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Japan Debt Downgrade: Fine Until Panic Hits!

  • Written by Syndicated Publisher 3 Comments3 Comments Comments
    May 28, 2012

    With Japan’s public debt about to hit 240% of GDP, Fitch Downgrades Japan’s Sovereign Rating.

    The ratings agency Fitch on Tuesday lowered its assessment of Japan’s sovereign credit to A+, an investment grade just above the likes of Spain and Italy, and criticized Tokyo for not doing more to pare down its burgeoning debt.

    Japan’s public debt will hit almost 240 percent of its gross domestic product by the end of the year, Fitch warned.

    The new rating also heightens the pressure on Prime Minister Yoshihiko Noda to rein in spending and raise taxes at a delicate time, when the Japanese economy is still recovering from natural and nuclear disasters last year.

    Mr. Noda has warned that Japan could eventually face a debt crisis akin to that afflicting Europe and is staking his job on a plan to double the consumption tax rate to 10 percent by late 2015. That increase, he has argued, is necessary to pay for soaring welfare costs and pension payments.

    But lawmakers even within his own party have attacked the plan, saying it would put a damper on growth just as Japan’s recovery gets on track. Even if Japan does double its sales tax, the revenue will most likely not be enough to balance in the medium term.

    According to the statement, Fitch lowered Japan’s long-term local currency rating to A+ from AA. It also cut the country’s foreign currency rating to A+ from AA. Fitch said the outlook was negative for both.

    The A+ rating puts Japan four notches below the ratings of other major economies like the United States, Britain, France and Germany, which all retain the top AAA rating from Fitch. Japan’s grade is now just one notch above Spain’s and two above Italy’s, countries that have struggled in the European debt crisis. Two other global ratings agencies, Standard & Poor’s and Moody’s Investors Service, lowered Japan’s credit rating last year.

    No Urgency for Japan (Until Sudden Panic Hits)

    As Japan’s debt careens out of control, Keynesian clowns do not want to do anything about it for fear of hurting the recovery. They have been saying the same thing for over 20 years.

    Nonetheless, the rally cry remains No Urgency for Japan to Deal With Debt.

    With Japan awash in cheap funding provided by domestic savings and local banks continuing to park their cash in government bonds, analysts tell CNBC the country faces no urgency in dealing with its rising public debt, despite the latest ratings cut by Fitch.

    The likelihood of a Europe style debt crisis for the world’s third-largest economy remains low, say analysts, because over 90 percent of government debt is domestically owned.

    “For as long as Japan’s debt is well-held by local savers and local investors – 93 percent – the impact, I think, on risk assets is going to be quite marginal,” John Woods, Chief Investment Officer, Citi Private Bank told CNBC’s “The Call” on Wednesday.

    Those low yields, however, also mean policy makers are under no pressure to deal with total debt that is more than twice as large as the country’s $5 trillion economy. Japan’s government has submitted plans to double the sales tax by 2015 but the law could split the ruling party and force early election, according to Reuters.

    “As long as these yields remain at such historically low levels, the impetus for the government to meaningfully change and reform its environment is going to be quite limited,” Woods said.

    Thomas Bryne, senior vice president at Moody’s Investor Service, said on CNBC’s “Asia Squawk Box” Wednesday that his firm had issued plenty of negative commentary since it downgraded Japan in August last year.

    “We’re concerned about the slippage in exports, perhaps the slippage in current account surplus, probably more concerned about the slippage in the fiscal deficit and we also note that attempts to put Japan on a long-term sustainable fiscal track are still partial and tentative,” he said.

    “As Long As …”

    The words “as long as” appeared twice in the above article. The key phrase was “As long as these yields remain at such historically low levels …”.

    Japan will go from no sense of urgency to panic urgency in a short sudden burst. Unfortunately, I cannot tell you when. However, I can say that the slippage in exports and current account surplus is very important.

    Given Japan’s aging demographics, pension plans became net sellers of bonds last year.

    For now, Japanese corporations purchase enough bonds to stem the tide. However, if exports collapse or interest rates rise significantly for any reason, the party will be immediately over.

    Bear in mind that “significantly” means a mere hike in the 10-year rate to 2.5% or so, perhaps less. Such a hike would consume 100% of Japan’s revenues just to meet interest on the national debt.

    At that point, whenever it is, the choice for Japan will be print or default. Either way, panic will set in along with a full-blown global currency crisis.

    Mike “Mish” Shedlock
    http://globaleconomicanalysis.blogspot.com
    Click Here To Scroll Thru My Recent Post List

    Images: Flickr (licence attribution)

    About The Author

    Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.  Visit Sitka Pacific’s Account Management Page to learn more about wealth management and capital preservation strategies of Sitka Pacific.

    You are currently viewing my global economics blog which typically has commentary every day of the week. I am also a contributing “professor” on Minyanville, a community site focused on economic and financial education.  Every Thursday I do a podcast on HoweStreet and on an ad hoc basis contribute to many other sites.

    When not writing about stocks or the economy I spend a great deal of time on photography and in the garden. I have over 80 magazine and book cover credits. Some of my Wisconsin and gardening images can be seen at MichaelShedlock.com.
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