Dagong Downgrades the Credit Rating Outlook of Japan to Negative
Dagong Global Credit Rating Co., Ltd.
February 11, 2018
Dagong Global Credit Rating Co., Ltd. (“Dagong”) has decided today to downgrade the credit rating outlook of Japan to negative while maintaining its local currency sovereign credit rating at A- and its foreign currency sovereign credit rating at A. Japanese government accomplishes nothing concerning structural reform for a long term, which leads Japan’s economy to rely heavily upon monetary and fiscal stimuli. Deep-rooted structural problems have been undermining the country’s economic foundation, and government solvency is being eroded as a result of deteriorating repayment sources and mounting debt from a high level.
The primary reasons for downgrading the sovereign credit rating outlook of Japan are detailed below:
1. The political ecology featuring interest groups makes it difficult for the government to pursue structural reform, thus the national economy can hardly bottom out. The close bond between political parties, bureaucrats and domestic interest groups render Japan’s political institutions extremely rigid. If structural reform threatens the immediate interests of the interest groups, it would end up a failure or merely a formality, and so the government has to employ a loose monetary policy and fiscal stimulus to fulfill their promises to voters. Abe Administration has no interest in breaking the country’s rigid political ecology, which means that Japan will continue relying upon monetary and fiscal stimulus in return of short-term recovery. The continuous lack of structural reform will surely cause the national economy to bear a heavy debt burden, which will undermine the economic foundation for growth.
2. Weak growth potential will render Japan’s growth rate low for an extended period of time. Due to lack of structural reform, it is constraining factors, including rigid deflation expectations, sluggish wage growth, and prudent industrial investment, among other reasons, which will diminish the positive impact of monetary and fiscal stimulus measures. It is forecasted that 2018 and 2019 will witness Japan’s growth rate drop to 0.7% and 0.6%, respectively. In the long term, low fertility and population aging will cause growing population imbalance, the labor market will show increased rigidity, and the lack of a driving force for innovation and inflexible corporate structures will erode the competitiveness of manufacturing internationally while the country will face more severe industrial hollowing-out. As a result, the medium and long term will see Japan’s growth rate average around a low 0.4%.
3. Japan’s repeatedly delayed fiscal consolidation will continue to undermine repayment sources. Due to a weak driving force for economic growth, and since the government does not take effective measures to curb the growing fixed expenditures, Abe Administration has postponed achieving fiscal balance till FY2020; thus in the short term, the country will continue employing fiscal stimuli to boost growth. It is projected that FY2018 and FY2019 will witness Japanese general government’s fiscal deficit rise slightly to 4.4% and 4.5% respectively, while financing needs at the same period will be as high as 133.9% and 115.5% of fiscal revenues, thus rendering repayment sources extremely vulnerable.
4. Continued debt monetization causes Japan to see mounting sovereign credit risks, thus solvency is being eroded. Fiscal consolidation is unlikely to push up government debt from a high level. It is expected that in FY2018 and FY2019, the ratio of Japanese general government debt to fiscal revenues will rise to 743.8% and 745.0% respectively, and will deteriorate to 748.0% in the medium term. 2017 witnessed Japanese government’s financial assets coverage upon debt stand at 48.6%. Given that the Federal Reserve’s rate rises will expand the spread between Japanese and U.S. bond yield, it will undercut the lure of Japan’s bond market. It is expected that Japanese government will rely more upon debt monetization to sustain debt rolling, thus government solvency continues to be eroded.
The main reasons for maintaining Japan’s local and foreign currency sovereign credit rating are as follows: first, around 90% of government debt is held by domestic financial institutions including banks and pensions, which will to a large extent absorb the shocks caused when foreign holders sell Japanese treasuries as a result of growing spreads; second, the country’s medium-and-long-term debt accounts for 80% of the total debt with ultra-long-term debt making up 38.7%, thus government repayment pressure is eased; third, a moderate surplus on the current account, substantial revenues from overseas investment, and a stable net creditor position can all guarantee government foreign-currency solvency. Therefore, Dagong maintains Japan’s local and foreign currency sovereign credit rating, and will closely follow any changes to aforementioned factors and make adjustments in accordance.