Japan’s risks raise possibility of further downgrade

By:
Jeremy Weltman
Published on:

Abenomics had been designed to rescue Japan from its awful deflationary torpor, but the economy is struggling again and its troubles could become a lot worse if China buckles.

Japan FX-R-600

Economists have seen it coming. On a total risk score of 67.2 out of 100, Japan has shed more than 10 points in Euromoney’s country risk survey since 2010, and is now lying 28th out of 186 countries in the global rankings, trailing most of its G7 peers.

That puts Japan in the lower half of tier two, one of five groups equivalent to an A- to AA rating, and less than two points higher than Oman and Poland, both commanding A- ratings.

The rating agencies disagree, but even Japan’s downgrade from Fitch (to A) might appear generous if its score decline continues:

 

Turn for the worse

The second-quarter economic contraction was disappointing, with exports to Asia and the US struggling, despite monetary policy expansion extending the yen’s depreciation.

Private consumption – accounting for 60% of GDP – shrank by 0.8% from the first quarter, which the government had hoped to avoid by delaying another rise in consumption tax from 8% to 10% until April 2017.

Deflation is moreover threatening to re-emerge as commodity prices flounder. The consumer price index rose by just 0.2% year-on-year in July, delaying the Bank of Japan’s 2% objective.

And all of this is, of course, taking place under the shadow of China’s emerging frailties weakening regional trade.

Refocusing on debt

All is not lost. Japan has huge reserves, a current-account surplus and its citizens are a thrifty lot, helping to offset the sovereign’s liabilities with an enormous supply of domestic savings.

Yet with insufficient tax revenue, rising social security spending and the economy under pressure, there is little prospect of a near-term improvement in fiscal indicators.

The general government deficit of 6.7% of GDP in 2014 was smaller than in previous years, but is at risk of widening, not shrinking, this year unless the situation improves.

The general-government-gross-debt burden increased to 246% of GDP by the end of 2014 and will rise further if economic growth falters, necessitating deeper reforms.

Risk experts, meanwhile, have long harboured serious concerns for the economy, the government’s finances, its policies and Japan’s demographics, all of which are scoring lowly in Euromoney’s survey.

The latter – a ticking time bomb, urging faster consolidation of the nation’s finances – chalks up just 3.4 points out of 10.

Further reading
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Yen: special focus

Writing in July, before the Q2 national accounts were released, Ieisha Montgomery, an associate international economist with The Northern Trust Company, noted the successes of Abenomics, but also warned against hubris.

"Major reforms, including implementing the second phase of the tax hike, will be needed to achieve a primary budget surplus by 2020," wrote Montgomery. "Currently, the government is leaning too heavily on projected growth to tackle the country’s debt issue."

Speaking to Euromoney since, Montgomery believes the Q2 growth figure does not spell doom for the Japanese economy, not least because corporate investment intentions are solid, and the increase to the minimum wage later in the year should provide a boost to consumer spending.

Still, the China effect is casting a huge shadow, she warns, noting: "Net exports could continue to be a drag [on economic growth] as the slowdown in China counterbalances the benefits gained from the weaker yen."

This article was originally published by ECR. To find out more, register for a free trial at  Euromoney Country Risk.