Moody’s Slashes Japan’s Credit Rating Citing Debt and Politics

Moody’s Investors Service (NYSE:MCO) has downgraded its rating on Japan’s (NYSE:EWJ) government debt by one notch to Aa3. Making the announcement Wednesday, Moody’s cited the nation’s massive debt, which has climbed to 234% of Japan’s gross domestic product since the 2009 global recession. The nation’s government leadership was also a factor in Moody’s decision as Japan prepares to elect its sixth leader in just five years, replacing Prime Minister Naoto Kan, whose response to the March tsunami and subsequent radiation crisis at the Fukushima power plant has been criticized as insufficient.

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With the downgrade, Japan (NYSE:EWJ) is now three notches below Moody’s top AAA rating, which the country lost in 1998. Japan is now at the same level as neighboring China, which just surpassed it last year to become the world’s second-largest economy. Moody’s warned in May that the government might lose its Aa2 rating because of insufficient policy response to rein in the growing public debt and stimulate economic growth. Standard & Poor’s downgraded Japan to AA minus, its fourth-highest rating, back in January.

In terms of its debt-to-GDP ratio, Japan (NYSE:EWJ) is by far the most indebted nation in the world, followed in a distant second by Greece with a comparably low national debt that’s around 139% of GDP. For that reason, the downgrade hardly came as a surprise, and the response from financial markets has been relatively muted.

The nation’s next leader will face many challenges, and must quickly respond with solutions and new policies if he is to keep his job long enough to have any impact. The prime minister will have to tackle the soaring yen, create a post-nuclear crisis energy policy, and rein in the public debt while paying for reconstruction following the March 11 earthquake, which knocked the economy back into recession.

Recent gains in the yen have threatened Japan’s (NYSE:EWJ) export competitiveness as it weakens foreign buying power. Just today, the Japanese government announced a new $100 billion emergency credit facility to help companies combat the strength of the yen and expand their overseas operations by buying foreign firms, taking a large step toward solving one of the nation’s largest problems. The government will also ask major financial firms to report on dealers’ currency positions for the current quarter in an attempt to curb speculation.

Many of the Democratic Party candidates for the premiership agree that the country must eventually raise its 5% sales tax to help fund the social welfare costs of its aging society. However, Moody’s (NYSE:MCO) said that even doubling the sales tax to 10% wouldn’t be enough to upgrade the nation’s credit rating; Moody’s is looking for Japan’s GDP to grow by 3%.