Global bond rating agencies have long fretted about Japan's stratospheric public debt level and serious structural weaknesses. And for just as long, investors have largely ignored the barking of the watchdogs.
When Moody's Investors Service downgraded Japan's credit rating by a notch in December to the equivalent of single-A-plus, government bonds actually strengthened. The yield on 10-year debt hit a record low later that month and kept on breaking records – reaching 0.195 per cent on Jan. 20 – as the Bank of Japan vacuumed up huge amounts as part of its war on deflation.
Monday, it was Fitch Ratings' turn to take the government to task for failing to get its fiscal house in some sort of order. Amid speculation that the Bank of Japan may boost its already massive asset purchases at its next rate-setting meeting Thursday – to cope with slowing inflation and sluggish growth – Fitch sliced its senior Japanese debt rating to single-A, a rung below Moody's. In Fitch's eyes, that ranks the world's third-largest economy below the likes of Estonia and Slovakia and on a par with Malta in terms of creditworthiness.
The news barely caused a ripple in the markets. The yen initially wobbled, but recouped most of its lost ground and has risen nearly 5 per cent against other major currencies so far this year. Indeed, speculators seem to be tiring of waiting for bets against the yen to pay off. Net short positions fell last week to the lowest level in two and a half years. On the equity side, foreign money has been pouring into Japanese stocks – more than $1.3-billion (U.S.) net last week alone.
Prime Minister Shinzo Abe is visiting the United States this week to talk about key security and economic issues, including the Trans-Pacific Partnership, the 12-country free-trade deal he has championed as a boon to the struggling Japanese economy and a lever for essential reforms such as deregulation of agriculture. Now, he is bound to face questions about the country's deteriorating financial health.
There are plenty of reasons for concern.
"Japan's main sovereign credit and rating weakness is the high and rising level of government debt," Fitch said in a statement. That's putting it mildly. Fitch calculates that gross general government debt will reach a 244 per cent of GDP by the end 2015, up from 227 per cent in 2013. No other country comes close. The ratio for Greece, a fiscal basket case by any measure, currently sits at a record 177 per cent.
The counterargument has long been that most of the public debt is held domestically by Japanese pension funds, other institutional investors and increasingly by the interventionist Bank of Japan. A high savings rate has made this possible, but a rapidly aging population and shrinking work force are sure to slice into those funds in coming years, and Japanese fund managers are being forced to join the global hunt for higher-yielding assets.
Fitch cited the government's failure to counter the loss of revenue stemming from its decision to delay a planned sales tax hike of two percentage points to 10 per cent this October, while proceeding with a corporate tax cut.
"A consumption tax hike will not improve the fiscal situation," economist Heizo Takenaka, a former cabinet minister, told me before Mr. Abe decided to postpone the second part of the sales tax increase in the face of faltering growth. "In order to realize fiscal consolidation, it is very important to cap expenditures."
But that doesn't appear likely either. Japan's private sector is still saving nearly 6 per cent of GDP at zero interest rates. Someone has to borrow and spend that much to keep the economy from shrinking.
That will fall to the government, which will be hard-pressed to achieve its target of a primary surplus by 2020, raising even more red flags for the credit monitors and investors at large.