on health and welfare”, potentially increasing the budget deficit.
Kan is likely to break a pledge to limit annual bond sales to 44.3 trillion yen (€390 billion), say analysts.
Others warn that Japan’s current ability to finance its debt has bred complacency and that a downgrade is necessary to make politicians on both sides realise the gravity of the situation.
“If this is the only way Japanese politicians can understand the change and the only way that general public can understand change, then this is good,” Daisuke Iwase, who co-founded Lifenet Insurance, told AFP on the sidelines of the World Economic Forum in Davos, Switzerland.
At the same forum, Miyahara Koji, chairman of Japanese shipping giant Nippon Yusen Kabushiki Kaisha, said: “The Japanese people need a shock.”