Moody's Investors Service, which has no plans to change its credit rating for Japan from A2, said the country's debt cannot grow faster than gross domestic product (GDP) for "an unlimited time" without defaulting.

Prime Minister Junichiro Koizumi has made reducing public spending a priority. Japan's yen-denominated public debt is near 144 per cent of GDP, the most among the Group of Seven (G7) industrialized nations.

The government plans to cut outlays for roads, bridges and other public-work projects by 3.5 per cent in the fiscal year that started in April.

"At some point, the economy will not be able to provide enough resources for the government to service its debt and avoid default," said Thomas Byrne, Moody's Asian sovereign debt-rating analyst.

The outlook on Japan's domestic debt rating is stable, New York-based Byrne said at a press conference in Tokyo.

Moody's lowered Japan's ranking, which affects about 459 trillion yen (US$4.23 trillion) of domestic currency bonds, to its sixth-highest level in February 2002.

The ratings company on April 7 raised Japan's foreign-currency debt rating to its top grade as sales of yen increased the country's US dollar reserves.

Koizumi's spending cuts will partly offset rising social-welfare costs that are helping to drive up total spending by a projected 0.4 per cent for the year.

Welfare and debt-servicing costs will together make up 46 per cent of total budget spending.

The country's ageing population is pushing up spending to build nursing homes and hospitals, and hire doctors and nurses, by 4.2 per cent this fiscal year to 19.8 trillion yen (US$183.3 billion), according to the government's budget proposal. That total is 2.5 times larger than the public-works budget.

"Moody's recognizes that the current economic recovery is stronger than expected," Byrne said. "The key thing is that if there is a recovery, that revenues increase further than debt increases."

Japanese bond yields have risen this month, increasing for the benchmark 10-year security to an almost four-year high of 1.92 per cent on Thursday, on expectations of faster economic growth.

The economy expanded by an annualized 6.1 per cent, for an eighth quarter of gains, in the three months until March 31. The rate was the fastest among the G7 nations.

Risks to economic growth are that a higher yen slows the recovery, Byrne said. A stronger currency cuts the profits that exporters such as Canon Inc and Toyota Motor Corp earn on overseas sales.

A slowdown in the Chinese economy and "limited policy manoeuverability" for the Japanese Government may also slow expansion in Japan, he said.

The central bank pushed overnight rates close to zero by raising its target for reserves available to lenders in March 2001, aiming to halt deflation and support growth.

"No matter which way you cut it, Japan's debt is large, especially for a peace-time economy," Byrne said. "Japan's debt position will continue to remain weak as long as there are deflationary problems."

Deflation, or a sustained drop in prices, saps the economy by cutting corporate profits and inflating the value of debt.

Slow economic growth generates less tax revenue for the government.

(China Daily 06/22/2004 page12)