Moodys warning to downgrade Japan - after the giant slipped back into recession in the first quarter due to falling output and exports following the recent earthquake and tsunami - came true, when it cut Japans debt rating from AAA to AA3 with a stable outlook.
Build-up in the government debt and increasing budget deficits are the chief reasons for this cut. At the same time, Japans government has been unable to adopt effective long-term policies as a result of frequent leadership changes.
Many experts believed that Japans rating downgrade would have a limited impact on the world economy because of the widely expected rating cut among market players. This was supported by the reaction of financial markets, which have been flat since the opening of the Asia-Pacific and European markets.
According to Goldman Sachs Group, impacts owing to the downgrade on the financial market would be temporary. Frank Gong, Managing Director of JP Morgan Chase, also believes that the current downgrade is not a signal of debt crisis in Japan, all thanks to the patriotic nation, which has been lining up to buy state bonds to support the government.
However, countries like Pakistan, with their financial system reliant on off-shore markets are likely to face reduced liquidity and a heightened refinancing risk in the short term as a result of this rating downgrade.
According to Pakistan Customs, the country imported $1.6 billion worth of different items from Japan in FY11, which include motor cars and vehicles, spare parts, iron, steel, chemicals, machinery and equipments, etc. With a likely depreciation of the Japanese yen, Pakistan is likely to have a positive impact on its import bill. Japan is one of the top oil consumers in the world and a fall in its demand is expected to reduce oil prices.
This impact, however, will be marginal as the rupee continues to be on the path of depreciation as well, suppressing the gains or appreciation from the yen depreciation.
However, Pakistan being a commodity exporter may enjoy gains from a rise in international commodity prices in the wake of the downgrade in Japans rating.
The inflow of remittances from Japan totaled only $8 million in FY11, which suggests a negligible impact on Pakistan on this front as a result of the recent downgrading.
Japans officials should be alarmed to this downgrade since, according to the Wall Street Journal, the gross debt now equals more than 200 percent of GDP. The next Prime Minister to be elected must focus on financial reforms including the tax increases and limit bond issuance to end the countrys ballooning debt. If such measures are implemented, Japan will most likely avert a prospective further rating downgrade in the future.