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Moody's Downgrades Japan On Concerns About The Prospects For Abenomics

Dec 1, 2014, 16:56 IST

Ratings agency Moody's downgraded Japan sovereign debt rating by one notch from Aa3 to A1 on concerns that Abenomics will fail to put government finances onto a sustainable path.

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Below are the three key reasons given for the downgrade:

1. Heightened uncertainty over the achievability of fiscal deficit reduction goals;

2. Uncertainty over the timing and effectiveness of growth enhancing policy measures, against a background of deflationary pressures; and

3. In consequence, increased risk of rising JGB yields and reduced debt affordability over the medium term.

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The ratings agency's review of the country paints a worrying picture for those who are currently bullish on the prospects for Prime Minister Shinzo Abe's reform programme. In particular, the delay of the second sales tax hike following the collapse in domestic demand and inflation after its first increase has put the government's budget consolidation efforts under threat.

As the ratings agency puts it, the indefinite delay in the sales tax rise "resulted in the delay of the 2015 budget, and a concrete plan to meet fiscal targets is not likely to emerge until the second half of 2015". With government debt projected to be 245% by the end of 2014 such delays could knock investor confidence in the country.

However, the country also faces pressure to increase growth and push inflation back towards the Bank of Japan's 2% target. Growth has contracted sharply after the sales tax increase in April and policymakers are now under pressure to improve the country's performance. In particular, the government faces a huge challenge in shifting the expectations of domestic investors that it can break with over a decade of deflation - something that it has so far struggled to achieve.

What this means is that the Japanese government is now stuck between a rock and a hard place. If Abe's reforms are seen as working to raise inflation, but without improving the government's finances, it could make paying for the state's huge debt burden much more difficult.

However, if it fails then Japan will still be left with the problem of how to pay for an ageing society without economic growth to help support its rising welfare bills. This could also cause investors to doubt the government's fiscal sustainability and increase its borrowing costs.

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Either way, Moody's is saying that the success of Abenomics is far from assured.

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