Aichi 'A+/A-1' Ratings Affirmed; Outlook Remains Positive

  • We expect Aichi's strong own-source revenue, backed by the prefecture's healthy economy, and prudential financial management to continue to support its creditworthiness.
  • We are affirming our 'A+/A-1' issuer credit ratings; our outlook on Aichi is positive.
  • The ratings and outlook reflect those on Japan because we do not believe Japanese LRGs could withstand a stress scenario in which the sovereign defaults on its debt.
TOKYO (S&P Global Ratings) March 14, 2019--S&P Global Ratings today said it 
has affirmed its 'A+' long-term and 'A-1' short-term foreign and local 
currency issuer credit ratings on the Prefecture of Aichi (Aichi). The outlook 
remains positive. 

Our ratings on Aichi primarily reflect its very strong economy, supported by a 
solid industrial base of manufacturers, which generates high level of 
own-source revenue that has improved the prefecture's operating balance under 
prudent expenditure management. The ratings also reflect the stable and 
predictable institutional framework for Japan's local and regional government 
(LRG) sector. On the other hand, chief constraints on the ratings are the 
prefecture's huge debt burden compared with rated peers globally and the 
common characteristic of limited budgetary flexibility among Japanese LRGs. We 
expect these factors to remain weaknesses for the prefecture. They lead us to 
assess the stand-alone credit profile (SACP) for Aichi as 'aa-'. However, our 
final ratings on the prefecture reflect our sovereign ratings on Japan because 
we do not believe Japanese LRGs could withstand a stress scenario in which the 
sovereign defaults.

We expect the local economy to perform stronger than the national economy over 
the next two years. Aichi has the second-largest economy among the prefectures 
and cities of Japan and hosts the headquarters of a number of internationally 
competitive manufacturers. Its GDP per capita has exceeded US$45,000 in our 
estimation and its population continues to grow marginally thanks to incoming 
migration, despite a decrease at the national level. Aichi is central to both 
the broader regional economy and national economy, and we expect its export 
industries to continue to generate growth.

Recovery of the prefecture's tax revenue base and its management of 
expenditures will help to control debt outstanding, in our view. The 
prefecture had a healthy operating margin until the global financial crisis. 
But its margins deteriorated sharply in succeeding years as tax revenues 
stagnated and national equalization transfers failed to plug revenue gaps. 
However, Aichi's operating margins have recovered since fiscal 2012 (ended 
March 31, 2013), thanks primarily to improved corporate tax revenues, driven 
mainly by manufacturers' sound operating performances. Meanwhile, we expect 
several changes in the tax system in fiscal 2019, such as the revision of a 
local corporate business tax, to be manageable for the prefecture. 

We forecast the prefecture's balance after capital accounts will remain in 
surplus for the next two years. This is even after we consider the following 
two factors. First, institutional limitations constrain the prefecture's 
ability to raise taxes even though we view the prefecture's level of 
own-source revenue as high compared with peers globally. Second, its capital 
expenditure will rise to a level seen before the global financial crisis, in 
our view, in response to the government's measures for disaster prevention and 
mitigation to be enacted through fiscal 2020. We also take into account that 
Aichi's revenues are relatively susceptible to factors in its external 
environment, such as currency volatility and other economic conditions, in our 
assessment on the prefecture.
 
The re-election of Aichi's governor for a third consecutive term in February 
2019 will help sustain the continuation of the prefecture's prudent management 
practices, with strong support from Aichi's assembly, in our view. We expect 
Gov. Hideaki Ohmura during his third term to maintain solid fiscal discipline, 
while leading his policy package that mainly focuses on: projects for becoming 
Japan's industrial center, development as an interregional economic hub 
through the maglev train, and opening a new Studio Ghibli theme park. 

We believe Japan's institutional framework is mature and favorably supports 
Aichi's prospects. Japan has a mature intergovernmental system, and the 
central government's strict control of regulations and budgets for LRGs 
ensures the system's predictability, transparency, and accountability. We 
consider the central government's weak fiscal position a constraint on the 
system's strength, but we also have a positive view of the LRG sector's 
balance of revenues and expenditures compared with those of the central 
government.

On the other hand, we expect debt ratios for the prefecture to remain very 
weak compared with those of rated peers globally. We believe the ratio of 
Aichi's tax-supported debt to consolidated operating revenue will hover at 
around 310%-320% toward the end of fiscal 2020. The ratio deteriorated in 
fiscal 2017 mainly due to a decline in operating revenues, stemming from a 
partial transfer of salaries for public school teachers and staffers, along 
with associated revenue sources, to the City of Nagoya. With an almost 
balanced budget and a slower increase in revenues, we expect existing debt to 
remain at its current level for the next two years or so. 

Despite Aichi's high debt burden, we view its contingent liabilities as 
limited. The prefecture owns stakes in many government-related entities. 
Guarantees on the external borrowings of Nagoya Expressway Public Corp. (not 
rated), central Aichi's toll-road operator, amount to about 17% of Aichi's 
operating revenues. However, we see only a remote likelihood of the actual 
burden of payment falling on Aichi, given stable cash flow from its toll-road 
operations.

We believe Aichi has ample internal cash holdings and strong access to 
external liquidity. We estimate that as of March 31, 2018, the prefecture's 
internal cash holdings covered more than 200% of its annual debt service 
costs. In our view, Aichi has a close relationship with MUFG Bank Ltd., a 
quasi-commitment line provider that ensures its short-term liquidity. In 
addition, Aichi has an established position in the bond market.

The positive outlook on Aichi reflects our outlook on our sovereign rating on 
Japan (A+/Positive/A-1). Our view that a Japanese LRG cannot be rated higher 
than the sovereign is a further constraint on our ratings on Aichi. Any 
changes in the outlook, the ratings, or both would likely depend on any change 
in those on the sovereign.

Our ratings on Aichi could come under pressure if the prefecture's SACP 
deteriorates substantially. That could happen in the event of unfavorable 
modifications in central government support for local governments and if an 
economic downturn weakens the prefecture's tax base--producing ongoing 
deficits after capital accounts that lead Aichi to draw on cash reserves to 
fund revenue shortfalls--and its liquidity coverage declines. While these 
factors may materially worsen Aichi's credit metrics, we consider these 
scenarios unlikely at this time.

We incorporate central government support for Aichi into our ratings on the 
prefecture. Changes to our sovereign ratings on Japan or changes to the 
Japan's public finance system may trigger a review of our ratings on the 
prefecture and of the institutional framework in which it operates. However, 
we do not directly link the ratings on the prefecture with those on the 
sovereign.