Moody’s Investors Service Inc. said Friday it has lowered its rating on yen-denominated domestic securities issued or guaranteed by the Japanese government to Aa2 from Aa1, given Japan’s massive public-sector debt.

The U.S. credit-rating agency also said it maintained a negative outlook on the government rating, but added that Japan’s Aa1 foreign currency country ceilings remain unchanged with a stable outlook.

The actions conclude its review for possible downgrades announced in February.

Moody’s said the downgrading of yen-denominated Japanese government bonds and the maintenance of a negative outlook reflected “policy shortcomings and structural problems that have resulted in a level of government indebtedness that has become the highest, relative to GDP among the advanced industrial economies.”

Japan’s public debt problem has been compounded by increasing pressures on its pension and health care systems as well as by possible increases in debts associated with the central government’s fiscal investment and loan program, local government finances and the financial sector, it said.

Moody’s said that although the Japanese economy is recovering from the 1997-1998 recession, the medium-term outlook remains uncertain and subject to downside risks, justifying the maintenance of a negative outlook.

“Eventually, a policy of fiscal consolidation will be required, although current economic conditions suggest that supportive monetary and fiscal policies remain necessary,” the agency said.

“Additionally, a process of reform and restructuring will be required without which Japan’s public-sector debt problem should continue to worsen and would become increasingly vulnerable to interest-rate or confidence shocks over the long term,” it said.

Moody’s, however, said it believes Japan’s considerable underlying economic strength may enable it to carry a higher level of public-sector debt compared with other advanced industrial states without the same debilitating economic distortions or financial dislocations.

“Moody’s believes that Japan’s strong external position as well as its large pool of domestic savings minimize future risks to the foreign-currency ratings,” it said.

Kamei raps Moody’s

The Liberal Democratic Party’s policy chief said Friday that Moody’s Investors Services Inc.’s downgrading of the government’s debt casts doubt on the U.S. credit-rating agency’s competence.

“Moody’s research ability is questionable,” Shizuka Kamei said. “Considering Japan’s overall national power, its (Moody’s) judgment is extremely inappropriate.”

Asked about the impact of the downgrading on Japan’s plans to compile an extra budget for the current fiscal year, Kamei said: “We won’t make any economic policy based on Moody’s ratings. We will continue policies that enables the economy to get firmly on the recovery path.”

Kamei also said he will exchange views on economic policy with Economic Planning Agency chief Taichi Sakaiya next week.

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