Moody’s lowers Japan’s rating to Aa3

Full statement follows:

Moody’s lowers Japan’s government rating to Aa3; outlook stable

Singapore, August 24, 2011 — Moody’s Investors Service today lowered the
Government of Japan’s rating to Aa3 from Aa2, concluding the rating
review that began on May 31. The outlook is stable.

The rating downgrade is prompted by large budget deficits and the build-up
in Japanese government debt since the 2009 global recession. Several
factors make it difficult for Japan to slow the growth of debt-to-GDP
and thus drive this rating action.

Over the past five years, frequent changes in administrations have
prevented the government from implementing long-term economic and fiscal
strategies into effective and durable policies. The March 11 earthquake
and tsunami, and the subsequent disaster at the Fukushima Daiichi Nuclear
Power Station, have delayed recovery from the 2009 global recession and
aggravated deflationary conditions. Prospects for economic growth are
weak, making it more difficult for the government to achieve deficit
reduction targets and implement its Comprehensive Tax and Social Security
Reform plan.

Support for the stable outlook comes from the undiminished home bias of
Japanese investors and their preference for government bonds, which
allows the government’s fiscal deficits to be funded at the lowest
nominal rates globally. We believe that this funding cost advantage will
be sustained by considerable institutional and structural strengths,
which will prevail even with large budget deficits in 2011 and 2012.

The rating action does not affect the Aaa country and bank deposit
ceilings, the outlooks for which remain stable. Those ceilings act as a
cap on ratings that can be assigned to the obligations of other entities
domiciled in the country. Japan’s short-term rating is unaffected and
remains unchanged at P-1.

RATINGS RATIONALE

The global financial crisis has had a severe effect on Japan’s economy.
The current government now forecasts a primary budget surplus (excluding
interest payments on government liabilities) by 2020, versus the former
Koizumi government’s target of a budget surplus by 2012. Headline general
government budget deficits will remain approximately at or above 7% of
GDP through 2015, according to the Cabinet Office’s “prudent” projection,
well exceeding nominal GDP growth rates and thereby contributing to the
inexorable rise in the debt-to-GDP ratio.

Large deficits and the collapse of growth since the early 1990s have led
to an overhang of government debt that is by far the largest among the
major advanced economies. That assessment holds true based on either the
International Monetary Fund’s (IMF) 2011 projection of 233% of GDP or the
Cabinet Office’s projection of 181% (the IMF has a broader accounting
definition). Moreover, neither the IMF nor the Cabinet Office foresees
containing or reducing the debt burden over the next decade under the
current policy framework.

The March earthquake and nuclear disaster may make it difficult for the
government to stay under its JPY44 trillion annual budget borrowing
ceiling (which excludes special reconstruction bonds) in the current or
next fiscal year, though the government’s new Medium-Term Fiscal
Framework for 2012-14 repeats its commitment to adhering to that target.
The government estimates that the total fiscal cost will be 5% of the
current year’s GDP, but that will be spread over 10 years.

The March earthquake also undermined Japan’s recovery from the 2009
global recession. Consumer spending has softened further and deflationary
pressures have intensified. Also, the strength of future investment
growth is more uncertain even though supply chain disruptions are
normalizing. This is because power capacity will be reduced from the loss
or suspension of supply from nuclear power plants in Fukushima and
elsewhere in the country. Japan’s economy has been in recession for three
consecutive quarters from October 2010 through June 2011.

In particular, the consequences of the Fukushima Daiichi Nuclear Power
Station disaster have not fully played out, and it is not yet possible to
precisely quantify its impact. The government may be exposed to
contingent liabilities even after it establishes a special compensation
entity that places the burden on the nuclear power industry. Furthermore,
reductions in the national power supply from a crippled and suspect
nuclear power sector would intensify headwinds against economic growth.

These developments further hamper the economy’s ability to achieve a
growth rate strong enough to steadily reduce the budget deficit. Although
the government and ruling party unveiled a comprehensive fiscal reform
plan on June 30, which identifies a broad range of measures to be taken,
it lacks precision. In addition, a divided Diet and tensions within the
ruling Democratic Party of Japan risk both the timing and implementation
of the reform plan. Indeed, the imminent change in the party’s presidency
and the election of a new prime minister reflect the factious nature of
the country’s politics.

While the government sees as feasible its medium-term policy target of a
halving of the primary budget deficit (excluding interest payments) to
approximately 3% of GDP by 2015, assuming the government doubles the
consumption tax to 10% by the middle of the decade, its ultimate goal of
achieving a primary surplus by 2020 would require additional, and yet
unidentified, fiscal measures. Moreover, even under the government’s more
vigorous and optimistic economic growth scenario, a decline in the
debt-burden trajectory would remain elusive.

CREDIT SUPPORT FACTORS

Japan’s very large economy and very deep financial markets provide the
wherewithal to absorb economic shocks. Its dependable domestic funding
base provides an exceptional home bias for the government, which can fund
itself at a lower nominal cost than any other advanced economy.
Furthermore, throughout the global financial crisis, in the months after
the March earthquake, and in recent days with renewed turmoil in global
markets, JGBs continue to demonstrate exceptionally strong safe-haven
features.

Related to Japan’s home bias is its strong external payments position,
which insulates the country from global financial market shocks. In
addition to a seemingly structural current account surplus on the balance
of payments, its net international investment position at more than 50%
of GDP is the largest of any industrialized advanced country, and is
almost twice as large as that of Germany. In fact, net income receipts
from overseas assets provide a bigger contribution to the current account
surplus than the trade balance.

The steady appreciation of the yen to post-war highs is a headwind
against export competitiveness, although the lack of price and wage
inflation in Japan somewhat offsets this effect. Even if exports falter
as a source of economic growth, we expect Japan’s external position will
retain its strengths.

And although the government’s June 30 Comprehensive Tax and Social
Security Reform plan is not fully worked out, it will help to sustain
market confidence if, in the not-too-distant future, the government
executes policies on a timely basis and economic growth recovers to
support the fiscal adjustment process.

CREDIT TRIGGERS FOR A FUTURE RATING ACTION

Credit-positive factors that could lead to a positive ratings outlook and
could eventually lead to a ratings upgrade:

1. Well-established progress in achieving fiscal consolidation targets

2. A robust and sustainable recovery from the recession

Credit-negative factors that could lead to a negative ratings outlook or
prompt a ratings downgrade include:

1. A delay in implementing the comprehensive tax and social security
reform plan

2. The economy’s inability to recover from the lingering effects of the
global recession and the ongoing consequences of the March earthquake,
tsunami and nuclear power plant disaster

3. A diminished home bias in the government bond market or substantial
erosion in Japan’s external strengths, which at some point would cause
the market to price in a risk premium to government debt, making sizable
annual refinancing requirements significantly more costly

PREVIOUS RATING ACTION & METHODOLOGY

The last rating action on the Government of Japan was on May 31, when its
government bond ratings were placed on review for downgrade.

The principal methodology used in this rating was Sovereign Bond Ratings
published in September 2008. Please see the Credit Policy page on
www.moodys.com for a copy of this methodology.

Press releases of other ratings affected by this action will follow
separately.