By Yasuhiko Seki

TOKYO (MNI) – Japanese financial markets on Tuesday shrugged off a
fresh warning on the nation’s burgeoning public debt from a U.S. credit
rating agency, even as Prime Minister Naoto Kan faces an increasingly
tough task of pushing his deficit reduction plan through the hung
parliament and start a national debate on the need for a sales tax hike.

While Japanese markets seem fully able to resist any near-term
sell-off due to the nation’s debt problem, economists warn that Tokyo
can’t sit still in the face of a rapidly aging population.

Moody’s Investors Service said earlier Tuesday that it had lowered
the outlook on Japan’s Aa2 sovereign debt rating to negative from
stable, citing the surging public deficit and slow policy response.

“The rating action was prompted by heightened concern that economic
and fiscal policies may not prove strong enough to achieve the
government’s deficit reduction target and contain the inexorable rise in
debt, which already is well above levels in other advanced economies,”
Moody’s said in a statement.

“Although a JGB funding crisis is unlikely in the near- to
medium-term, pressures could build up over the longer term which should
be taken into account in the rating, even at this high end of the
scale,” it said.

The action by Moody’s came after Standard & Poor’s last month cut
Japan’s sovereign debt rating to AA-, the fourth-highest level, citing
the government’s lack of a “coherent strategy” to deal with a debt
burden approaching 200% of gross domestic product.

Thomas Byrne, senior vice president of Moody’s Investors Service,
said recently that any policy drift or friction that prevents passage of
tax reform bills in parliament would be a credit-negative development.

Japanese analysts do not share Moody’s negative sentiment about
the domestic bond market, at least in the near term.

“The market was right in ignoring the warning,” said Akio Yoshino,
chief economist at Amundi Japan Co.

“Unless the investment and savings balance drastically changes in
Japan, the latest warning from the rating agency won’t pose a serious
downside risk to the Japanese government bond market,” he said.

In fact, Japanese government bonds extended their gains further
after Moody’s announcement. The yield on 10-year JGBs fell 3.5 basis
points to 1.275%, after falling to as low as 1.2600% at one point.

The yen also quickly trimmed its losses, after temporarily
weakening to Y83.50 in immediate reaction to the announcement. The
currency was quoted around Y83.32 in late Asian afternoon trading.

The Nikkei 225 Stock Average closed down 192.83 points, or 1.78%
at 10,664.70 on Tuesday but today’s losses were driven by the growing
civil unrest in the Middle East and North Africa.

“If the JGB market stands firm despite the news on the rating
(outlook), it’s unlikely to cause a major downturn in the yen or
(Japanese) stocks,” Yoshino added.

Junko Nishioka, chief economist at RBS Securities, agreed with
Yoshino on the short-term impact of the credit warning on financial
markets.

“Given the likelihood that the debt holding structure of Japanese
government bonds will remain intact and that Japan can continue to
maintain a current account surplus in a stable manner, it is highly
unlikely that Japan will face a Greece-like deficit problem in the
foreseeable future,” Nishioka said.

“Therefore, it is difficult to see a sharp and sustained spike in
yields on Japanese government bonds stemming from rising risk premiums
for holding JGBs,” she added.

Still, some economists warn that Japan is gradually running out of
time to put its fiscal house in order in light of the aging population
and political instability — Kan is the fifth prime minister in the past
five years and his popular support has fallen to an historically low.

Public expectations were high in 2009, when the Democratic Party of
Japan took power away from the Liberal Democratic Party with a full
plate of policy reform promises.

But the DPJ’s first prime minister, Yukio Hatoyama, barely stayed
in office for 10 months, having failed to cut the deficit by simply
slashing “wasteful” spending.

“The government of Japan has a poor ability to control its purse;
most housewives are much more capable than that,” said Mitsuru Saito,
chief economist at Tokai Tokyo Securities.

“If you keep spending twice as much as what you are making, it
would not be a surprise if you went under eventually,” he added.

By the end of March 2012, the level of outstanding Japanese
government bonds will total Y668 trillion, 138% of projected gross
domestic product, according to an estimate by the Ministry of Finance.

Japan’s total outstanding long-term debt, including JGBs and
municipal bonds, is estimated to total Y891 trillion, 184% of projected
GDP.

As a result, Japan will remain the most heavily indebted
industrialized nation, dwarfing gross public debt held by Greece.

Japan, hypothetically, needs to make interest payment on its
government bonds of Y27.2 billion each day during the year to March 31,
2012, with the annual interest bill expected to reach Y9.9 trillion in
the current term.

The warning from the credit rating agencies also came as the public
approval ratings for the cabinet of Kan tumbled after the minor cabinet
reshuffling last month failed to boost confidence in the government’s
ability to push key budget and tax bills through the hung parliament,
with the upper house controlled by the opposition.

The approval rating for the cabinet dropped to 19% in a weekend
poll conducted on Feb. 19 and 20 by the Mainichi Shimbun newspaper, down
from 29% in its January survey.

The reading was the lowest since the Democratic Party of Japan took
power away from the Liberal Democratic Party in September 2009 and it
also fell below the key 20% mark which often resulted in the resignation
of past prime ministers.

Kan took office in June last year after Hatoyama resigned, with his
public support slumping to the 20% threshold after he failed to secure
the relocation of a controversial U.S. air base on the southern island
of Okinawa, one of several broken promises.

The Mainichi poll also found that the disapproval rating for Kan’s
cabinet rose 11 percentage points to 60% in the wake of the reshuffling
of the cabinet last month and that some 60% of respondents said Kan
should call a snap election.

“Apparently, Japanese citizens are losing confidence in the DPJ’s
ability to make changes to Japan’s administration system and prospects
for the nation’s economy,” Saito said.

“And as they are losing their trust in Kan, they can’t possibly
accept any proposal for hiking the sales tax rate from the current 5%,
which is the ultimate measure to fix the budget problem,” he added.

Kan last month called for cross-party discussion on tax reforms,
which include a possible increase in the sales tax rate, but none of the
opposition parties has so far accepted.

The opposition New Komeito party has decided to vote against
legislation needed to issue deficit-financing bonds to pay for the child
care subsidy in the fiscal 2011 budget even if Prime Minister Kan agrees
to step down as part of the bargain, the Nikkei newspaper reported
today.

New Komeito decision came after the main opposition Liberal
Democratic Party and Your Party decided to reject the government’s
budget-related bills, leaving little room for the bills to get through
the opposition-controlled upper house.

The Social Democratic Party is also expected to formally announce
its opposition to the budget legislation.

“Unless Japanese financial markets went berserk in a way that can
spook politicians, they won’t make any constructive compromise on
a drastic tax reform,” RBS’s Nishioka predicted.

tokyo@marketnews.com
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