Credible Debt Stabilisation Strategy Still Key for Japan

Shinzo Abe’s new Liberal Democratic Party (LDP) government appears to be committed to reflating the economy via fiscal, monetary and investment-promotion policies (the "three arrows"). The government has taken its first step in implementing these policies with a JPY10trn (USD112bn, 2.2% of 2013 GDP) stimulus package, announced Friday and approved by the cabinet this week.

Our downgrade of Japan to ’A+’ in May 2012, and the Negative Outlook on the rating, already reflect the risk posed by high and rising general government debt ratios. The size of the fiscal stimulus package is not large enough to alter the rating; but as we said at the time of the downgrade, a lack of new fiscal policy measures aimed at stabilising public finances amid further rises in General Government Debt ratios could lead to a downgrade.

The stimulus package will entail around JPY5.2trn of construction bond issuance, breaching the limit on annual net JGB issuance of JPY44trn set out under the Fiscal Management Strategy. Thus it appears to abandon an integral part of the previous administration’s fiscal framework. Mr. Abe has indicated that he will outline his own government’s medium-term fiscal policy in June. We will assess this in due course as part of our reviewing the new government’s fiscal and economic strategy as a whole.

A staggered 5pp rise in the consumption tax to 10% in 2014-15 was the centrepiece of the previous government’s fiscal consolidation plan, expected to yield about 2.5% of GDP in additional revenue. Mr Abe has said he will review the desirability of the hike in light of economic data in 2013. By itself, postponement of the increase would be negative for the fiscal outlook. But as the hike was only scheduled to happen in 2014-15, there should be sufficient time for Fitch to take stock of any new fiscal strategy before resolving the Negative Outlook.

Mr Abe has also reiterated his call for the Bank of Japan to adopt an inflation target of 2%, via additional monetary easing if necessary. The fall in the currency since the election indicates the credibility that currency markets ascribe to Mr Abe’s stated desire to loosen the monetary policy framework. Japan’s export-driven economy means sustained yen depreciation may be the easiest single way to boost growth (although the impact would be likely to vary across sectors).