Hungary and Portugal credit ratings have just been reduced to junk status. And while that should send shivers down the spine of anyone who wonders about Japan’s “investment” in the EFSF bailout fund, the news that S&P is signalling a fresh downgrade of Japan’s debt should make everyone wonder if holding JGBs is really that great of an idea.
Citing uncertainty over the country’s ability to meet ‘austerity’ targets and its rising susceptibility to external shocks – given its heavy reliance on external investors – Moody’s just downgraded Hungary to Junk Ba1 (with a negative outlook).
Moody’s Statement Summary:
The key drivers for the downgrade and negative outlook are as follows:
1.) The rising uncertainty surrounding the country’s ability to meet its medium-term targets for fiscal consolidation and public sector debt reduction, particularly given Hungary’s increasingly constrained medium-term growth prospects.
2.) The increased susceptibility to event risk stemming from the government’s high debt burden, heavy reliance on external investors and large financing needs as the country enters a period of heightened external market volatility.
Moody’s believes that the combined impact of these factors will adversely impact the government’s financial strength and erode its shock-absorption capacity. The rating agency’s decision to maintain a negative outlook on Hungary’s ratings is driven by the uncertainty surrounding the country’s ability to withstand potential event risks emanating from the European sovereign debt crisis.
Moody’s has also downgraded by one notch to Ba1 from Baa3 the foreign-currency debt rating of the National Bank of Hungary (NBH) given that the Republic of Hungary is legally responsible for the payments on NBH’s bonds.
With its 10Y yield currently at 9%, only 190bps wider than Italy, we thought it somewhat ironic that Hungary’s average 10Y yield from SEP09 to SEP11 was 7.2% – almost exactly where Italy finds itself trading currently.
Fitch Ratings has dropped Portugal’s credit rating to junk status based on the growing debt and weaker outlook for the economy. The long-term rating was lowered one level to BB+ from BBB- with a negative outlook, Fitch said today in an e-mailed statement. Portuguese 10-year bonds fell after the announcement, with the yield at 12.14 percent at 1:09 p.m. in Lisbon.
“The country’s large fiscal imbalances, high indebtedness across all sectors, and adverse macroeconomic outlook mean the sovereign’s credit profile is no longer consistent with an investment-grade rating,” Fitch said. The ratings of utility EDP-Energias de Portugal SA (EDP) and telecommunications company Portugal Telecom SGPS SA (PTC) are unaffected, Fitch said.
Standard & Poor’s said Japanese Prime Minister Yoshihiko Noda’s administration hasn’t made progress in tackling the public debt burden, an indication it may be preparing to lower the nation’s sovereign grade.
In fact, Noda has been doing everything but cutting spending; bailouts for corporations whining about the strong yen even as Japan refuses to call out the Us for its weak dollar policy, foreign aid to countries all around the globe, bailouts for Europe (which will likely be worthless once the whole EU thing plays out), and all sorts of planned subsidies to accommodate the US-dominated TPP free trade agreement.
“Japan’s finances are getting worse and worse every day, every second,” Takahira Ogawa, director of sovereign ratings at S&P in Singapore, said in an interview. Asked if that means he’s closer to cutting Japan, he said it “may be right in saying that we’re closer to a downgrade. But the deterioration has been gradual so far, and it’s not like we’re going to move today.”
A reduction in S&P’s AA- rating would be a setback for Noda, who took office in September and has pledged to both steady Japan’s finances and implement reconstruction from the nation’s record earthquake in March. It’s unrealistic for Japan to think it can escape the debt woes that have engulfed nations overseas unless it can control its finances, according to Ogawa.
And then there’s the latest from the IMF which has cautioned that a sudden spike in Japanese debt yields would put Japan in the category of Greece and Italy…if not worse.
The IMF has issued a warning to Japan over its increase in public spending following the March earthquake.
If Japan is to continue being a “positive force in the region”, it must consolidate its fiscal position by cutting back on the additional spending which has pushed its public debt to new levels.
Japan’s rate of public debt is currently 220 per cent of its GDP – the highest level among advanced economies.
The IMF report predicts “GDP growth is likely to slow to -0.7 per cent this year before rising to 2.9 per cent in 2012.”
“Fiscal consolidation would also benefit Japan’s partners by releasing a pool of savings for other countries to borrow and reducing risks from a disruption in the Japanese government bond market,” says the report.
Given Japan has one of the lowest tax revenues in the world, the IMF recommends reconstruction spending be financed by an a 2-3 per cent increase in the consumption tax, to 8 per cent. This should then be increased further to 15 per cent.
Under existing government proposals, the sales tax will be doubled to 10 per cent by the mid-2010s.
Unfortunately, while Noda has broached the subject of raising taxes, nothing has been done about cutting spending. While taxes are politically unpopular, they will be pushed through. Spending cuts are another matter as the government has succeeded in making the majority of Japan dependent on government funds, including many very powerful industries and bureaucratic ministries which have much more influence in what politicians do than the lowly taxpayers.
Of course, real market forces – unlike the artificial machinations of the BOJ and the Finance Ministry – will ultimately decide Japan’s fate. For individual investors, particularly savers who are helping to keep Japan’s yield at unsustainably low levels, it may be time to start making moves to protect your wealth.