Moody's downgraded its credit rating for Japan on Monday, citing "rising uncertainty" over the country's debt situation and Prime Minister Shinzo Abe's faltering efforts to kickstart growth, with an election just two weeks away.
The ratings agency said it cut Japan's rating by one notch to A1 from Aa3, after the economy sank into recession during the July-September quarter.
Last month Abe announced that a planned sales tax rise set for next year would be delayed, as he called a snap election described as a referendum on his "Abenomics" growth blitz.
However, observers said it was more likely aimed at consolidating his power ahead of a party leadership vote next year.
Tokyo raised the sales levy in April -- to 8% from 5% -- for the first time in 17 years, to help pay down one of the world's largest public debt mountains.
The levy rise delivered a body blow to Abe's efforts to rev up growth, just as the world's number three economy appeared to be turning a corner after years of deflation.
"The first driver for the downgrade... is the rising uncertainty over whether the government's medium-term deficit reduction goal is achievable, and whether policymakers can overcome the tensions inherent in promoting growth while simultaneously stabilizing and reversing the rising debt trajectory," Moody's said.
But postponing the fresh tax rise to 10%, initially planned for late 2015, "poses risks" to Japan's fiscal health, Moody's said.
The yen briefly fell to a fresh seven-year low of 119.12 against the dollar after the Moody's announcement.
Preliminary GDP data last month showed Japan's economy shrank 0.4% in the July-September quarter, following a 1.9% contraction in the April-June period.
All eyes are now on the revised third-quarter figures due out next week and a possible upward revision.
But analysts say Abe must still follow through on promised reforms to the highly regulated economy.
"The second driver for the downgrade is the rising uncertainty over the government's ability to enhance medium-term growth through structural economic reform... success in which will be crucial to achieve fiscal consolidation," Moody's said.
"While some indicators suggest a pick-up in economic activity over the past year, potential economic growth remains low."
Yoko Takeda, chief economist at Mitsubishi Research Institute, said the downgrade should be a wake-up call for Tokyo, the latest in a series of calls for Japan to get its fiscal house in order.
"It is an important message to Japan," Takeda said.
"I don't see there being a short-term impact from the downgrade, but it's a message telling Japan to set up a mid- and long-term plan to get rid of concerns about its fiscal soundness."
Standard & Poor's would maintain its Japan rating of AA- with a negative outlook, Takahira Ogawa, the firm's Japan analyst, told Dow Jones Newswires on Monday after the Moody's downgrade.
Japanese firms, which once led the world in innovation, are facing stiff competition from emerging nations including China, while a falling number of working-age people is shrinking the country's tax base even as soaring ranks of seniors strain the public purse.
That has raised concerns about funding its ballooning debt, although Japan's bonds are generally held domestically at low interest rates -- unlike some indebted eurozone nations that faced off with international creditors.
"Debt sustainability will rest on the continued willingness of domestic investors to provide funding at affordable rates for the government," Moody's said.
"This looks likely to remain the case as long as investor confidence is not undermined."
Despite the rating cut, Moody's noted that Japan was not in a disastrous situation.
"Whatever the challenges facing the government, Japan retains very significant credit strengths," it said, pointing to a "large, diverse economy" as well as moderate household debt, a healthy banking sector and low unemployment.
Copyright Agence France-Presse, 2014