Japan and the United States faced new pressure to confront their swollen budget deficits as the IMF and rating agencies demanded more evidence they can bring their public debts under control. The International Monetary Fund said the G7's two biggest economies needed to spell out credible deficit-cutting plans before the markets lose patience and dump their bonds.
On Friday, Japan's Prime Minister Naoto Kan vowed to push ahead with tax reforms aimed at curbing the country's debt, but an uncooperative opposition and divisions within his own party on policy make the chances of success slim. "The important thing is to maintain fiscal discipline and ensure market confidence in Japan's public finances," Kan, who took over in June as Japan's fifth premier since 2006, told parliament's upper house.
Ratings agency Standard & Poor's cut Japan's long-term debt rating on Thursday for the first time since 2002, and hours later Moody's Investors Service warned the risk of the United States losing its top AAA rating, although small, was rising. Bond markets reacted calmly, but the latest warnings about the colossal liabilities piled up by the two countries raised fears of rising borrowing costs that could hamper attempts to restore fiscal discipline and consolidate a fragile recovery.
"In advanced economies where fiscal sustainability has not been a market concern, credible plans going well beyond 2011 need to be put in place urgently to lock in benevolent market sentiment," the IMF said in its "Fiscal Monitor" report.
The 2007/08 financial crisis prompted a dramatic rise in developed world debt, as governments spent billions of dollars propping up sinking economies and bailing out stricken banks. In the United States, outstanding public debt has ballooned to more than 60 percent of total output since the financial crisis, and, with a record $1.5 trillion budget deficit expected this year, is set to grow further.
Japan is in an even worse position. Its debt has been growing for years as it tried to revive the economy from a huge asset bubble burst in the 1990s and outstanding long-term government debt now stands at around 180 percent of GDP. Kan has made tax and social security reform, including a future rise in the 5 percent sales tax, a priority given the rising costs of Japan's fast-ageing society and a public debt that is the biggest among advanced nations.
Kan needs help from opposition parties to pass broad reforms and to enact a record $1 trillion budget but analysts said the ratings downgrade may prove to be a wake up call to lawmakers and so garner support for his cause. In Europe, where Greece and Ireland have been driven by bond market pressure to take bailouts, many governments have adopted austerity measures to cut their deficits.
But the IMF said new tax cuts in the United States and increased spending in Japan had set back progress in rich nations more generally. Ratings agencies fretted that politics is making reining in the deficit harder for both countries. Moody's worried that a US Congress where the Republican now control the House of Representatives might fail to consider and pass some of the deficit-reducing measures proposed by a panel mandated by Democratic President Barack Obama. S&P, which cut Japan's long-term sovereign rating to AA minus, voiced similar concerns about Tokyo.
"In our opinion, the Democratic Party of Japan-led government lacks a coherent strategy to address these negative aspects of the country's debt dynamics, in part due to the coalition having lost its majority in the upper house of parliament last summer," the agency said. The debt fears hanging over much of the developed world underlined the two-speed recovery from the financial crisis, which has seen emerging economies rebound strongly, especially in Asia, while the traditional powers struggle.