Scope Ratings has today affirmed Japan’s long-term local-currency rating at A+. The agency has also affirmed the long-term foreign-currency issuer rating of A+, along with a short-term issuer rating at S-1+ in both local and foreign currency. The sovereign’s senior unsecured debt in local and foreign currency was also affirmed at A+. All Outlooks are Stable.

For the detailed research report, please click HERE.

Rating drivers

The ratings are supported by a broadly diversified and wealthy economy, strong funding flexibility, robust public institutions, a sound external position, and a resilient financial system. Rating challenges reflect Scope’s view that Japan’s fundamentals are weakened by the country’s high public-debt burden and weak debt dynamics, as well as a weak growth outlook with growth potential that is under trend. 

Japan’s A+ rating benefits from one of the most diversified economies in the world. The country continues to be world class in key areas such as electronics and machinery. Japan has benefited from eight quarters of uninterrupted expansion, with real GDP expected to grow at 1.6% in 2017 thanks to a continued pickup in international trade and temporary fiscal stimulus. Although fiscal consolidation is set to resume in 2018, growth is projected to remain close to 1% in 2018 and 2019, as export growth remains robust with preparations for the 2020 Olympic Games and the accompanying urban redevelopment expected to generate one-off positive growth of 0.2-0.3 percentage points to GDP. Structural shifts within the Japanese economy are also expected to remain largely positive, with greater diversification within intermediate demand and increasing value-added in both manufacturing and exports. The unemployment rate fell to 2.4% in January 2018, the lowest since April 1993.

Japan also enjoys strong funding flexibility based on its safe-haven status. This reflects a large domestic investor base, with 89% of Japanese government bonds held by resident investors in September 2017, supported by a sizeable pool of private-sector savings. The importance of the yen as global reserve currency further eases funding flexibility. Moreover, the composition of public debt helps to maintain low borrowing costs. Average debt maturity is also relatively long at eight years and eight months as of the end of 2016, but short-term debt (under two years) remains substantial at 24.8% of the total debt stock at the end of 2016. Medium- and long-term debt (5-10 years) decreased from 27.6% of debt in 2007 to 23.2% at the end of 2016, with super long-term debt (10+ years) increasing from 16.5% in 2007 to 29.3% at the end of 2016.

The ratings are further underpinned by Japan’s sound external position. A positive net international investment position of 61.0% of GDP at the end of FY 2016 reflects high income flows from abroad, which has helped to maintain current-account surpluses for more than two decades. The current-account surplus has accelerated since 2015, reaching 3.6% of GDP in 2017 after several years of lows due to high energy prices and weak exports. The recent signing of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) may support overall economic growth in Japan by strengthening export demand with key trading partners via reductions in both tariff and non-tariff measures.

The Japanese banking system has proven to be resilient in the face of significant challenges. It is one of the largest and most complex in the world: total financial assets of around 620% of GDP in September 2016, over half of which are held by commercial banks; the three-largest banks alone hold 18% of total financial assets. The insurance sector is highly concentrated and the second-largest in the world after that of the US, with total financial assets of around 75% of GDP. Japanese banks are largely healthy, with low and declining non-performing loan ratios and an average capitalisation of 13% of risk-weighted assets. Local-currency liquidity indicators are favourable due to the Bank of Japan’s large excess reserves.

The stability of the political environment in Japan was reinforced after the snap election in October 2017 that led to a strong affirmation of the administration of Shinzo Abe, which maintained its majority of two-thirds of the seats. Scope expects continuity of the Abenomics strategy first launched in 2013 aimed at bolstering growth and end deflation through a policy mix of monetary policy easing, flexible fiscal policy and structural reforms. While the exact content is still being worked out, a number of reform initiatives presented on January 22nd, 2018 by Prime Minister Abe are positive and appear well-aimed at addressing major challenges to Japan, especially the need to improve life-long productivity in the face of demographic challenges.

Despite these strengths, the ratings are constrained by Japan’s weak public finances and high debt burden. Headline deficits averaged 6.4% of GDP from 2010 to 2017, adding to gross debt as a percentage of GDP of 240.3% in 2017, the highest of any country rated by Scope. Public debt is projected to gradually decrease to 233.9% in 2022 due to an improving primary balance and a negative interest-growth differential. The primary deficit is projected to decline in 2018 as the impact of the supplementary budgets fades. The government projects its headline deficit to fall from -4.1% of GDP in 2017 to -3.3% in 2018. A VAT tax hike scheduled in October 2019 will move the VAT from 8% to 10% and could have a positive effect on debt dynamics to the extent that increased revenue is earmarked for debt consolidation, improving the primary balance from -2.1% of the baseline scenario to -1.1% in 2022 and reducing gross debt by 3.4% of GDP by 2022. However, it is Scope’s view that the long-term target of a primary surplus by 2020 will be difficult to achieve, even with robust GDP growth.

Under Scope’s debt sustainability analysis, a moderate reduction in Japan’s public debt is possible only if the government can balance its primary balance over an extended period. As a result, debt dynamics are sensitive to shock scenarios and shifts in market sentiment. A modest shock scenario from weak growth, fiscal slippages, or increased financing costs would significantly increase the debt-to-GDP ratio to well over 250% in 2022, further weakening credit fundamentals.

It is Scope’s view that achieving fiscal sustainability requires the implementation of further measures to bolster economic growth. Japan’s weak potential growth, which Scope expects to average less than 1% during the next 10 years, is below the historical trend of greater than 1%. The government’s growth strategy – the third 'arrow' of Abenomics – has so far been unable to counter unfavourable demographics and structural bottlenecks in the labour market, which remain major factors limiting future growth. Between 2015 and 2025, Japan’s overall population will decline by 3.6%, but the nation’s working-age population is expected to decline even more, by 7.2%. This, combined with the anticipated slow pace of domestic investment, constrains the economy’s growth potential significantly.

Sovereign rating scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on relative rankings of key sovereign credit fundamentals, signals an indicative A (a) rating range for Japan. This indicative rating range can be adjusted by up to three notches on the Qualitative Scorecard (QS) depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis. For Japan, the following relative credit strengths have been identified: i) economic policy framework, ii) macroeconomic stability and imbalances, iii) market access and funding sources, iv) current-account vulnerabilities, v) external debt sustainability, vi) recent events and policy decisions, vii) financial-sector oversight and governance, and viii) macro-financial vulnerabilities and fragility. The following relative credit weaknesses have been identified: i) growth potential of the economy, ii) fiscal performance and iii) debt sustainability. The combined relative credit strengths and weaknesses indicate a sovereign rating of A+ for Japan. A rating committee has discussed and confirmed these results.

For further details, please see Appendix 2 of the Rating Report.

Outlook and rating-change drivers

The assignment of a Stable trend reflects Scope’s view that risks to the ratings are now broadly balanced.

The ratings could be downgraded following: i) a sharp deterioration in the economic outlook, ii) a strong deterioration in fiscal results, and/or iii) a reversal of structural reforms. The rating could be upgraded if: i) growth accelerated sharply, ii) debt were to be reduced more than expected, and/or iii) reforms significantly boosted growth potential.

Rating committee

The main points discussed during the rating committee were: i) Japan’s demographic trends impact on economic growth potential, ii) fiscal performance and debt sustainability, iii) external position and the yen reserve currency status, iv) Prime Minister Abe’s structural reforms plan, v) the banking and financial sector performance, vi) recent political and geopolitical developments, vii) natural disaster risks.

Methodology

The methodology applicable for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available at www.scoperatings.com.

Historical default rates from Scope Ratings can be viewed in Scope’s rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA) at http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default and definitions of rating notations can be found in Scope’s public credit rating methodologies at www.scoperatings.com.

The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months. A rating change is not automatically ensured, however.

Regulatory disclosures

This credit rating and/or rating outlook is issued by Scope Ratings AG.

Rating prepared by John F. Opie, Lead Analyst, Associate Director

Person responsible for approval of the rating Dr Giacomo Barisone, Head of Public Finance

The ratings/outlook were first assigned by Scope as a subscription rating in January 2003. The ratings/outlooks were last updated on 29.09.2017.

The senior unsecured debt ratings as well as the short-term issuer ratings were last updated and rated for the first time by Scope on 29.09.2017.

Solicitation, key sources and quality of information
The rating was initiated by Scope and was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party.

The following material sources of information were used to prepare the credit rating: the Ministry of Finance of the State of Japan; Bank of Japan; the Japanese Research Institute; Mizuho Research Institute; Cabinet Office; Financial Services Agency; Ministry of Economy, Trade and Industry; Ministry of Internal Affairs and Communications; National Institute for Defense Studies; Nomura Global Markets Research; IMF; OECD; and Haver Analytics.

Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Conditions of use / exclusion of liability
© 2018 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis, Scope Investor Services GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope cannot, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided “as is” without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or otherwise damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party, as opinions on relative credit risk and not as a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5, D-10785 Berlin.

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