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     [ Japanese ]
 

1.

We are aware of the explanations given in your publications and believe your most recent credit research (“Japan: Near-term risks overstated”) merits attention in its relatively realistic analysis. However, your explanations remain mostly qualitative in nature and short of specific, quantitative explanations about default risk and international comparisons. Since sovereign ratings differentiate countries’ default risk by putting them in different rating categories, you should provide objective reasons as to why they differ, rather than merely describing the economic and fiscal conditions and policy direction of each country. Lack of such elaboration would intensify the concern over the reliability of sovereign ratings, combined with their short history and shortage of statistical justification. In your calculation of a sovereign’s default risk, to what extent factors such as “economic fundamentals” are taken into account, in addition to fiscal indicators?

   

2.

You explain that “in the absence of corrective policy action, the government of Japan could be caught in a domestic debt trap from which it can escape only through monetization or default. In such a scenario, there is a possibility that the government of Japan may reschedule its debt with bondholders rather than risk financial collapse and the economic instability that would be associated with outright monetization of a huge stock of domestic debt.” However, what we are looking for is not such an abstract description, but an explanation that specifies the time span and describes concretely the contingency you believe might occur.

How are the following factors considered in your analysis?
 

1)

Currently, 95% of JGBs is funded domestically at low interest rates. In addition, while the deficit of the general government was ¥ 32 trillion, the excess savings of the private sector stood at ¥ 42 trillion in 2001. Moreover, the current account surplus will continue and, as you note, the risk of capital flight is small for some time to come. Thus, there is no constraint on fund flows.
 

2)

Unlike an emerging market economy whose domestic currency bond defaulted recently, Japan has a strong external balance and, under the floating exchange rate system, far more flexibility in its domestic monetary policy. Moreover, the risk of hyperinflation is virtually nil.
 

3)

A forced rescheduling of debt would be tantamount to a virtual tax imposed on the domestic population, given the fact that residents hold 95% of JGBs. In the past, you have noted that Japan has room to improve the fiscal balance, but cast doubt about its implementation. It is unrealistic to contemplate the adoption of a measure that would throw the financial markets into great turmoil, while casting doubt on an ordinary fiscal consolidation program. (Contrary to your perceived assumption of a lack of such program, the program is clearly indicated in the “Reform and Perspectives”)
 

3.

Because government debt is ultimately redeemed with future tax revenues, evaluation of economic fundamentals is extremely important. You explain that “A wide range of factors inform our assessment of sovereign creditworthiness in addition to those you identify”. However, outside fiscal indicators, there is little quantitative comparison and/or explanation. Does this mean that only fiscal indicators are considered in your evaluation of relative judgment of default risk? If you argue that you do take into account economic fundamentals as well, you should explain in more detail how and to what extent each of these factors is taken into account.
 

4.

You mention that “in our view, the Financial Services Agency's current assessment of the health of the financial sector does not fully reflect the true scale of impaired loans”. We understand that the FSA, fully recognizing the magnitude of NPL problems and the importance of bank restructuring, has implemented various measures, including special inspections, and is determined to continue making every effort in a speedy and firm manner in order to better monitor and secure the soundness of the financial sector. I would like you to provide the bases for your judgment, and your underlying assumptions on arriving at your estimate of the “true scale of impaired loans”.