Bank of Japan’s new moves spark concerns

S&P Global currently rates Japan’s government bonds A+, with its last downgrade dating back to 2014 when rating agencies Moody’s and Fitch Ratings lowered its ratings following the implementation of a consumption tax increase.

Analysts now fear that this may change as Japan’s apex bank, the Bank Japan has begun unwinding its ultra-easing program which has been on for a decade. This move, which would involve doing away with its yield curve control, would expose Japanese Government Bonds (JGB) to a potentially phased downgrade; since it is likely to cause a rise in interest rates.

The long-term effect therefore would be increased skepticism concerning the Japan’s public finance, which may impede its access to foreign currency as well as the ability of Japan-headquartered firms to expand into international economies.

This recent developments has caused some industry experts and observers to draw a comparison between Japan and the UK with one bank executive quoted as saying: “BOJ officials always talked about not wanting to end up like the U.K. and the Truss shock,” referencing the reactions of markets when the former UK Prime Minister’s policy decisions led to a jump in interest rates. Some market observers have drawn a parallel between the said policy decisions and a marked dump of the British pound and bonds.

The current steady ratings of the country’s bonds has not a proper reflection of Japan’s deteriorating fiscal health. Over the eight-year period, national debt rose from from 774 trillion yen to 1.026 quadrillion yen (about $7.7 trillion).

Japan has not recorded a downgrade because it has kept interest rates close to zero. The apex bank’s purchase of the bonds has contributed significantly to the maintained rating. Since it is now necessary to dial back the easing programs, the challenge the Bank of Japan faces is finding a way to exit it without triggering a spike in interest rates.

It is customary for ratings agencies to call for a review of bonds rating when interests rates rise while prices remain stagnant. This is primarily because this situation sets off a chain of events that lead to debt deterioration.

From 2010, Japanese lenders have raised sizeable cross-currency repos, meaning they accessed foreign currency using JGBs as collaterals. A rating drop could hinder their ability to continue doing so. For example, analysts predict a rating drop to triple B could means JGBs become unacceptable as collateral. Banks will also suffer a commensurate downgrade, stopping them from accessing foreign currency.

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