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Japan ratings split highlights risks

TOKYO: Depending on whom you believe, Japan is either crawling out of its worst recession in half a century and building the base for a durable recovery, or sinking inescapably into debt.

Starkly different reports in recent days by two big international credit ratings agencies, Standard & Poor's and Moody's Investors Service, highlight a split in views on the risks facing the world's second-biggest economy.

Moody's announced last Thursday that it might downgrade government bonds issued in yen because of the explosion of public debt. But S&P overnight reaffirmed its top-notch rating on the view that the government can manage its debt burden.

Yet even if S&P's more benign view is true, the government will still come under pressure later this year to come up with a plan to bring debt under control through tax hikes or sharply reduced spending. And that raises concern whether the nation's fragile economic recovery could survive either course of action.

MARKETS NOW SEEING GLASS HALF-EMPTY

Moody's reawakened the markets to the nightmare scenario of a giant economy, addicted to fiscal stimulus and losing its punch, slipping so deep into debt that it cannot grow its way out.

The government has spent more than 120 trillion yen ($1.1 trillion) since 1992 trying to revive the economy from the funk it tumbled into with the collapse of the nation's asset-price bubble of the late 1980s. That has left Japan with a public debt soon to equal 130 percent of gross domestic product -- the worst in the industrial world.

S&P, by contrast, largely buys the government line that massive government spending and a year of near-zero interest rates leave the economy poised to recover under its own steam, allowing a prudent paring of debt in coming years.

Government debt is "manageable in the context of Japan's economic and external strengths", S&P said in affirming Japan's triple-'A' rating. The government is gambling that a decade of deficit spending is about to pay off, with a recovery that will lay the groundwork for paying off the worst debt in the industrial world.

But financial markets, after bidding up the yen and Japanese stocks last year on signs of a strong recovery, now are focusing instead on expectations that Japan slipped back into technical recession in the second half of 1999.

Shrugging off the S&P vote of confidence, the yen on Tuesday slipped to six-month lows against the dollar and three-month lows against the euro as worries grew over Japan's ability to achieve a sustainable economic recovery.

A weaker yen, while helping Japan's powerful exporters by boosting the value of overseas sales, could eventually threaten the ultra low interest rates that have kept Japan's debt-service burden in check.

SHOWDOWN LATER THIS YEAR

Finance Minister Kiichi Miyazawa candidly admits that 10-year bond yields, stuck below two percent, are "extremely abnormal". He also publicly frets that an economic pickup -- rather than allowing the economy to simply grow its way out of debt -- would push government bond yields up and compound the debt-service burden.

"It's going to come to a head sometime this year," said economist Matthew Poggi at Lehman Brothers. "If the economy doesn't recover, the government will have to make a choice about fiscal policy again."

Even one of the most vocal Japan bulls, Richard Jerram of ING Baring Securities, who blasted Moody's for threatening a second downgrade in two years when the economy has clearly improved, expressed hope that the move will prompt the government to outline a medium-term fiscal reform plan.

S&P cautioned that recent backsliding on economic reform could keep growth low and eventually threaten Japan's top-notch rating. Faulting past stimulus packages as being larded with unneeded pork-barrel spending, it said government spending must more effectively boost confidence and attack the overcapacity that continues to plague the economy.

Miyazawa insists the government wants to wean the economy from its stimulus fixes later this year if growth picks up again. But economists note that pressure may build for yet another stimulus package, especially as Prime Minister Keizo Obuchi must call general elections by October.

Even the pessimists agree that it is virtually unthinkable that Japan would default on its debt and is armed with gigantic foreign reserves, domestic savings and a world-beating industrial base. Optimists, conversely, agree that the government is saddled with policy headaches for years to come. -Reuters