Japan's risks rise along with its debt levels

Fitch Ratings will not change its sovereign rating on Japan based on promises made by the ruling Liberal Democratic Party ahead of its election victory last month, a Fitch official said on Tuesday.

Andrew Colquhoun, head of Asia-Pacific sovereign rating at Fitch, told reporters on a conference call that the ratings agency would evaluate the actions the new government takes from now.

"We will be looking at Japan's economic and fiscal strategy as a whole, including any potential revisions to the Bank of Japan's mandate," he said.

Prime Minister Shinzo Abe has made reviving the economy his government's top priority, but his spending promises have raised concerns that Japan's public debt burden, already the worst among major economies, could deteriorate further.

Colquhoun said that if the new government's policies were able to foster growth domestic product growth, that could be favourable for Japan's rating.

Abe has called on the BOJ to take bolder monetary easing measures to beat deflation, and achieve a 2 percent inflation target.

A rise in inflation expectations prompting a sharp rise in yields of Japanese government bonds is a potential risk that Japanese authorities are likely "well apprised of," Colquhoun said.

"My own feeling, and this is really just speculation, is that I don't think that's a risk they would be willing to incur, so I don't expect that to be a source of a shock for JGB yields," he said.

He noted that JGB yields have risen since mid-November, as the likelihood grew that the LDP would return to power.

"There

has been some market reaction, but not a very severe one," he said.

The 10-year JGB yield stood at 0.825 percent on Tuesday. Benchmark yields dropped as low as 0.685 percent as recently as Dec. 6, their lowest since June 2003.

Further quantitative easing from the BOJ might also act to constrain any rise in marketable debt yields, as similar central bank action has done in other advanced economies, he said.

But Colquhoun emphasized that Japan's situation is not 'entirely rosy.'

Japan's public debt burden, more than twice the size of its $5 trillion economy, piled up during the LDP's more than half a century of almost unbroken rule in Japan.

In May last year Fitch cut Japan's rating by one notch to A plus due to political bickering over a plan to raise the country's sales tax and warned that further downgrades are possible.

"The main thing behind that negative outlook is that as public debt ratios rise, in our view, despite the ongoing strength of sovereign funding conditions, the risk of some kind of accident which upsets sovereign funding conditions continues to rise with the debt levels," he said.

"It would be impossible to predict exactly how and when that might occur, but the increasing risk of such a negative outcome is behind the migration downward of Japan's ratings in recent years," Colquhoun said.

Fitch's rating on Japan is one notch below its rival ratings agencies. Moody's Investors Service rates the country Aa3 with a stable outlook.

Standard & Poor's rates Japan at AA minus with a negative outlook.

All the ratings are broadly in the middle of the investment grade range of ratings.