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TOKYO (MarketWatch) — Standard & Poor’s on Thursday cut Japan’s long-term sovereign-credit rating, with the news sending the yen sharply lower against its major rivals.
The rating agency said it downgraded Japanese debt to AA minus from AA, but it also reaffirmed the nation’s short-term ratings at A-1 plus.
The news sent the U.S. dollar higher against the yen, hitting ¥83.18 after having traded at ¥82.14 shortly before the announcement.
The euro also spiked higher, climbing to ¥113.41 for a 0.7% gain, according to FactSet Research data. See more on trading in the dollar and other currencies.
S&P said in a statement that it “expects Japan’s fiscal deficits to remain high in the next few years, which will further reduce the government’s already weak fiscal flexibility.”
The deficit should fall “only modestly,” to 8% of gross domestic product in the fiscal year beginning April 2013, compared to an estimated 9.1% for the current fiscal year ending March 31, according to S&P.
Finance Minister Yoshihiko Noda said he wouldn’t comment directly on the downgrade.
S&P also pointed to Japanese deflation and its aging population as drags on the economy:
“Falling prices have matched Japan’s growth in aggregate output since 1992, meaning the size of the economy is unchanged in nominal terms. In addition, Japan’s fast-aging population challenges both its fiscal and economic outlooks. The nation’s total social-security-related expenses now make up 31% of the government’s fiscal 2011 budget, and this ratio will rise absent reforms beyond those enacted in 2004.”
S&P also criticized the current Japanese government, saying the ruling Democratic Party of Japan “lacks a coherent strategy to address these negative aspects of the country’s debt dynamics.”
Still, it said its outlook on Japan’s long-term rating is stable, reflecting its view that an external balance sheet and “monetary flexibility” are helping offset the nation’s fiscal problems.
Wiggle room
Takahira Ogawa, S&P director for sovereign and international public finance rating, in Singapore, told reporters during a telephone conference, the outlook could improve if Tokyo made progress on social security and tax reform.
“I don’t think our action is self-fulfilling,” Ogawa said, referring to the downgrade.
He added that was little hope for change in the short term as a political consensus was unlikely to be reached before the next election.
Still, Ogawa said he was encouraged by Prime Minister Naoto Kan’s recent emphasis on fiscal consolidation, including a proposal to increase the consumption tax, but cautioned markets would likely be looking for progress in the next year to 18 months.
Noda, the finance minister, acknowledged that the government must advance its fiscal overhaul project to retain investor confidence in Japanese public debt.
“It is important to send out messages when necessary that Japan is trying to put itself on the path toward fiscal improvement, we will maintain fiscal discipline by delivering results,” Noda was cited as saying in a report by Dow Jones Newswires.. “It is important to gain the trust of the markets.”
Noda cited enacting the next fiscal year’s budget plans by the end of March and drafting a long-term tax and social-security overhaul by the end of June.
Not the first time
J.P. Morgan strategists said “anyone aware of Japan’s terrible fiscal balance would not be surprised” about the downgrade despite the market reaction, as Japan had been under review by S&P for a downgrade for the past year.
The analysts noted that S&P and Fitch Ratings both cut Japan to a rating of AA minus back in 2002, though S&P raised it back to AA in 2007.
At the time of the 2002 downgrades, they said, the dollar initially rose 0.5% against the yen, only to drop about 12% in the three months after the initial S&P rating cut.
S&P’s Ogawa also cautioned against making direct comparisons between Japan’s fiscal position and that of the U.S., adding that Thursday’s downgrade was the result of cumulative years of fiscal excess.
“Japan has been running significant fiscal deficits for 20 years, and yes, the U.S. has a more or less similar size of [annual] fiscal deficit [as a percentage of GDP], but their starting point is substantially better than Japan. That could make quite a lot of difference,” Ogawa said.
