Dagong Global Credit Rating Co., Ltd.
December 2, 2016
Dagong Global Credit Rating Co., Ltd. (“Dagong”) has decided today to maintain the local and foreign currency sovereign credit ratings for the State of Japan (“Japan”) at A- and A, each with a stable outlook. While the economy is recovering under fiscal and monetary stimulation, the already-high government debt continues to accumulate. The sluggish implementation of structural reforms will stunt the improvement of government solvency.
The primary reasons for maintaining the sovereign credit ratings of Japan are detailed below:
1. The domestic political situation remains stable, but geopolitical risks are pending. Seizing over half of the seats in the parliamentary election in July 2016, Abe’s coalition government has a solid administrative foundation. The economic stimulation and structural reforms are thus expected to be implemented consistently. Since the seats supporting the amending of the Constitutions in both Houses is expected to exceed two thirds, constitutional amendment can be expected in the future, which will stoke geopolitical conflicts and have a debilitating impact on Japan’s trade with neighboring countries. In addition, the precipitously rising uncertainty in the Trans-Pacific Partnership Agreement will not be conducive to the improvement of Japan’s debt repayment environment.
2. The government’s economic stimulation will sustain Japan’s mild economic growth in the short term, but the sluggish implementation of structural reforms continues to limit long-term economic growth. In the short term, the effects of the negative interest rate policy have been minimal, and the deflation expectation remains to mute private-sector demand, while the appreciation of the Japanese yen and higher international oil prices will weaken the contribution of trade to economic growth. The Japanese government put forward a supplementary budget and later announced a front loading of the fiscal year 2016/2017 initial budget in order to continue to increase public consumption and investment in the short term. It is estimated that Japan’s economic growth will reach 0.5% in 2016 and 0.4% in 2017. Due to the resistance of groups with vested interests and insufficient fiscal support and supplementary measures, the promotion of structural reforms has been slow, leaving problems, such as an aging population, labor market segmentation, and manufacturing industry hollowing, to constrain mid- and long-term economic growth in a persistent way. It is estimated that Japan’s long-term economic growth rate will only average about 0.4%.
3. Public finances remain under pressure while government debt continues to accumulate. In the short term, fiscal incentives to foster economic growth will be a burden on public finances, so Japan’s general government primary fiscal deficit is estimated to reach 5.2% in 2016 and 5.4% in 2017. Unable to make ends meet, the Japanese government has to rely upon debt financing, and the bond dependency ratio is projected to increase to 37.2% of GDP in 2016. Subject to a persistently high fiscal deficit, the government debt burden continues to increase and is estimated to reach 250.3% and 253.3% respectively in 2016 and 2017. The extremely low financing costs will help government’s debt rollover, but the aging population in the medium term will require higher social security expenditure, and the normalization of interest rates may add to interest expenditure, thus making fiscal consolidation more difficult. In short, government solvency will remain under pressure.
4. Despite high external debt, massive overseas assets and revenues will shore up foreign currency solvency. While the shrinking of the trade deficit is unlikely to continue because of the yen’s appreciation and higher energy prices, the current account surplus will remain supported by increasing returns on overseas assets. Meanwhile, although Japan’s total external debt reached 71.1% of GDP by the end of 2015, its net international investment position was 68.0% of GDP with its primary foreign-currency assets can cover debts in corresponding currencies. Therefore, government solvency can be effectively sustained by its massive oversea assets persistent current account surplus.
In the short term, continuous monetary easing and fiscal accommodation will buttress Japan’s economic growth, while the negative interest rate policy will ease pressure upon government’s short-term debt repayment, which is conducive to maintaining stable government solvency. Therefore, Dagong has decided to maintain a stable outlook for both the local and foreign currency sovereign credit ratings of Japan for the next one to two years.