Moody's: Japan's planned use of private capital for water utilities is credit positive for regional and local governments

Moody's Japan K.K. says that planned changes to the legal framework governing Japan's water utilities system to promote the use of public-private partnerships (PPPs) and private finance initiatives (PFIs) in 2017, particularly through concessions, will be credit positive for the country's regional and local governments (RLGs).

This approach represents a change from the current framework which mandates that RLGs operate water utilities and will be credit positive for these governments because water concessions under a stable regulatory framework will alleviate their financing burdens.

Such a development will in turn help the RLGs meet their substantial infrastructure maintenance and replacement costs, and promote the operational efficiency of infrastructure systems.

Moody's conclusions are contained in its just-released report on Japanese RLGs, "New Initiative to Open Water Systems to Private Finance Is Credit Positive for RLGs." The services of water utilities in Japan include the supply of water to households and commercial users as well as the operation and maintenance of pipelines and drains.

More generally, the proposed reform on water utilities is part of expected Japanese government policy measures to encourage the use of private capital for refinancing the infrastructure debt of RLGs.

The government submitted its proposal to change the Water Act, which governs Japan's water system, to the national parliament on March 7, 2017 and it is expected to be approved by June at the earliest.

Few private operators currently manage a water utility in Japan because the Act states that the operator has to be a local government -- city, council or village -- or approved by a local government. The proposed changes will add the regulatory framework to the Act to standardize concession agreements.

The success of these latest initiatives to attract private capital will depend upon having a regulatory regime that provides visibility around investment returns, particularly given the long-term nature of these concessions.

In this context, Moody's notes that regulated water utilities generally exhibit a significantly lower business risk than many other rated sectors, reflecting their almost monopoly status and strong regulatory supervision due to their vital role in providing water and wastewater services and the impact these have on the country's health and environment.

Furthermore, in 2018, the government will start waiving early redemption charges on early repayment of loans it advanced to RLGs when interest rates were higher, provided that they open public infrastructures to private capital through concessions.

This will ease the infrastructure funding burden of the RLGs and will allow them to refinance the loans, which carry high interest rates as they were originated up to 30 years ago, with less expensive private debt, when they open their infrastructure operations to private entities.

The cities of Osaka (Osaka City Government, A1 stable) and Hamamatsu (Hamamatsu City, A1 stable) will be the main beneficiaries, because among Japanese RLGs they are leading the large-scale transfers of public infrastructure to private capital. The central government will encourage smaller municipalities to follow suit.

Moreover, we view the central government's initiatives to encourage the use of private funds for refinancing infrastructure debts as a proof of its commitment to strengthen the sustainability of the supportive institutional framework surrounding RLGs.

Municipal water systems in Japan carry, on average, heavy debt of about three times revenues, which require annual debt finance and support from tax revenue.

Japan's water systems are ageing and will need more annual funding to meet maintenance and replacement costs, possibly JPY1 trillion per year until 2050, according to estimates by the Japanese government, and therefore requiring increased borrowing.