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Tokyo, Japan. Image © iStock

The agency said although it does not expect a sharp rise in the country’s very low interest rates, higher bond yields will make it more difficult to stabilise or reduce its debt-to-GDP ratio, which sits at an estimated 248% as of March.

“Over time, higher bond yields will raise government funding costs,” Fitch said in a note.

“We estimate that a 100 basis point increase in interest rates today would lift government debt-to-GDP by 3 percentage points by 2024-25.”

Italy’s 150% debt-to-GDP ratio is the second-highest among investment grade countries – well below Japan.

Fitch said high debt “is Japan’s main credit weakness”, although in March it affirmed its judgement of its creditworthiness at ‘A’.

At the same time the agency improved the outlook on Japan from ‘negative’ to ‘stable’ citing “rising confidence that debt-to-GDP would stabilise over the medium term”.

Fitch said Japan should target GDP growth in the next few years and cut the deficit in order to do this, particularly as the impact of Covid-19 on public finances fades.

Unions demanded higher wages in March, although Japan’s year-on-year inflation (1.2%) remains far lower than in many other countries.

“We believe modestly higher wage-driven inflation would have generally positive near-term effects on Japan’s government debt trajectory, mostly due to stronger nominal GDP growth,” said Fitch.

“Nonetheless, the effects of inflation on fiscal dynamics, growth and monetary policy in the medium-term are uncertain and there is a risk of outcomes that would damage Japan’s creditworthiness.”