TEXT-Fitch:Japan consumption tax vote factored into rating

(The following statement was released by the rating agency)

June 26 - The likely passage of legislation that will allow a doubling of consumption tax in Japan is already reflected in the sovereign's ratings, Fitch Ratings says. Our decision to downgrade Japan to 'A+' in May, prompted by rising general government debt (GGD) ratios, was taken in anticipation of the measure being passed.

Increasing the consumption tax to 10% from 5% is expected to raise about 2.5% of GDP in additional revenue. As the only substantial measure planned to improve Japan's weak public finances, failure to pass the relevant legislation would have been negative for the sovereign. It could potentially have increased pressure on the rating if it was not clear that it would be re-introduced to the Diet, or that the Japanese authorities had an alternative plan to achieve an equivalent fiscal impact.

The highly controversial measure, which will not be enacted until 2014-2015, is vulnerable to implementation and political risk, with a significant faction of the governing party opposed to the increase. According to the draft bill, doubling consumption tax depends on policies being in place that would lead to 3% nominal GDP growth and 2% CPI, although the status and force of this conditionality is unclear.

On Tuesday, the Lower House of Japan's parliament (the Diet) voted 363-96 for the bill. The measure will now go to the opposition-controlled Upper House, where approval is virtually guaranteed thanks to the backing of opposition parties. But it is possible that the ruling DPJ may split.

Even if it is enacted, Japan still faces an enormous fiscal challenge compared to other major advanced economies. GGD at end-2011 was 225% of GDP, making it the most indebted Fitch-rated sovereign. The fiscal deficit was 10.1% of GDP in 2011 and the IMF placed the cyclically-adjusted balance at negative 8.1%, weaker than the US on negative 7.2% or the UK on negative 6.3%.

Thus a lack of additional new fiscal policy measures aimed at stabilising the public finances amid further rises in GGD ratios could lead to a downgrade. This is reflected in the Negative Outlook on the rating.