S&P Cuts Japan’s Rating for First Time Since 2002; Euro Rises

Ratings company faults debt planning; ECB talks tough on monetary policy

Standard & Poor’s cut Japan’s sovereign debt rating by one notch on Thursday, saying that the nation “lacks a coherent strategy” to cope with a debt level that it predicts will only peak in the mid-2020s. The yen fell in response, although world markets showed muted reaction to the news. The euro benefited, responding also to tough talk from the European Central Bank (ECB) as tighter monetary restrictions loomed.

Japan’s debt rating now stands at AA-, according to a Reuters report, which is one notch below both Moody’s and Fitch’s ratings. S&P pointed to Japan’s aging population as one factor in its decision, since rising social welfare costs will increase the nation’s debt load. Currently Japan’s debt is double its $5 trillion economy and on the rise.

In a statement, S&P said in part about the decision, “In our opinion, the Democratic Party of Japan-led government lacks a coherent strategy to address these negative aspects of the country's debt dynamics, in part due to the coalition having lost its majority in the upper house of parliament last summer.”

Kaoru Yosano, Japan’s economics minister, said that S&P’s action was regrettable. While Prime Minister Naoto Kan is advocating consideration of a national sales tax increase to help manage the country’s burgeoning debt, the proposed budget includes record spending of 92.4 trillion yen ($1 trillion) and also plans for increased debt issuance that will outpace tax revenues for the second straight year.

While the rating cut will not have all that much influence on the outside world—some 90%-95% of Japan’s bonds are held domestically—and S&P said the long-term outlook was stable, the reminder of sovereign debt woes in general, coupled with ECB concerns, made investors react, largely to paper rather than equities. Lorenzo Bini Smaghi, ECB rate-setter, said that an expected rise in imported goods inflation could not be ignored, and his comments drove investors to seek higher interest rates and turn to the euro.

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