S&P Cuts Japan Credit Outlook On Quake Concerns
TOKYO (Leika Kihara) - Standard and Poor's threatened to cut Japan's sovereign credit rating again, warning the huge cost of last month's devastating earthquake will hurt already weak public finances unless bickering politicians can agree to raise taxes.
It affirmed its long-term sovereign credit rating on Japan at AA minus -- the lowest among the major agencies -- but downgraded the outlook to negative from stable.
The change comes three months after S&P had cut Japan's sovereign credit rating -- the first reduction since 2002 -- saying the government had no plan to deal with its mounting debt while adding the administration's loss of an upper house majority had compounded the problem.
Public debt, already twice the size of the $5 trillion economy, is set to swell as the country faces reconstruction costs following the March 11 earthquake and tsunami that could reach 50 trillion yen ($613 billion), S&P said.
"If there are no revenue enhancing measures such as tax increases, we expect the central and local governments to bear most of this cost," the agency said.
However, the country's deepest crisis since World War Two has not healed rifts between the government and the opposition, whose majority in the upper house stands in the way of fiscal reform.
In addition, Prime Minister Naoto Kan's deep unpopularity means that even within his party, he has little room for maneuver to shore up the country's public finances.
"This will put more pressure on the Japanese government to do something about revenue enhancement," Takuji Okubo, chief economist at Societe Generale, said.
Still, Okubo said the S&P action could help the government's case for fiscal reform, which centers on raising the 5 percent consumption tax -- something acknowledged by Japan's finance minister.
"Fiscal reform is something we cannot avoid," the minister, Yoshihiko Noda, said. "The government at present is doing its utmost for disaster relief and reconstruction. It is important to pursue fiscal reform at the same time. We will try to gain trust in Japan's economy and public finances in and outside Japan."
BUDGET DEFICIT SWELLING
Japanese sovereign credit default swaps were 1 basis point wider at 77 basis points after the S&P announcement, but they remain well off post-quake peaks near 120 basis points and a few basis points tighter than just before the disaster.
The yen dipped shortly after the announcement with the dollar climbing to an intraday high of 81.781 yen, but analysts said the S&P move was unlikely to have much impact.
"The impact on the forex market is likely to be temporary," said Masafumi Yamamoto, chief currency strategist at Barclays Capital in Tokyo.
Moody's Investors Service, which cut its outlook on Japan's rating to negative from stable in February because of concerns about the government's fiscal deficit, said on Wednesday it was maintaining the outlook at watching developments.
"We are interested in the bottom line, that's the rating bottom line -- the government fiscal deficit and government debt," said Tom Byrne, senior vice-president, in an interview.
Japan is not alone among industrialized countries in confronting a swollen budget deficit.
Just last week S&P slapped a negative outlook on the top-level AAA credit rating of the United States, where lawmakers are also squabbling over how to deal with a massive fiscal deficit.
The European Union is facing a critical test as the region deals with its worst debt crisis since the single euro currency was launched.
Japan's government has estimated that the cost of the damage from the 9.0-magnitude earthquake and tsunami on March 11 could reach just above $300 billion. A nuclear power crisis resulting from the tsunami has further damaged the economy.
However, S&P projected reconstruction costs at between 20 trillion yen and 50 trillion yen ($245 billion to $613 billion).
It said if government revenues are not boosted, these costs would add 2 percent of gross domestic product to the general government fiscal deficit this year and 1 percent next year. Deficits would remain above 8 percent through 2014, it said.
"Much will depend on Japan's political leadership and its ability to forge a political consensus on how to offset fiscal measures in the future," S&P said.
Japan is expected to pass an initial 4 trillion yen ($49 billion) extra budget for disaster relief in early May that won't entail fresh borrowing, but that is just a down payment on the expected cost of rebuilding in Japan's devastated northeast.
"Given the huge damage from the earthquake, everyone knows that government spending will be massive," said Junko Nishioka, chief economist at RBS Securities Tokyo.
"We are not expecting big new government bond issuance for the coming second supplementary budget but political deadlock is likely to heighten the negative risk for sovereign debt."
The Bank of Japan, which reviews policy on Thursday, relaxed its already super-loose policy just days after the disaster and has added its voice to those calling for a more credible plan by the government to fix the country's finances.
Japan's reliance on domestic investors, who hold about 95 percent of the government's debt, shields it from the sort of turmoil that has rattled high-debt euro zone countries and explains the subdued market response to the S&P news.
But mounting welfare costs and shrinking savings as a result of a rapidly aging population raise questions of the longer-term sustainability of Japan's debt burden.
"One day there will be a more serious reaction to a more serious warning -- but this doesn't look like that day," said Rob Ryan, foreign exchange strategist at BNP Paribas in Singapore.
"I think this was something that was inevitable after the triple disasters."
In a sign of the economic impact of the quake, tsunami and nuclear power crisis, data on Wednesday showed retail sales fell in March at the fastest annual pace since 1998.
The figures provided the first clear measure of how private consumption -- which makes up more than half of the economy -- has reacted to the disaster.
It also highlighted the need for the government to quickly resolve the nuclear crisis, ensure power supply and help manufacturers restore damaged supply chains so they can produce more goods, economists said.
S&P said the downgrade of the ratings outlook meant that a cut in the actual rating could follow over the next two years if there is no fiscal consolidation.
AA minus is S&P's fourth-highest rating and puts Japan on a par with S&P's rating for Saudi Arabia and one level below of Spain.
Moody's warned in February it might cut its Aa2 rating -- its third highest -- if government policies fall short of comprehensive tax reform.
Fitch Ratings has an AA rating -- the company's third highest -- with a stable outlook.
(Additional reporting by Rie Ishiguro and Stanley White; Editing by Joseph Radford and Neil Fullick)
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