KUALA LUMPUR: Standard & Poor’s Ratings Services has revised to negative from stable its outlook on the 'AA' long-term rating on Japan unless measures can be taken to stem fiscal and deflationary pressures.

The ratings agency said at the same time, it affirmed its 'AA' long-term and 'A-1+' short-term local and foreign currency sovereign credit ratings on Japan.

"The outlook change reflects our view that the Japanese government’s diminishing economic policy flexibility may lead to a downgrade unless measures can be taken to stem fiscal and deflationary pressures," said S&P in a statement issued on Tuesday, Jan 26.

At a forecasted 100% of GDP at fiscal year end March 31, 2010, Japan’s net general government debt burden is among the highest for rated sovereigns.

S&P said the new Democratic Party of Japan (DPJ) government's policies point to a slower pace of fiscal consolidation than previously expected.  

The international ratings agency said combined with other social policies that are not likely to raise medium-term trend growth and with persistent deflationary pressures, it forecast Japan’s net general government debt to GDP will peak at 115% of GDP over the next several years.

The affirmation of the ‘AA’ sovereign ratings on Japan rests on the country’s strong net external asset position, the yen’s status as a reserve currency, the financial system’s resiliency throughout the recent global recession, and the economy’s diversification.

"We believe that these strengths will keep the government’s rating in the ‘AA’ category, even if further fiscal deterioration leads to a one notch downgrade," it said.   

A strong net external asset position and the yen's key international currency position provide ample external liquidity and good access to global capital markets. Japan is the world's largest net external creditor in absolute terms with projected net assets of an estimated 309% of current account receipts at the end of 2009.

The country's current gold and foreign exchange reserves of over US$1 trillion are second only to China's. S&P expects Japan's net external assets to rise further in the coming years due to continued current account surpluses.

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.

S&P said it would look for signs of government policy toward fiscal consolidation in the update of its medium-term fiscal plan, due to be released in the first half of 2010. Additional policy initiatives may also be revealed after the upper house elections in July.

If on the other hand it concludes that government policies, either on the fiscal side or structural reform side, will moderate the government’s debt trajectory, the ratings could stabilize at the current levels