DBRS Assigns A (high) Rating to Japan, Stable Trend

DBRS, Inc. (DBRS) has today assigned issuer ratings of A (high) to Japan’s long-term foreign and local currency debt, and issuer ratings of R-1 (middle) to its short-term foreign and local currency debt. The trend on all ratings is Stable.

The Stable trend reflects Japan’s formidable strengths as the third-largest economy. The country’s sound external sector, high private sector savings, domestic investor confidence in government debt, and the Yen as a reserve currency facilitate low financing costs. Bank of Japan purchases of Japanese Government Bonds (JGBs) could maintain low borrowing costs despite a very high public sector debt burden. The Liberal Democratic Party’s majority control over the National Diet increases support for the possible introduction of structural reforms. Nonetheless, DBRS rates Japan A (high) because of its very high and rising public debt, its chronic government deficits, and longstanding structural constraints that have resulted in low growth and deflationary pressures.

In an effort to address these issues, the government deployed expansionary policies this year in the form of bold monetary and fiscal stimulus. If the administration succeeds in introducing supply-side structural reforms and medium-term fiscal consolidation, this could help to stabilize the public debt to GDP ratio. A stable and eventually lower debt ratio would be credit positive, since DBRS places the greatest weight on debt and liquidity in its analysis of Japan.

However, although monetary and fiscal stimulus has contributed to real economic growth, higher inflation expectations, and stronger consumer and investor sentiment, the debt ratio has continued to rise. Over the coming year, DBRS is willing to wait for the introduction of a more detailed medium-term fiscal consolidation plan and structural reforms. However, rising debt without stabilization in sight will put downward pressure on Japan’s ratings. Conversely, the Stable trend could be changed to Positive if structural reforms and fiscal consolidation result in a lower deficit, better growth prospects, and a stabilization of debt to GDP.

Japan’s formidable strengths are unique. Japan benefits from safe haven status, reflecting investor confidence in the country’s capacity to service debt even during periods of investor risk aversion. The predominance of the Yen as one of the world’s reserve currencies facilitates funding flexibility. Moreover, the composition of the public debt helps to maintain low borrowing costs. Over 90% of JGB holders are domestic investors, external debt is low, and the average debt maturity has increased to nearly eight years. Japan’s deep pool of private sector savings and private sector aversion to risky investments perpetuates high demand for JGBs. The 10-year JGB yield has averaged 1.1% since 2009, and declined to 0.6% in November 2013.

In spite of a higher deficit and rising public debt to GDP, the 2013 stimulus policies introduced by Prime Minister Shinzo Abe and the Bank of Japan (BoJ) produced largely encouraging results through the third quarter of 2013. Japan’s 2013 budget included a public works stimulus of 1.4% of GDP, while the BoJ committed to doubling the monetary base through quantitative easing (purchasing JGBs), and reaching a 2% inflation target “at the earliest possible time, with a time horizon of about two years” as of April 4, 2013. The initial impact of these policies has been stronger growth, higher exports and corporate profits, a marked depreciation of the Yen, and a return of inflation.

Following the initial fiscal stimulus, the government plans to implement a still to be defined medium-term fiscal consolidation. The consumption tax is scheduled to rise from 5% to 8% in 2014. This aims to halve the general government primary deficit from an official estimate of 6.6% of GDP in fiscal year 2010 to 3.3% of GDP in 2015. Thereafter, the government will seek to reduce the public debt to GDP ratio. To offset any negative effects of the consumption tax increase on growth, the government could provide an additional ¥5 trillion in stimulus (approximately 1% of GDP), as well as lower the corporate tax rate from 38.0% to 35.6%.

The ratings are further supported by Japan’s strong external position. Firms have geared toward liquid low-risk instruments or investments in foreign assets. A positive international investment position of 62.3% of GDP reflects high income flows from abroad, which has helped keep the current account in surplus for more than two decades. The trade balance has deteriorated since late 2011 due to rising import costs, yet possible Japanese inclusion in the Trans-Pacific Partnership Agreement (TPP) could lead to higher exports, lower trade costs, and positive spillovers to the domestic economy.

Offsetting these positive developments are Japan’s very high public sector debt and deficit. Gross debt has increased by 103% of GDP since 2000, reaching well over two times Japan’s $5.3 trillion economy. The government has sustained its high debt level, but the steady increase in the debt stock casts doubt over the sustainability of low JGB yields. The rising debt to GDP ratio, potential pressures on debt servicing, and exposure to shocks could put downward pressure on the ratings over the coming years.

The increase in the debt burden can be partly attributed to deficit spending to offset the 2008-2009 financial crisis and 2011 earthquake, tsunami and Fukushima nuclear disaster. More important however is that long-term social and demographic pressures are likely to keep expenditures high, while low growth could dampen revenue collection.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

The sources of information used for this rating include the Ministry of Finance (Japanese Government Bonds, Quarterly Newsletter, October 2013), Cabinet Office of Japan (Basic Framework for Fiscal Consolidation: Medium-term Fiscal Plan, August 2013; Economic and Fiscal Projections for Medium to Long Term Analysis, August 2013), Bank of Japan (Introduction of the "Quantitative and Qualitative Monetary Easing”, April 2013), IMF, OECD, BIS, World Bank, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Fergus J. McCormick
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 20 November 2013

For additional information on this rating, please refer to the linking document under Related Research.