Fitch Downgrades Japan to A From A+

Fitch researchers wrote:

– Fitch’s downgrade reflects the fact that the Japanese government did not include sufficient structural fiscal measures in its budget for the fiscal year April 2015-March 2016 (FY15) to replace a deferred consumption tax increase. The agency had placed Japan’s IDRs on Rating Watch Negative on 9 December 2014 following the government’s decision to delay the scheduled consumption tax increase that was the centrepiece of its medium-term fiscal consolidation effort. At that time, Fitch said the ratings would be downgraded in the absence of broadly equivalent fiscal measures to replace the deferred consumption tax increase in the FY15 budget.

– The FY15 budget cut corporate tax rates, although the base was broadened, making the measure’s impact broadly neutral overall. However, the government has said it wants to cut corporate tax rates again in FY16. The government also introduced a supplementary budget for FY14 in January 2015 that essentially spent an unexpected increase in revenue. These developments increase Fitch’s uncertainty over the degree of political commitment to fiscal consolidation. The government is set to unveil a new fiscal strategy in the summer of 2015. The details of the strategy will be important, but the strength of the government’s commitment to implement it will be even more important and will only become clearer over time.

– The government may still achieve its interim fiscal target of a 3.3% of GDP primary budget deficit (excluding earthquake reconstruction spending) in FY15. Corporate tax receipts are rising strongly, despite the rate cut, driven by buoyant corporate profits. High dividend payments are also boosting personal income tax receipts. The government expects these items, together with the lagged effect of the 2014 consumption tax hike, to generate about 0.6% of GDP in additional revenue in FY15. However, corporate profits are being boosted partly by the 8% trade-weighted depreciation of the Japanese yen in the twelve months to end-March 2015. This is unlikely to be sustainable. Pressure on the budget could rise in FY16 if corporate profits fell back.

In short, currency impacts for companies will disappear at some point, and a fumbling government, if it stays in place, will continue ineffective policies.

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