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. Last Updated: 07/27/2016

Japan Hit by Credit Downgrade

TOKYO -- Ministers reacted with a mixture of contrition and resentment Tuesday after ratings agency Standard & Poor's cut Japan's sovereign credit standing to the same level as Malta's.

S&P cited stalled reforms and the flagging popularity of Prime Minister Junichiro Koizumi for its decision to lower Japan's long-term local and foreign currency ratings by one notch to AA-minus, the lowest among major industrialized nations.

S&P said it was keeping its negative outlook on Japan, putting it at risk of a further downgrade at some point, due to the delays in structural reform that Koizumi pledged would be the cornerstone of his administration.

The widely expected cut, announced in New York before Japan's financial markets opened, briefly dented the yen. But the currency had regained its points by mid-afternoon Tokyo trading and stood at 131.40 per dollar.

Yields on Japanese government bonds, or JGBs, inched up but Tokyo stock prices closed 1.88 percent higher as several chip issues benefited from upbeat earnings forecasts by some of their U.S. peers.

Finance Minister Masajuro Shiokawa said the downgrade could not be totally ignored. "It is one indication that Japan needs to improve its fiscal situation and dispose of its non-performing bank loans,'' he said.

Economics Minister Heizo Takenaka said S&P was pointing out the risks facing the Japanese economy, including its mountain of bad loans and the need to restore fiscal discipline.

"It's a message telling us to do more reforms so we would like to press ahead with that,'' he said.

But the decision drew a rebuke from Vice Finance Minister for International Affairs Haruhiko Kuroda, who said public confidence in rating agencies had taken a knock since energy trader Enron collapsed last year under a mountain of debt.

"Since Enron, the credibility of credit rating firms has been lost. We cannot understand the reason why JGBs have been downgraded,'' Kuroda said.

Japan suffered the indignity of a downgrade despite flickering signs that its third recession in a decade might be drawing to an end on the back of strengthening export demand.

The Finance Ministry's regional bureaus reported Tuesday that a decline in production was halting in many regions and corporate earnings were set to improve.

In its announcement, S&P said the world's second-largest economy had not done enough to promote structural reform and that a long-awaited report issued last Friday by Japan's top financial regulator into problem bank loans was disappointing.

"A day of reckoning is at hand,'' said John Chambers, deputy head of sovereign ratings at S&P.

The downgrade, which warns investors that Japanese debt has a higher degree of risk, is S&P's second since November and comes as Koizumi struggles to recover from a series of money scandals that has rocked his government.

"We had hoped that Junichiro Koizumi's administration would press for private-sector and governmental reform,'' said Takahira Ogawa, head of S&P's Asian sovereign ratings team.

"But given the government's falling popularity and the problems that have beset key ministers and aides, Standard & Poor's has lowered its expectations in three key areas,'' he said.

S&P's cut brought its rating into line with that of rival Moody's Investors Service, which rubbed salt into Japan's wounds by charging Koizumi with failing to tackle the country's economic problems vigorously enough.

The government's attitude seems to be that, in the absence of a full-blown crisis, Japan can ride out passing storms without the need for drastic action, senior analyst Thomas Byrne said.

In mid-February Moody's said it might take the major step of cutting its Aa3 rating on Japan's domestic debt by two notches.

A one-notch cut by Moody's to A1 would put Japan's domestic debt rating on a par with that of Hungary and Chile. A two-notch cut to A2 would put it level with Poland's and Latvia's ratings.

"I think Moody's will downgrade by two notches by mid-May. But I think that the market has pretty much factored this in, so the impact again should be limited,'' said Xinyi Lu, chief strategist at UFJ Bank.

A single-A rating by Moody's could cause Japan problems since some fund managers are prevented from holding debt rated less than AA.

Japan has largely been immune to repeated cuts in its credit standing because its debt is entirely denominated in yen and about 95 percent is owed to domestic investors. It also runs a big current account surplus and sits atop the world's highest pile of savings.

Analysts say the combination of these factors has prevented an Argentina-style capital flight despite a rapidly growing public debt burden, which at more than 130 percent of gross domestic product is the worst in the industrialized world.

But Byrne said it was impossible to know when investors would start to demand much higher yields in return for continuing to bankroll the government.

"At some point, our concern is that this could snowball out of control, and then you'd have an abrupt shift in sentiment. And of course that would be a crisis.''