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| 1. | 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?
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| 2. | You explain as default risk that “a future government might institute a tax on interest or a capital levy aimed at JGBs, or might possibly reschedule its debt”. However, this kind of contemplation is unrealistic in light of such factors as the macro-economic balance and the composition of JGB holdings, and requires more elaboration specifying the time span and describing 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 for some time to come, and the risk of capital flight is small. 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) | The kind of burden forced upon bondholders that you suggest would be tantamount to a virtual tax imposed on the domestic population, given the fact that residents hold 95% of JGBs. 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. | |
| 3. | Because government debt is ultimately redeemed with future tax revenues, evaluation of economic fundamentals is extremely important. Your explanation remains inadequate as to how economic fundamentals are considered in your relative comparison of each sovereign’s default risk. | |
| 1) | Your “quantitative comparison” shows mostly those factors related to the fiscal deficit. While you say that such factors as the macro-balance and the strong external position are included in your consideration, it remains unclear how and to what extent each of these factors is taken into account. | |
| 2) | Neither is it clear how you compare the sustainability of public finance in relation to the macro-balance. For example, you say that “the large pool of domestic savings is taken into account indirectly through the real interest rate”. This should mean that the ample private savings more than offsets the fiscal deficit in Japan, resulting in the relatively low real interest rate. In other words, even from your viewpoint, Japan’s fiscal deficit is manageable. | |
| 3) | You say that “the bigger the public sector, the easier to carry a larger debt”. However, the sustainability of public finance requires a dynamic analysis, taking into account the potential of the economy and future revenue generation capacity. Your view is unrealistic in its neglect of the linkage between public finance and the real economy, where a large public sector often becomes an obstacle for private sector development. | |
| 4) | You say that “the external sector is more relevant to the government’s foreign currency rating”. Then, since Japan’s current account surplus, net foreign assets, and foreign exchange reserves are the largest in the world, Japan’s foreign currency rating must be AAA. Moreover, since the ultimate issue is the government’s solvency, the strong external position should be reflected in the domestic currency rating as one of the important economic fundamentals. | |
| 5) | Your explanation about consistency with other countries is not persuasive either, because you have attempted to justify all the cases we questioned on the basis of the relative sizes of the fiscal deficits alone. For example, how did you take into account the external imbalances, respectively, of the U.K. in the aftermath of the sterling crisis, or of the U.S. suffering from the “twin deficits” in the ‘80s? Moreover, while you often mention the necessity of reform in Japan, how did you evaluate that of the U.K. in the ‘70s? In this connection, you may be reminded that the U.K. was still mired in a nearly 30-year economic slump in 1978 when you rated the U.K. foreign currency bond AAA; on the other hand, Mrs. Thatcher did not become Prime Minister until 1979, and her reforms got off the ground only well into the ‘80s. It seems that your rating standard has not been consistent throughout this past period. | |