Japan faces downgrade and a slow recovery

The difficult short- and long-term challenges facing the Japanese economy have been underlined by the Moody's ratings agency, which says it may slash the nation's sovereign debt ratings. It has placed Japan's Aa2 foreign and local currency bond ratings on review for a possible downgrade.

Moody's is only the latest to issue such a negative statement – a few days ago Fitch revised its Japan sovereign rating outlook to "negative" from "stable".

Short-term concerns focus on Japan's ability to recover from the recent natural and nuclear disasters. Industrial growth bounced back by 1 per cent during April, it was also disclosed yesterday, but that was below consensus expectations and disappointed the markets. Unemployment also edged higher, to 4.7 per cent from 4.6 per cent in March. Meanwhile, the Japan Automobile Manufacturers Association reported that production in April totalled 292,001 vehicles, a dramatic drop from 731,829 a year earlier and the seventh such decline.

But the longer-term outlook for Japan's public finances is also worrying the analysts. With national debt at about 200 per cent of GDP, Japan has long defied the normal rules, because her large workforce of hard savers has funded her deficits, channelled through conservative institutions such as the post office into government bonds, despite their ultra-low yields.

However, the political stasis in Tokyo is adding to concerns. Moody's stated: "Without an effective strategy, government debt will rise inexorably from a level which already is well above that of other advanced economies." The announcement, not unexpected, prompted a modest sell-off of Japanese bonds.

The world's third largest economy slipped back into recession in the first quarter following the March earthquake, tsunami and nuclear accident. Moody's added that the cost of repairing infrastructure could further jeopardise Japan's financial position.

Opposition parties are to table a no-confidence motion in the Kan government this week.