By: Dr. Mike Campbell

After Standard and Poor’s reduction of the credit rating on the world’s largest economy, the USA, fellow ratings agency Moody’s has moved to downgrade the credit rating for the world’s third largest economy, Japan.

Moody’s have reduced the rating on Japan’s long term sovereign debt from Aa2 to Aa3 which means that investors in Japanese bonds are exposing themselves to a slightly higher risk of default. Inevitably, this may mean that the Japanese find themselves paying more interest to attract investors to new bond issues. Moody’s said that they believed the outlook for Japan to be stable. Japan has the highest public debt level of any country and is having to deal with clean-up and reconstruction following March’s devastating earthquake and tsunami. The Japanese government chose not to go to the market to obtain funds to help with impact of the disaster because of fears that this would push up borrowing costs.

Moody’s explained their move in a statement: "The rating downgrade is prompted by the large budget deficits and the build-up in Japanese government debt since the 2009 global recession. The March earthquake also undermined Japan's recovery from the 2009 global recession".
In the aftermath of the natural disaster consumer and industry spending has declined which reduces the government’s revenue. On-going disruption to the nation’s power supply and damage to the infrastructure will hamper recovery and may deter investment in the public and private sectors.

Whilst the government has pledged to reduce the budget deficit (not the public debt) to zero by 2020, the nation is afflicted by political instability with five prime ministers in as many years and the current PM is set to resign shortly, largely over his handling of the natural disatster.
Moody’s pointed out in their statement that: "Frequent changes in the administrations have prevented the government from implementing long-term economic and fiscal strategies into effective and durable policies". Many analysts take the view that Japan’s situation is likely to deteriorate further before any improvement.