Japan


	May 9, 2002	atimes.com

Japan

Japan's rating wars: Whose default is it?
By Richard Hanson

TOKYO - It's time to give Japan a break on falling sovereign ratings - like maybe another decade, to be fair - and give the lousy economy opportunity to right itself. And to really square things, just roll the ratings back up to AAA, where the world's second largest (and least likely to default) economy belongs; not surfing rat-bottom in the pile of Group of Seven industrial countries.

That is just about the gist of the message the Japanese government sent in what appear to be unprecedented letters to the top three international rating agencies - Standard & Poor's, Moody's Investors Service and Fitch Ratings - just before Japan's Golden Week holidays began in late April.

While not exactly a declaration of hostilities, the blunt-speaking Haruhiko Kuroda, Ministry of Finance (MOF) Vice Minister for International Affairs, was bluntly public about his feelings regardingrecent bad news from the rating agencies. The MOF believes that they have erred. "Considering the strong fundamentals of the Japanese economy, the current ratings of Japanese Government Bonds [JGB] are already too low and any further downgrading is unwarranted," Kuroda wrote on April 26. "Your explanations regarding rating decisions are mostly qualitative in nature and lack objective criteria, which invite questions about the larger issue of the reliability of ratings itself."

That is tough talk. And the stakes in this confrontation between Japan and the rating world are high. For one, starting in 2006, generally accepted rating standards on sovereign debt will play a far greater role in measuring the financial health, or capital adequacy, of Japan's already bad-loan burdened banks.

New rules agreed to under the aegis of the Bank for International Settlements (BIS), the Basel-based central bankers' bank, could force banks to raise more capital. A bank holding Single-A rated governmentbonds will set aside capital amounting to 20 percent of their value to cover the risk weighting. (Banks can use their own internal models for rating debt risk, or accept the ratings of an outside rating agency.)Single A is the next notch down for Japan Government Bonds (JGB). Hence the worried letters.

In mid-April, S&P cut its rating a notch to AA- (Double A Minus) from AA, with a negative outlook for Japan's yen-denominated sovereign long-term debt. S&P were dismayed by the lack of progress (on thepolitical front) in pushing badly needed reform and stiff economic measures. For Japan, this was a embarrassingly short interim after last November's cut. This gave the impression that Japan's problems were getting worse quickly. (S&P was actually the last of the three to abandon its AAA for Japan, in February 2001.)

Meanwhile, this week Moody's keeps hinting blithely that it, too, will soon chop again from its Aa3 rating - maybe next week by one of two notches. Moody's started the deluge from Japan's AAA citadel way back in November 1998 when Japan was moved to Aa1 from the company's coveted Aaa ranking. Fitch Ratings was the second rater to lower Japan's sovereign rating, in June 2000, to AA+ from AAA, but has been comparatively less eager to cut further from its current AA rating. A senior official confided that Fitch received a somewhat nicer letter from Kuroda as a result of such restraint.

More alarming than the problems facing the banks as a result of lower JGB ratings is the trickle-down effect of higher borrowing costs for the entire economy. There is already abundant worry over the drag thatultra-low growth or shrinkage in Japan's economy has on the world economy. Japan's economy is expected to shrink this year.

Even a calm view of this prospect is alarming. A sanguine look at the rating cuts points out that Japan's enormous reserves in personal financial assets provide a cushion for the economy. The vast majority of this money will stay at home, reasons Yasuhiko Shibata, a senior fellow at the Yomiuri Research Institute. Since about 95 percent of all JGBs are bought by Japanese investors (with few other domestic options) the impact of a lower rating on investor behavior is negligible. Banks already offer near zero deposit rates. If the government maintains a reasonable coupon on JGB the people will buy.

So are ratings just a matter of a damaged national reputation (read ego)? No. Shibata lists three economic minefields that warn against "pussyfooting" around with any backlash from lower ratings and more focus of reforms and getting the economy going.

Government bonds define the upper limit on the ratings for private business bond issuers. A drop in sovereign ratings means lower ratings for big business, such as Sony and Toyota. That raises the cost of issuing bonds and thus doing business.

Trading houses and banks are already at or near the bottom of the rating pit. They could be in danger of not being able to raise capital in international markets.

A depressed international view of the Japanese economy could prompt a selling spree of the yen against the US dollar. That raises the likelihood of higher import costs (a cheaper yen make imports paid for in dollars more expensive). That means inflation in a deflating economy. The fear is stagnant growth and inflation, a nasty combination dubbed stagflation during oil crisis-plagued 1970s.

These are some of the reasons to take the rating agency judgements seriously. But it calls for more serious efforts to tackle fundamental economic reforms. There shouldn't be any "pussyfooting" over theimpact of lower ratings.

But the Ministry of Finance is determined to seek a resolution to the problems that it sees in the way the rating agencies have judged Japan - the decisions that are made on "qualitative" grounds or those that lack "objective criteria". On the top of the priority list is to ask the rating agencies to clarify the rating standards used for Japanese government bonds and "increase the objectivity and transparency of sovereign bond ratings". In short, the MOF wants a closer look at what the rating industry calls the "black box" from where the ratings emanate.

The government says that it will put top priority on implementing the reforms that are still lacking, and which worry the rating agencies. The bee in the MOF's bonnet is that Japan is singled out among itspeers in the advanced industrial world for scrutiny over the basic rating question of whether there is any threat off default. Will Japan fail to pay its debts? Defaulting on debt is "unimaginable", says the MOF. Modern history seems to support that assertion. The list presented as proof is concise. Japan has the largest savings surplus in the world. This makes it possible to finance most debt at home stably and cheaply at very low interest rates. To boot, Japan is also the largest creditor county in the world, and it has the largest foreign exchange reserves on earth.

Now the reader may wonder what on earth would Japan really want to gain from browbeating the rating agencies over its loss of the AAA. This is an emotional problem. Japan believes it is not being treated equally. That is why Japan's Finance Ministry takes it a bit personally. The MOF has suffered its own sharp downgrading of its rating within the pecking order of the government since the scandal-ridden 1990s led to the breakup of its once extensive powers. The MOF, which created the rating standards for Japan in the 1980s, doesn't even have a direct regulatory role in overseeing them. This task belongs to the Financial Services Agency (FSA), created two years ago. The MOF chafes at the fact that Japan is being treated differently in its decade of economic peril than the United Kingdom and the US and other countries were treated in their eras of economic trouble. The UK never lost its AAA, even when forced to borrow from the International Monetary Fund during the sterling crisis in 1976. US Treasury Bonds maintained an AAA even as the country suffered the twin deficits of fiscal and trade problems in the 1980s.

"Should JGBs be downgraded to single-A, this would assign Japan to the same rating as emerging markets with wide gaps in economic fundamentals," Vice Minister Kuroda argues. Japan wants to fix itself. As with the UK and the US in a different era, Japan has woken from a decade (the 1990s) with no reason to believe that it can prosper without going through a lot of pain. This is why Japan may just need another decade of grace to get its economic house in order. This would be good for the world. And this is why the badge of an AAA is worth fighting for.

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