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Japan downgrade not a surprise

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Japan’s credit rating downgrade was not a surprise, says Andy Tidby, Product Manager Japanese Equities, Invesco…

Japan’s debt is too high, which is both obvious and well known, and its credit rating has been under pressure for some time. In that sense the downgrade was not a surprise, although the timing is interesting given that Prime Minister Noda has staked his political future on increasing the consumption tax, which is a key pillar in addressing the debt issue over the long term. There are political difficulties in passing the necessary legislation, but a decision is likely either way in the near-future.
We see little impact on equity market sentiment, or on the Japanese government bond market. JGB demand remains healthy with bond auctions typically well covered. Also, Japan’s debt is around 90% domestically owned, so Japan is not at the mercy of foreign investors. The yield on the 10-year JGB is among the lowest of any government in the world, so servicing costs are low. Japan is also the world’s largest net creditor, providing it with a current account surplus, and household savings alone are of a similar magnitude to the level of debt. 
For the equity market, the drivers are cyclical rather than structural (like the level of debt) and here we remain positive. The market is trading below the value of its net assets, yet a strong profit recovery is expected this year (of around 20%-25%), balance sheets are generally robust and the domestic economy is also on a recovery path, recording annualised growth of 4.1 % in the first quarter with growth for the year as a whole expected to be around 2%. The Topix is also just 3% or so off its lows following the collapse of Lehman Brothers, despite the improvements in the economy and corporate profitability seen since then. The market has clearly been influenced by the problems in Europe and this remains a risk, but the US economic recovery looks sustainable and with policymakers in China leaning towards greater prioritisation of growth, we think the potential for Japanese equities, which are cheap in our view, is strong.

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