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Japan’s Ratings Outlook Cut on Lack of Hatoyama Plan

Jan. 26 (Bloomberg) -- Japan’s sovereign credit rating outlook was lowered by Standard and
Poor’s on concern Prime Minister Yukio Hatoyama’s administration lacks a plan to rein in the
world’s largest debt load.

“The policies of the new Democratic Party of Japan government point to a slower pace of fiscal
consolidation than we had previously expected,” S&P said in a statement today. Japan’s rating
could be lowered from the current AA, the third highest, if economic data “remain weak” and
measures to buttress growth “are not forthcoming,” the company said.

Today’s move highlights concern that the shrinking Japanese population and contracting gross
domestic product will erode a savings pool that has kept benchmark 10-year note yields
more than 2 percentage points less than U.S. Treasuries. Japan, which has $10 trillion of debt,
is the latest to be served warning on fiscal deficits, following Greece and Spain in recent

“Should the change in outlook spur people to start seriously doubting Japan’s fiscal health,
yields on long-term government bonds will climb,” said Hiroshi Morikawa, a senior strategist
at MU Investments Co., which manages $13 billion in Tokyo. “That will not only limit the
government’s fiscal- stimulus measures but will also boost borrowing costs, deterring
companies from investment.”

Swaps Reaction

The yen pared gains immediately after the release, before resuming a rally against the dollar.
It was up 0.9 percent at 89.52 as of 9:42 a.m. in London. Credit-default swaps showed an
increase in Japanese bond risk. The cost of protecting the debt from default for five years
gained 6 basis points to 90 basis points and traded at 88 basis points as of 4:53 p.m. in
Tokyo, according to BNP Paribas SA prices.

S&P reduced the outlook to “negative” from “stable.” Any cut to the local-currency rating
would be the first for Moody’s Investors Service or Fitch Ratings since 2002, data compiled by
Bloomberg show. Moody’s and Fitch Ratings kept their grades unchanged today.

Finance Minister Naoto Kan told reporters in Tokyo that the government will pursue both fiscal
discipline and economic growth. National Strategy Minister Yoshito Sengoku, who yesterday
said the debt situation is "more than very severe," said today that the S&P step is a warning
from the markets.

Bond yields rose yesterday after the government said the nation’s debt will probably swell to
973 trillion yen ($10.8 trillion) by the end of fiscal 2010, 8 percent more than the estimated
900 trillion yen for the year ending March 31.

Hatoyama Blow
The outlook cut is the latest blow to a prime minister whose ratings have fallen since the
Democratic Party of Japan ousted the Liberal Democratic Party in September. Hatoyama had
to replace his first Finance Minister, Hirohisa Fujii, due to illness, while Ichiro Ozawa, the
No. 2 DPJ official, is being investigated for a land deal by his campaign finance organization
that led to three arrests.

Hatoyama is planning to sell 44.3 trillion yen in bonds to fund his record budget proposal, an
amount that could increase if the nation’s recovery slows or tax receipts slide. He won
elections in August pledging to bolster households’ purchasing power.

S&P said it will monitor the government’s medium-term fiscal plan due to be released in the
first half of 2010. Further steps may also be unveiled after elections in July for the upper
house of Japan’s parliament, the company said. Should the commitments “moderate the
government’s debt trajectory, the ratings could stabilize at the current levels,” it said.

AA Category

Because of Japan’s international assets, including about $1 trillion of foreign-exchange

holdings, the yen’s status as a “reserve currency” and the economy’s “diversification,” S&P
said it expects the rating to remain in the AA category even if the grade is lowered a step.

Greece saw its credit rating lowered to five steps above noninvestment grade by Moody’s last
month and also cut at S&P and Fitch. The nation’s government has since proposed cutting its
budget deficit by almost 10 percent of GDP in three years. Spain’s credit outlook was lowered
by S&P in December.

While the yield premiums on Greek debt over German securities reached the widest since the
2001 debut of the euro after the ratings moves, the impact on Japan may be less immediate.
Investors outside Japan own about 6 percent of the nation’s government bonds, and domestic
buyers have sought the notes as a haven amid the nation’s shrinking economy.

Domestic Investors

“If the U.S. were to have such cut, people will stop buying government bonds,” said Toshio
Sumitani, chief strategist at Tokai Tokyo Securities Co. “But in Japan, 90 percent of bond
holders are Japanese. So there is very little reason for the government to worry about foreign
investors when issuing new debt.”

Moody’s rates Japan’s debt at Aa2, also the third-highest investment grade, with a stable
outlook. Fitch’s outlook is one step lower, at AA-. An S&P cut to AA- would put Japan on par
with Taiwan and Kuwait, Bloomberg data show.

“The public finances remain supported by relatively moderate debt-service burdens,” Andrew
Colquhoun, a member of the sovereign ratings group for Asia and the Pacific at Fitch in Hong
Kong, said today. “If we look at government interest payments as a percentage of tax
revenue, Japan’s burden is below that of Italy and Canada, and not too far off of the U.S.’s.”

Thomas Byrne, senior vice president of Moody’s in Singapore, said that “even though Japan
is issuing a record amount of JGBs, we think the market will finance this without putting big
upward pressure on yields.”

Changing Guard

Byrne earlier this month said that the replacement of Japan’s finance minister four months
into the government’s term increased concern about the commitment to contain the debt.
Japan’s government needs a “well-articulated” target to reduce public borrowing, he said in

In the run-up to the Dec. 25 budget unveiling, Fujii had insisted on keeping new bond sales for
the next fiscal year at the same level as the previous government budgeted for the year
ending in March. Kan, by contrast, has repeatedly signaled his priority is economic growth.

Kan said today that fiscal discipline is important and that markets will be able to absorb new
bond issues. He reiterated his call for the Bank of Japan to end deflation, which has restrained
a recovery from the nation’s worst postwar recession.

The central bank today left its benchmark interest rate at 0.1 percent and Governor
Masaaki Shirakawa pledged to maintain an extremely accommodative policy.

Japan’s GDP shrank to the lowest level since 1991 in the third quarter, unadjusted for price
changes, and it’s poised to lose its title this year as world’s second-largest economy to China.
Its population has been falling since 2006.