Japanese leaders vowed on Friday to push ahead with tax reforms needed to rein in bulging public debt, but doubts persisted over whether the government could succeed in the face of a divided parliament.
Rating agency Standard and Poor's cut Japan's long-term debt rating on Thursday for the first time since 2002 while the International Monetary Fund had harsh words for Washington and Tokyo, saying they need to act urgently to cut their deficits.
Prime Minister Naoto Kan has made tax and social security reform, including a future rise in the 5 percent sales tax, a priority given the rising costs of Japan's fast-aging society and a public debt that is the biggest among advanced nations.
The important thing is to maintain fiscal discipline and ensure market confidence in Japan's public finances, Kan, who took over in June as Japan's fifth premier since 2006, told parliament's upper house.
But with Kan's voter support sagging at around 30 percent, opposition parties which control the upper house have shown little inclination to compromise -- something S&P highlighted when explaining its reasons for the downgrade.
Kan's finance minister echoed his stance, saying the government must show its commitment to fiscal discipline, while Deputy Chief Cabinet Secretary Hirohisa Fujii said the government would take S&P's criticism to heart.
The Japanese government must humbly take the rating by a leading world ratings agency and further deepen its awareness of the importance of restoring fiscal health, Fujii, a former finance minister, told a news conference.
DROPPING THE BALL?
Analysts had said the S&P downgrade could bolster Kan's campaign for fiscal reform, but the premier initially did little to sell his case, telling reporters after the downgrade was announced that he was not very familiar with the matter.
Analysts said Kan's early response had given the opposition fresh ammunition to attack.
People will question to what extent he is really thinking about the Japanese economy and fiscal situation, said independent political analyst Atsuo Ito.
In a sense, the S&P downgrade is evidence of tough criticism of the (ruling) Democratic Party of Japan (DPJ), so the opposition can argue that it is time for a change in government.
The head of the second-biggest opposition party, the New Komeito, told the upper house that doubts about Kan's leadership were increasing.
Voices saying we cannot entrust government to you are growing, Natsuo Yamaguchi said.
Kan defended his remark on Friday, telling parliament he had meant only that he had not heard about the ratings cut.
I have been fully aware of the importance of public finances and government bonds since I served as finance minister when the Greek debt crisis hit, Kan told parliament.
The Japanese government bond market took the S&P move in stride, reflecting the fact that domestic investors hold about 95 percent of the country's debt.
This limits any impact of selling by foreign investors, who may take a dimmer view on JGBs in the wake of the rating cut, said Jun Ishii, chief fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities.
Kan's immediate challenge is to persuade opposition parties to help enact budget-related bills needed to implement a record $1 trillion budget for the 2011/12 fiscal year from April 1.
Opposition parties control the upper house, where they can block bills, although the budget itself can be enacted after approval by the lower house, where the DPJ has a majority.
Some pundits have said Kan could be forced to resign or even call a snap election if the budget-related bills get stuck.
The opposition will decide its response based on the trends in public opinion, analyst Ito said. Mistrust in the government is increasing, so they won't compromise easily ... They will make big demands and see how the government reacts.
The main opposition Liberal Democratic Party (LDP) has demanded Kan's Democrats abandon costly campaign promises to put more cash in consumers' hands to boost growth, but Kan's critics inside his own party are opposed to such a change. (Additional reporting by Kiyoshi Takenaka; Writing by Linda Sieg, Editing by Dean Yates)