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Downgrade can help Kan make case for fiscal reform

by Shinya Ajima

Kyodo News

Japan’s deteriorating public finances have prompted Standard & Poor’s to cut its sovereign debt rating, but experts say the move has had little negative impact and could even help the government persuade the public to accept reforms that might result in a tax hike.

The U.S. rating agency on Thursday downgraded Japanese long-term debt for the first time since 2002, knocking it down a notch to AA- from AA. This put it in the same group as China but below Spain, which is being threatened by the sovereign debt crisis in Europe.

S&P cited the lack of a “coherent strategy” by the government of Prime Minister Naoto Kan to restore Japan’s finances, which are ranked the worst among major developed countries because the combined debt of the central and regional governments is nearly 200 percent of gross domestic product.

Normally, a sovereign debt downgrade leads to more costly borrowing by prompting interest rates on bonds to rise.

On Friday, however, the yield on the benchmark 10-year Japanese government bond ended lower from the previous day, meaning more investors bought it. Kan said the lack of a major reaction was “good.”

“The impact from the decision by S&P on financial markets will be limited,” Takahide Kiuchi, chief economist at Nomura Securities Co., said in a report.

Kiuchi said it is already well known that Japan faces fiscal problems. “It is not that we have got any fresh bad news,” Kiuchi said, adding that the focus instead is on the fact that Kan has expressed his intention to press for social security and tax reforms.

Kan says he will present by June a reform package that is expected to involve specifics on the size and timing of a consumption tax hike to help finance the country’s swelling welfare costs.

Lee Chiwoong, an economist at Goldman Sachs Japan Co., echoed Kiuchi’s view, saying the S&P’s move is not based on any new information about the debt or the fiscal situation in Japan.

Market participants seem to have already factored in the undesirable fiscal conditions in Japan, Lee said. “Changes in a rating agency’s ratings are seen more by the market as confirmation of their views than as new information.”

S&P also gave its rating a “stable” outlook, acknowledging the huge surplus in Japan’s balance of international payments.

Some 95 percent of Japan’s debt is held domestically, and thus the country is believed to be immune to some extent to worries about a possible deterioration in the external balance because of foreign investors ditching its debt — a big difference from troubled European countries such as Greece.

Although there is concern about Japan’s rising debt, some point out that a more serious problem is people’s apathy about the issue.

Under the circumstances, speculation is growing that the credit downgrade may have more significance in the political arena than in financial markets.

“Giving a lower rating to Japanese government bonds has a certain effect in revealing to the public the government’s lukewarm efforts toward fiscal restoration,” Chotaro Morita, head of Japan fixed-income strategy at Barclays Capital Japan Ltd., wrote in a report.

The downgrading “could even be positive news to the bond market if pressures from overseas (investors) have an effect, even if it is small, to push the ruling and opposition parties to hold talks in an attempt to realize fiscal reconstruction,” Morita said.

Kan, faced with a divided Diet in which the opposition camp controls the Upper House, has repeatedly invited the opposition bloc to join the nationwide debate on financial reforms.

Hiromichi Shirakawa, chief economist at Credit Suisse in Japan, said the credit downgrade has come at a perfect time for the government and the ruling parties and that they could “utilize it politically.”

“There could be a nonpartisan move to accelerate fiscal rehabilitation efforts by capitalizing on external pressures in the form of the credit rating cut,” he said.

It is evident that some members of Kan’s Cabinet feel the temptation to make opportune use of the rating cut.

Japan’s sales tax rate is “only 5 percent,” Kaoru Yosano, economic and fiscal policy minister, said on a TV program on Thursday.