Japan Ratings Affirmed At #A+/A-1#; Outlook Remains Stable

Stocks and Financial Services Press Releases Tuesday April 18, 2017 17:49
S&P Global Ratings--18 Apr--S&P Global Ratings

On April 18, 2017, S&P Global Ratings affirmed its 'A+/A-1' foreign and local currency unsolicited sovereign credit ratings on Japan. The outlook on the long-term ratings remains stable. Our transfer and convertibility (T&C) assessment remains 'AA+'.

RATIONALE

Our ratings on Japan reflect our view that the country's strong external   position, prosperous and diversified economy, political stability, and stable   financial system balance its very weak public finances, which are exacerbated   by an aging population and persistent low or negative inflation.

Japan is a relatively high-income economy. We estimate per capita GDP will range between US$37,000 and US$39,000 through to the end of fiscal 2020 (ending March 31, 2021). We estimate Japan's weighted average per-capita income growth in fiscals 2011 to 2020 at about 1%.

The strength of Japan's institutional and governance effectiveness remains a key factor supporting the sovereign ratings. Japan's homogeneous and cohesive society, generally effective checks and balances within government, strong

respect for the rule of law, and free flow of information facilitate policymaking. This has helped achieve popular acceptance of challenging policy initiatives, such as the 2014 increase in the sales tax rate. However, we see slow decision-making among policy institutions somewhat impairing policy implementation.

Japan's strong external position and monetary policy settings also support its sovereign credit fundamentals. The free-floating yen's status as a reserve currency reflects these strengths. We believe the yen derives its status from the credible political and policy institutions in the country--including the Bank of Japan (BOJ)--along with a sound financial system, freedom of capital flows, and sizable domestic capital markets. Demand for the yen as a reserve currency reduces Japan's vulnerability to large fluctuations in international capital flows and augments the BOJ's ability to conduct

monetary policy.

A strong external balance sheet further strengthens support for the sovereign ratings. Despite the slide in the household saving rate as the population ages, the current account remains in consistent surplus. This indicates that private-sector savings (net of investment) in the country continue to exceed net dissaving in the government sector. We expect Japan to post current account surpluses averaging about 4% of GDP in calendar years 2017-2020. We project that, with these surpluses, Japan will maintain a small narrow net external debt position, with the country's total external debt exceeding external financial and public-sector financial assets by 20% to 30% of current account receipts over the next few years. This metric does not include external assets held by the nonfinancial sector, which are substantial. Taking

all external assets and liabilities into account, we expect Japan's net international asset position to be about 300% or more of its current account receipts over the next few years.

While Japan's external balance sheet is strong, government finances are very weak and are a significant constraint on its creditworthiness. Economic damage as a result of the global financial crisis that began in 2008 and the 2011 Great East Japan Earthquake depressed government revenue, contributing to rising general government debt at an average annual pace of close to 10% of GDP between fiscals 2009 and 2012. More recently, a pickup in government revenue growth since fiscal 2013 has helped narrow the fiscal deficit somewhat. Looking ahead, we expect government debt to grow at a slower annual rate of about 4.5% of GDP over fiscals 2016 to 2019. The corresponding increase in net general government debt will bring it to about 136% of GDP in fiscal 2020 from close to 126% of GDP in fiscal 2015. This level of general government indebtedness is among the highest for sovereigns that we rate.

Despite building a huge stock of debt, the BOJ's sizable purchases of Japanese government debt have kept government borrowing costs low. The central bank now holds over 42% of Japanese government bonds outstanding. With most Japanese government securities yielding negative returns, this dampens the government's debt-servicing costs as bonds mature and the government issues new debt at these negative interest rates.

Japan has by far the world's highest debt rollover ratio (including short-term debt), so negligible yields will thus soon pass through to, and bring down, government borrowing costs. However, should real interest rates increase at some point, this would severely strain the government's debt dynamics. This could occur if investors demand a higher risk premium and push up nominal interest rates, but we consider the greater risk is from renewed and persistent deflation.

While Japan's government has a heavy debt burden, we believe it faces limited contingent liabilities. The nation's banking system is relatively large, with assets worth nearly 3.5x GDP in 2016. However, we assess the risks Japanese banks face as relatively modest and classify the banking sector in group '2' of our Banking Industry Country Risk Assessment (with '1' representing the lowest risk and '10' representing the highest risk). We also do not envisage other sources of contingent liabilities posing a significant risk to public finances.

OUTLOOK

The stable outlook on the long-term ratings on Japan reflects our expectations that nominal economic growth averaging 2% and negative effective real interest rates on new issuances of government debt will slow the rate of expansion in the government debt burden over the next two years and eventually stabilize it. We could raise the sovereign ratings on significant improvements in the government's fiscal performance, likely brought on by stronger real and nominal economic growth. We could lower the sovereign ratings if we conclude that the responsiveness of policymakers is insufficient to sustain growth, keep deflation at bay, and eventually stabilize the government debt burden.


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