Announcement: Moody's: Japan's credit strengths remain robust; foremost credit challenge is maintaining debt sustainability

Moody's Investors Service says that Japan's (A1 stable) credit strengths include a broad and deep domestic market for government debt, the country's large, diverse and high-income economy, and a very strong external payments position.

In particular , the sovereign's exceptionally low funding costs reflect high and persistent net private domestic saving rates channeled to fund government debt, given domestic investors' unwavering home bias.

In recent years, unprecedented monetary expansion undertaken by the central bank has contributed to these very low funding costs.

Moody's conclusions are contained in its just-released Annual Credit Analysis, "Government of Japan -- A1 stable". It elaborates on Japan's credit profile in terms of economic strength, High (+); institutional strength, Very High; fiscal strength, High (-); and susceptibility to event risk, Low (-). These are the four main analytic factors in Moody's Sovereign Bond Ratings Methodology. The report is an update to the markets and does not constitute a rating action.

Moody's notes that Japan has recorded six consecutive quarters of positive quarter-on-quarter GDP growth as of Q2 2017, its longest since the period between Q1 2005 and Q2 2006.

We expect robust growth in external demand to continue this year and next. Combined with ongoing policy stimulus and construction for the 2020 Olympics, we forecast real GDP growth at 1.5% in 2017 and 1.1% in 2018, above Japan's long-term potential. Japan's growth potential remains among the lowest globally, constrained by adverse demographics.

The foremost credit challenge for Japan is maintaining debt sustainability. In the near term, positive, albeit low, real GDP growth and inflation, favorable funding conditions, and further fiscal consolidation will help keep debt affordable.

Implementation of the consumption tax hike planned for October 2019 is a flagship measure towards additional fiscal consolidation over the medium term, as fiscal pressures from higher aging-related social spending build.

While the government has maintained its target of achieving a primary fiscal balance, the time horizon and path to such rapid consolidation remains unclear.

The policy stimulus put in place as part of Abenomics and expanded in 2016 has combined with a global upturn to lift GDP growth above potential. While boosting growth in the short run, the fiscal impulse has come at a cost of delayed fiscal consolidation. Meanwhile, progress on lifting inflation towards levels above 2% has been modest, with long-term inflation expectations stabilizing at levels well below the central bank's target.

Geopolitical risk has increased in relation to higher uncertainty about a potential military conflict on the Korean peninsula. While the probability is still low, a conflict that leads to durably lower nominal GDP growth would significantly undermine the Japanese government's efforts to stabilise its debt burden.

Sustained fiscal consolidation and debt reduction would be credit positive and could, over time, lead us to take a positive rating action. On the other hand, evidence that the government is unable to achieve meaningful medium-term fiscal consolidation and a stabilization of debt in an environment of a further slowdown in long-term growth and rising pressure on government spending would lead to a negative rating action.

A return of significant deflationary pressures that accompany a severe loss of economic momentum, or a deterioration in debt affordability due to funding pressures would also be credit negative.