By: Dr. Mike Campbell

Moody’s is one of the biggest credit ratings agencies in the world. In essence, the function of a ratings agency is to provide impartial advice on the risk associated with investing in a specific bond issue, in terms of an investment grade status with AAA being the best possible. The issuing body pays a fee to the rating agency for this service which is designed to give investors a clear idea of the risks (or otherwise) associated with a vehicle. The yield that the issuer has to pay to investors is directly proportional to the perceived risk of a default on the bond.

Japan has the greatest level of public indebtedness of any industrial country as a proportion of its GDP. Japanese debt currently stands at almost twice the nation’s GDP. Some months ago, PM Naoto Kan remarked that if the financial markets lost confidence in Japan’s ability to service its debts that the country would risk a financial collapse.

Yesterday, Moody’s downgraded the Japanese rating from AA to AA-; this is not to suggest that they believe that Japan is in imminent risk of a financial collapse, but that they recognise that there is a higher risk in investing in a Japanese bond.

If the markets react to Moody’s decision, it is likely that Japan will need to pay a higher yield on future bond issues. This will push up the cost of borrowing to the Japanese nation – we have seen this before with both the Greek and Irish sovereign debt problems.

Whilst Ireland and Greece could not depreciate their currency since both were members of the Eurozone, Japan would have this possibility in extremis, however we are a very long way from such a possibility.