TOKYO Standard & Poor's warned on Monday it could lower Japan's sovereign rating if the economy expands less than expected or if public debt continues to grow, as the country's unpopular government struggles to win support for higher taxes.
The ratings agency affirmed its AA- rating on Japan with a negative outlook, but also warned that higher taxes wouldn't solve the structural problems that push up Japan's welfare spending and increasingly pressure state coffers.
Japan's debt burden is the heaviest among industrialised economies, and it may not be able to postpone drastic spending cuts and aggressive tax hikes much longer as Europe's debt crisis threatens the global economy.
One problem is that Japan's ruling Democratic Party lacks the majority needed to override opposition in parliament, so policy making often moves at a slow pace.
"In this environment, it's difficult to get opposition parties to agree to policies that will increase the burden on the public," Takahira Ogawa, director of sovereign ratings at Standard & Poor's in Singapore, said on a conference call.
"This difficulty in pushing through policies is a negative for Japan's sovereign rating."
S&P and Fitch both rate Japan AA- with a negative outlook. Moody's Investors Service ranks Japan at the same level, at Aa3, but has a stable outlook.
All three agencies rate Japan three notches below the top AAA rating.
Japan's rating could fall if real gross domestic product growth per capita drops below S&P's forecast of 1.2 percent, according to a statement released earlier.
S&P also expressed concern that the government isn't doing enough to bring down its debt quickly enough.
"We would also consider lowering the long- and short-term ratings if the government's debt trajectory remains on its current course or begins to erode the nation's external position," S&P said in the statement.
"On the other hand, we may revise the outlook to stable if the government were to implement robust and sustainable fiscal consolidation."
Late last year, the ruling Democratic Party agreed on a timetable on increases in the sales tax to pay for welfare spending. It said it would increase the 5 percent sales tax to 8 percent in April 2014 and then to 10 percent in October 2015.
Prime Minister Yoshihiko Noda needs opposition votes to pass the tax hike in a divided parliament, but his public approval ratings are sinking and the opposition is refusing to cooperate as it looks to force an election.
Higher taxes could help reduce revenue shortfalls, but that wouldn't change Japan's ageing population, which continuously pushes up welfare costs, S&P said.
Japan's sovereign ratings are also constrained by the government's weak policy foundations, the ratings agency said.
Even if the sales tax rises to 10 percent, that would not be enough to lower the ratio of public debt to gross domestic product, which is the highest among industrialised nations and almost twice the size of Japan's $5 trillion economy, government estimates show.
"Without broad-based welfare reform and higher economic growth, tax hikes alone won't lead to lasting progress in improving Japan's public finances," Ogawa said.
Japan's rating does draw support from its ample holdings of external assets in its foreign exchange reserves and its current account surplus, S&P added.
(Additional reporting by Mayumi Negishi; Editing by Joseph Radford and Richard Borsuk)