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Summary of response to S&P

    [ Japanese ]
 

1.

We are aware of the explanations of rating classifications given in your website materials, etc. However, what we are looking for is not such an abstract description, but an explanation that describes concretely and quantitatively why you believe Japan’s default risk to be higher than some other countries. While your explanations describe your assessment of the economic and fiscal conditions and policy direction in Japan, since sovereign ratings differentiate countries’ default risk by putting them in different rating categories, you should provide objective reasons as to why they differ. 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 define as default a failure to meet a financial obligation on the due date and situations where debt is exchanged on terms less favourable than contained in the original issue, and in you latest report say “there is the risk that, even if reform is pushed through and sustainable growth is restored, it could be too late to avoid default”. 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.

You agree that sovereign ratings should not be based solely on fiscal indicators and say that such factors as economic structure are included in your consideration. However, it remains unclear as to how each of the factors you mention (outside fiscal indicators) are considered in your calculation of default risk.
 

1)

You say that you examined how Japan's key economic and financial indicators compare with those of other countries in your recent report. However, the indicators elaborated in relation to ratings are only fiscal, and there is no logical explanation as to how other factors are taken into account. In addition, while you say that you view Japan’s economic fundamentals as strong as those of other similarly rated sovereigns, your comparisons reveal that they are in fact stronger than most AAA rated sovereigns, and this fact is not reflected in your ratings of JGBs.
 

2)

In relation to the macro-balance, you say that “in our view, reducing the fiscal deficit will be challenging when interest rates begin to rise, as new bank lending resumes and the economy recovers from recession.” However, this kind of situation should raise both nominal and real growth rates and increase tax revenues as well as accelerate the disposal of NPLs, which is most welcome from the viewpoint of fiscal consolidation. It is not appropriate to emphasize only the concerns about higher interest rates while neglecting the far larger positive effects of a recovery.
 

3)

You say that little weight is given to their countries’ individual current account positions for governments that have adopted the euro. However, even in these countries, the sustainability of investment well in excess of domestic savings should be an important question. Moreover, the fact that some countries outside the euro also enjoy high ratings despite large differences in economic levels and external strengths with Japan seems to suggest that only fiscal indicators are taken into account.
 

4)

Your explanation about comparisons with the U.K. in the ‘70s and the U.S. in the ‘80s is not persuasive either, because you have attempted to justify the case on the basis of the relative sizes of the fiscal deficits alone. In particular, you state that “the role of the IMF was very different in the days before the Latin American debt crisis, and Standard & Poor’s did not then view recourse to IMF facilities by a major IMF shareholder (the U.K.) as evidence of an impairment of credit standing.” However, one cannot deny the fact that the loss of confidence in the sterling was serious enough for the U.K. to request IMF financing for BOP support. Moreover, the high inflation and interest rates behind this show clear contrasts against the current Japanese situation where these problems do not exist. If you focus on the size of the fiscal deficit alone, you will miss the broader perspective of the economy. Finally, while you seem to predicate progress of reform in the U.K. in the ‘70s (cf. website), 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, that Mrs. Thatcher did not become Prime Minister until 1979, and that her reforms got off the ground only well into the ‘80s. Your clarification about this would be appreciated.
 

4.

You mention that “the government is likely to have to bear a substantial portion of the cost of recapitalizing the banking system”. We understand that the FSA fully recognizes the magnitude of NPL problems and has implemented various measures in order to better monitor and secure the soundness of the financial sector, and that Japanese banks currently satisfy criteria for soundness so that there is no need for the injection of public capital. Finally, you mention that the special inspections were limited both in scope and in remedies. However, as the FSA has already explained, the special inspections were conducted to cover all large debtors whose market evaluations had significantly changed, as an additional measure to strengthened regular inspections.
 

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