S&P has another go at Japan | FT Alphaville

S&P has another go at Japan

Amid a stream of gloomy forecasts for Japan’s economic outlook this year, it was a downgrade that had to happen at some point, though some were left wondering whether S&P’s move on Wednesday to cut its outlook for Japan’s sovereign debt from “stable” to “negative” was slightly – err, hasty.

S&P cited concerns about the effect of massive reconstruction costs following the March 11 earthquake and tsunami disasters on Japan’s already wide fiscal deficits. Coming on the heels of the agency’s January downgrade of Japan’s sovereign credit rating, and its shock move last week to cut its outlook on US sovereign debt, it makes S&P look rather zealous – perhaps overly so, given that Japan is yet to detail how it proposes to pay for reconstruction.

But the mood on Wednesday was certainly conducive to S&P’s move on Japan, which came just after Greek debt yields soared on Tuesday fanning fears that Athens would fail to meet its deficit targets and be forced to restructure its debts.

As the FT notes, S&P cited concerns that the Japanese government would have difficulty devising a plan to pay for reconstruction, which S&P estimates will range from Y20,000bn ($245bn) to Y50,000bn – well above the government’s own calculations and average estimates among Japan analysts of Y10,000bn to Y30,000bn.

“The negative outlook signals that a downgrade is possible if Japan’s public finances weaken further over the next two years in the absence of fiscal consolidation to offset them,” S&P said.

As was clear in S&P’s January downgrade, Japan’s fiscal position was a concern even before the March 11 disaster. But, notes the FT:

S&P expects that costs related to the quake, tsunami and nuclear accident will increase Japan’s fiscal deficit above prior estimates by a cumulative 3.7 per cent of GDP  through 2013…. Japan’s gross debt, which is expected to exceed 200 per cent of GDP this year, is almost entirely held domestically.

How Japan will pay for the reconstruction is the key question for every economist, commentator and investor dealing with Japan.

Interestingly , however,  while growth forecasts are being slashed for this year, as we recently noted, they are almost uniformly bullish on the country’s prospects for 2012.

For example, even the IMF, which has taken a harsh view of the US and UK economies, has been quite mild on Japan – and surprisingly optimistic about next year in its early April forecasts.

After trimming  its economic growth forecast for Japan this year to 1.4 per cent from the previous 1.6 per cent, citing the impact of the March 11 disasters on the economy and the country’s industrial supply chain, the Fund raised its estimate for Japan’s growth in 2012 to 2.1 per cent, citing the stimulatory effects of reconstruction spending and investment in the wake of the disasters.

Here’s what S&P’s sovereign ratings director, and some key Japanese officials, had to say on Wednesday, courtesy of Reuters:

Takahiro Ogawa, S&P sovereign ratings director:
“With politics, it’s very difficult to tell. Any changes in politics that have negative implications for fiscal or macroeconomic policy could be a trigger for future action …If you look at long-term rates, they show that markets aren’t worried now, but reconstruction spending will slowly erode Japan’s fiscal position… A lack of consensus on economic policies contributed to the change in the ratings outlook….

“The government can do more by having a better review of spending to use public funds more efficiently. There are also revenue-enhancing measures, but it’s up to the government to decide how to fund reconstruction… If the government spends money wisely, reconstruction spending could push up domestic demand, which could lead to an increase in revenue.”

Finance minister Yoshihiko Noda:
“I won’t comment on specific action by private rating agencies… 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… Fiscal reform is something we cannot avoid.”

Japan chief cabinet secretary Yukio Edano:
“Obviously various steps are needed, including fiscal ones, to deal with the natural and nuclear disasters. But on the other hand achieving this while retaining trust in JGBs is a key principal we want to firmly retain.”

Japan deputy finance mininster Fumihiko Igarashi:
“It (the negative ratings outlook) shows the earthquake has cast doubt about Japan’s fiscal reform efforts.”

[From a separate report]:

Takuji Okubo, SocGen chief Japan economist
“This will put more pressure on the Japanese government to do something about revenue enhancement”. Still, he added, the S&P action could help the government’s case for fiscal reform, which centres on raising the 5 per cent consumption tax — something acknowledged by Japan’s finance minister.

Junko Nishioka, chief economist at RBS Securities Tokyo
“Given the huge damage from the earthquake, everyone knows that government spending will be massive,” said  “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.”

Rob Ryan, FX strategist, BNP Paribas, Singapore
“One day there will be a more serious reaction to a more serious warning — but this doesn’t look like that day… I think this was something that was inevitable after the triple disasters.”

Meanwhile, the usually savvy Masamichi Kanno at JPMorgan in Tokyo, says in a note entitled “No surprise, again”, that S&P’s action was “not a big deal for us and most likely for majority of market participants”.

Indeed, he adds:

While we share the agency’s concern on Japan’s fiscal health, the estimated benchmark cost for rebuilding looks too large for us. We currently assume that the aggregate cost is ¥15 to 20 trillion in this and next year (maybe more in longer run), of which fiscal spending is ¥10 to 15 trillion… But there is much confusion with the power game among politicians. At this point, it is highly uncertain how much the government will spend for rebuilding as an aggregate. Anyway, ongoing development in the nuclear accident and politics on the fiscal consolidation remain the key focus for economy and fiscal health. It probably takes at least a few months to be more clear on both fronts.

That appears to sum up the situation in Japan quite neatly. S&P might do well to take note…

Related links:
Japan disaster coverage
– FT.com
The hidden slide of Japanese business sentiment – FT Alphaville
Five reasons the yen will strengthen – FT Alphaville
S&P downgrades Japan (January 2011) – Lex