Japan should set a "well-articulated" target to reduce government debt that is already the largest in the world, according to Moody's Investors Service.

"Deficit reduction and a debt target would help support a rating," Moody's Senior Vice President Thomas J. Byrne said Tuesday in Singapore. "Things we are most concerned about are the lack of well-articulated long-term fiscal consolidation and a debt reduction plan."

The Cabinet approved a budget guideline Tuesday for the year starting April 1 and said it will keep new bond issuance at around ¥44 trillion. Faced with declining tax revenue and a ballooning public debt burden, the Democratic Party of Japan is faced with the challenge of maintaining fiscal discipline without choking off a recovery from the country's worst postwar recession.

The government will compile the medium-term fiscal framework in the first half of next year to restore the nation's financial health, according to the budget guideline. The government will also aim to reduce deficits and the ratio of debt to gross domestic product in a stable manner in the long term, it said.

"Right now, the strategy is not well-articulated," Byrne said. "That's why we are watching very closely."

Standard & Poor's is also focusing on the medium-term fiscal trajectory and the feasibility of the government's policy for fiscal consolidation, said Takahira Ogawa, director for sovereign ratings at S&P in Singapore.

"We think Japan's credit quality is on the trend of deterioration but not to the extent for us to change the outlook or downgrade," Ogawa said Tuesday. S&P rated Japan's sovereign rating at AA with a stable outlook.

Prime Minister Yukio Hatoyama last week indicated he might be willing to exceed the ¥44 trillion bond sales cap in the interest of economic growth, while Finance Minister Hirohisa Fujii said the ceiling must be adhered to. Deputy Prime Minister Naoto Kan Monday said keeping the cap was important to prevent long-term bond yields from rising.

Even if the government fails to keep the bond sales cap, it won't necessarily affect Moody's view on Japan's credit quality, Byrne said. Moody's rates Japan's debt at Aa2, the third-highest investment grade, with a stable outlook.

"One year of exceptionally large budget deficits will not automatically trigger a negative rating action," Byrne said. "The government, in any given year, can issue a lot of debt, maybe it misses its deficit target for a particular year, and that would be OK if there's a medium-term plan that's credible to reduce the deficits."

Former Prime Minister Junichiro Koizumi of the Liberal Democratic Party had a target to achieve a balanced budget by the year ending March 2012. Hatoyama's LDP predecessor government, led by Taro Aso, abandoned the goal and postponed it by about a decade. Aso also set a new target of reducing the debt to GDP ratio in the early 2020s.

"We think it's highly likely that it's financeable for the next year or two without putting any upward pressure on interest rates," Byrne said. "We would have concerns that the financeability and the affordability of government debt could be jeopardized without a long-term fiscal consolidation target."