Would Japan be downgraded?

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The Japanese government’s move on June 1st, 2016 to defer a 2 percentage point increase in the national sales tax was broadly expected given the stagnant state of the economy.  Its implications for the creditworthiness of Japan is not very clear.

Increasing taxes is a critical component of trimming Japan’s huge amount of debt. As such, the postponement raises fear over the unsafe state of government funds as well as the stability of “Abenomics” – a group of fiscal and monetary programs aimed to revamp the weak economy.

That does not mean that all rating agencies have a negative opinion. S&P Global Ratings, one of the leading global credit rating agencies sees no consequence on Japan’s credit ratings because of the news.

It doesn’t mean an end of initiatives by the Japanese government for fiscal consolidation. Once the economic circumstances are correct, the government in Japan is expected to increase the sales tax since the countries debt levels are very high and there is no scope for the country to continue existing levels of expenditure.

Fiscal performance is not expected to weaken any further. In 2015, S&P Global Ratings reduced Japan’s rating to A+ from AA- (four levels lower than its best rating of AAA).

The Japanese government must develop a plan to generate growth and control inflation. Once the conditions become perfect (as in 2013), the government can increase the tax. Again, even if there is slow growth as a consequence, there would be a rise in tax revenue.

The tax hike is expected in 2019, while the government is promising large-scale fiscal stimulus measures.

However, Fitch, another prominent global credit rating agency displayed a very cautious view. A delay weakens the reliability of the political commitment to fiscal consolidation.

In April 2016, Fitch confirmed Japan’s long-term rating at ‘A,’ observing that the countries huge government debt was a critical factor limiting the rating. The credit rating agency would adopt a wait and watch approach before drawing any further conclusions for Japan’s ratings.

Some analysts cautioned that the third largest global economy could possibly re-enter recession. Given the nation’s moderate consumption and growing inflation levels, certain experts have said Tokyo must reduce the consumption tax instead of encouraging spending.

If the government went ahead and lowered the tax, investors may exit the Japanese Government Bond market, thereby resulting in an increase in interest rates.

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