Japan goes to AA

Indeed, Japan seems to be in a very vigorous economic mood at the moment with particularly consumption figures looking healthy in Q1. Perhaps the recent upbeat performance in Q4 2006 and Q1 2007 is in part why Standard Poor chose today to raise the credit rating on Japan (i.e. government debt) from AA- to AA.

Japan's debt ratings were raised one level to AA, the third-highest grade, by Standard & Poor's after the government cut borrowing and nursed a recovery in corporate earnings.

The increase in the long-term foreign and local currency debt ratings from AA- was the first by S&P since it assigned Japan the top AAA grade in 1975. Japan was downgraded three times between February 2001 and April 2002 as economic growth stalled amid deflation and banks struggled to dispose of bad loans.

S&P today said the banking system has been restored to ``good health'' and the world's second-largest economy will grow at about 2 percent, twice the pace of growth during the decade after an asset bubble burst 16 years ago. Prime Minister Shinzo Abe's government could improve the rating further if it finds the political will to raise taxes and cut spending, S&P said.

Clearly, this indicates that Japan is on the right way towards a sustainable recovery does it not? Well, there are two aspects of this of coures. First of all we have the actual credit upgrade by S&P. I have no doubt that the credit agencies' analysis on the Japanese banking sector is true in the sense that substantial reforms have been undertaking in order to bring back the sector to kind of efficiency on the back of the slumber in the 1990s. Yet, I am also a bit surprised on the short termism displayed in the outlook on government debt and public finances. Surely the recent efforts by Abe in terms of trimming the public budget and holding off sales of bonds are important but in the longer run should we not look at a rising old age depencancy ratio in order to gauge Japan's solvency and indeed ability to sustain debt at current levels? Ah well, I won't rain on the parade here and of course credit ratings can go south again soon enough and indeed we are perhaps looking at a short term improvement in the governmental debt position, but of course it is the longer term where I am worried. On another note, Bloomberg's surveyed economists point to a quickening in inflation which might prompt the BOJ to raise rates sooner rather than later in 2007 (if at all). This should clearly be seen in a more short term perspective than the credit rating decision above but still there is a pretty clear link since rising real interest rates also meant that yen denominated debt will be more expensive to service and then we do need to look at a rising old age dependancy ratio especially if your medium to long term macroeconomic outlook on Japan includes a reversion to a balanced growth path and thus also interest rate normalization.

In general, on Japan I also want to point towards some other sources before I leave. First of all we have Takehiro Sato's recent analysis on Japan. It is a very comprehensive account and analysis I have to say so be sure to give it a quick glance. Moreover, I also stumbled upon this article in the FT today about how Japanese asset holders (both retail and institutional) is now beginning to contemplate how to make all those assets earn a reasonable rate of return. Now, the interesting thing is of course to how big an extent this will prompt capital to flow abroad from Japan's borders in the search for yield. Lastly, we have Brad Setser's recent post which takes the pulse on another aspects of capital flows from Japan, namely the carry trade which is to say this is what the discussion converges on in the comments section. In reality, Brad sets off to note the recent reserve accumulation data in different central banks, well worth a look!

Japanclaus vistesen