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Tokyo - Ratings agency Moody's downgraded Japan's credit rating by one notch on Wednesday, blaming a build up of borrowing and revolving-door politics for delaying efforts to cut the world's largest debt.
The downgrade of Japan's government bond rating to Aa3 from Aa2 came days before the nation was due to see its sixth new leader in five years, with Prime Minister Naoto Kan set to resign over his handling of the March 11 disasters.
While expected, the decision by Moody's put further pressure on a political leadership charged with safeguarding a recovery from the impact of the March 11 earthquake and tsunami, a surging yen and a slowing global economy.
Moody's move also comes after the United States saw its top AAA rating cut by Standard & Poor's, amid growing fears for eurozone giants such as Italy and Spain, and puts Japan on a par with China.
The agency said its first Japan downgrade since 2002 was due to large budget deficits and the rise in Japanese government debt since the financial crisis, coupled with the lack of long-term planning to deal with it and the prospect of weak future growth.
"Over the past five years, frequent changes in administrations have prevented the government from implementing long-term economic and fiscal strategies into effective and durable policies," said Moody's.
"The March 11 earthquake and tsunami, and the subsequent disaster at the Fukushima Daiichi nuclear power station, have delayed recovery from the 2009 global recession and aggravated deflationary conditions."
Moody's also downgraded some of the nation's major banks, including Mizuho Bank, Bank of Tokyo-Mitsubishi UFJ and Sumitomo Mitsui Banking Corporation, local governments and other companies in the wake of its Japan move, helping send the Nikkei index down 1.07%.
Kan described the downgrading as "regrettable" while Finance Minister Yoshihiko Noda - a key contender in the race to replace Kan - defended the creditworthiness of Japan's bonds.
"The smooth sales of Japanese government bonds at recent auctions show that confidence remains unshaken," Noda told reporters.
Markets offered a limited reaction given that Moody's warned in May that it would likely downgrade Japan.
The yen, which hit a post-war high of ¥75.95 to the dollar last week, remained in a narrow range around the ¥76.60 level after the announcement and bond yields were steady.
"The market's reaction to Moody's downgrading is limited as the move was not a big surprise," said Sumino Kamei, senior analyst at the Bank of Tokyo-Mitsubishi UFJ.
Former foreign minister Seiji Maehara is seen as the favourite to replace Kan, but whoever does must move quickly to secure Japan's post-quake recovery while winning confidence that Japan can cut its debt, say analysts.
Japan's debt stands at around 200% of its GDP, after years of pump-priming measures by governments trying in vain to arrest the economy's long decline.
Much of government spending is swallowed up by a social security system catering to a rapidly ageing population, while entrenched deflation and the feeble economy have made it hard for lawmakers to curb borrowing.
The March disasters helped plunge the economy back into recession and will force the government to borrow more to help fund reconstruction.
Japan saw its third straight quarterly contraction in April-June, with the economy shrinking by an annualised 1.3%.
The rise of the yen meanwhile threatens exporters already facing a slowing global economy, raising the prospect of more production being moved overseas to retain competitiveness.
On Wednesday, Noda pledged stronger market oversight and unveiled a $100bn facility aimed at helping to weaken the yen after repeated attempts to cool the unit through market intervention, but the plan underwhelmed markets.
The programme would encourage firms to exchange the Japanese currency for foreign denominated assets, with the one-year facility aimed at encouraging merger and acquisition activity to make the most of the strong unit.
