Well, this isn’t good.

Fitch Ratings downgraded Japan’s credit rating after the government failed to replace a sales tax in the current fiscal year.

The ratings agency, one of the big three, lowered its rating on the country’s staggering debt one notch from A+ to A with a stable outlook. The top grade, AAA, is five notches above A. The problem is Japan needs to bring down its debt. At $11 trillion, this is the largest national debt in the developed world and it’s more than twice the size of Japan’s economy.

However, Asia Unhedged believes taxes hurt growth and Japan’s experience last year provides ample evidence to this. Last spring, the country increased the sales tax. Whatever the desired effect was, no had hoped that it would trigger a decline in both consumer and business spending that pushed the economy into a recession. But, that’s what they got.

So, Prime Minister Shinzo Abe did what any reasonable man would do. He eliminated the new tax hike scheduled for the fiscal year that begins this month.  But obviously being reasonable doesn’t work for the ratings agencies. Moody’s downgraded Japan to A1 in December because of the delay in the sales tax increase. S&P gives Japan an AA- rating with a negative outlook, which means don’t be surprised with another downgrade. This is three notches below its top rating.

With evidence that Japan’s taxpayers are not on board with the program, maybe lifting taxes now isn’t the best idea. So, while a downgrade isn’t great, a recession is definitely worse.

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