In a generally strong global economic recovery, Japan has been one of the weakest links, struggling to gain any sort of traction while battling deflation and ineffective policies from a government elected with hope for great changes. An already tough road back to sustainable economic growth got even tougher on Tuesday when Standard & Poor’s Ratings Services threatened to cut Japan’s government debt rating as the world’s second largest economy struggles to address deteriorating public finances.
Although S&P retained its long-term AA credit rating, the agency lowered its outlook on that rating from “stable” to “negative,” indicating that an actual downgrade could occur “unless measures can be taken to stem fiscal and deflationary pressures.” The statement went on to note that “the ratings on Japan could fall by one notch if economic data remain weak and measures to boost medium-term growth are not forthcoming, given the country’s high government-debt burden and its weak demographic profile.”
Japan’s tax revenues are expected to total about half of the government’s expenditures in the coming year, forcing a new round of debt issuance totaling nearly $500 billion. That would bring Japan’s public debt to about $9.4 trillion, or 180% of gross domestic product, by March 2011. While debt at such levels would be by far the highest in the industrialized world, some analysts point out that unlike the U.S., which owes much of its sovereign debt to China, Japan’s debt is owned mostly by domestic investors.
Other countries maintaining a AA rating with a negative outlook from S&P include Ireland and Bermuda. Chile and Slovenia are among those with a AA rating and stable outlook.
Ratings agencies, including S&P, Moody’s, and Fitch, have seen their credibility called into question in recent years following the collapse of many securities that had maintained quality ratings. Still, a downgrade from one of the big three can have a major impact on equity markets, as proven over the last month as each warned over a deteriorating fiscal situation in Greece.
Concerns that Greece may default on government debt have weighed on the broader euro zone economy in 2010, as investors worried that a potential fiscal crisis could spread throughout the region. A successful bond issue earlier this week eased some fears, but the cost to insure against a default, as well as credit spreads to higher quality sovereign debt, remain high.
Japan ETFs In Focus
The prospect of a ratings downgrade sent Japanese markets lower, the latest blow to a stock market that has remained flat as emerging and developed economies around the world have raced to reclaim ground lost during the recent downturn. In addition to Japanese equity ETFs (a complete list can be found here), several other funds could be on the move as investors evaluate the impact of S&P’s revised outlook. For regular updates and actionable investment ideas, sign up for our free ETF newsletter.
- SPDR Barclays Capital International Treasury Bond ETF (BWX): This ETF includes government bonds issued by investment-grade countries outside the United States, in local currencies, that have a remaining maturity of one year or more and are rated investment grade or higher. Less than 15% of the fund maintains a rating below AA, but BWX has a weighting of about 24% to Japan. Among the nearly 20 other countries are Italy, Germany, Canada, and Greece.
- SPDR Barclays Capital Short Term International Treasury Bond ETF (BWZ): This ETF is similar in many respects to BWX, but invests exclusively in debt with a remaining maturity of one to three years. BWZ also allocates about 24% of its holdings to Japanese debt, meaning that this ETF could be very sensitive to changes in Japan’s outlook.
- WisdomTree Dreyfus Japanese Yen Fund (JYF): A strong yen has taken a significant amount of blame for Janap’s prolonged economic slump, as a relatively expensive currency has created strong headwinds for the country’s export industry. This ETF is designed to deliver returns reflective of both money market rates in Japan-which are currently near zero-as well as changes in the value of the yen relative to the greenback.
Disclosure: No positions at time of writing.