TOKYO, Japan

MOODY’S Investors Service sounded the latest alarm on Japan’s massive debt, cutting the outlook on the country’s credit rating as it questioned the government’s power to enact reforms.

The rating agency yesterday changed its outlook for Japan’s Aa2 rating from stable to negative, meaning an actual downgrade in the rating is more likely. Moody’s said it was the first negative action against Japan since May 2002.

The decision strikes another blow to confidence in Prime Minister Naoto Kan, who faces political gridlock, plunging public approval ratings and the highest debt burden among advanced economies. The downgrade comes less than a month after Standard & Poor’s cut Japan’s credit rating for the first time in nine years, to AA-minus from AA.

Moody’s said the downgrade stems from “increasing uncertainty” over Japan’s ability to implement effective measures to rein in ballooning public debt, which stands at roughly 200 per cent of gross domestic product.

The finance ministry estimated in January that the country’s public debt would swell to 997.7 trillion yen (US$12 trillion) by March 2012, up from 943 trillion yen this year.

In its statement, Moody’s cited comments last month by Bank of Japan Gov. Masaaki Shirakawa, who said “no country can continue to run fiscal deficits forever.”

Prime Minister Naoto Kan is pushing to reform the country’s tax and social security systems. But Moody’s said Kan may not be able to make much progress. Public support for his administration has fallen to below 20 per cent. Meanwhile, opposition parties are refusing to vote for a record 92.4 trillion yen budget for the next fiscal year starting April or cooperate with Kan on wider reforms.

“The divided Diet — in which the opposition Liberal Democratic Party controls the Upper House — and the intensifying level of political challenges to Prime Minister Kan together threaten to bog down” tax reform efforts, Moody’s said.

Despite its concerns, Moody’s said Japan does not face an immediate crisis. The country still boasts a big economy, deep savings and a current account surplus. Nearly all of the country’s debt is held domestically.

A downgrade in a rating outlook is one step removed from an actual credit rating cut.

Moody’s said it could lower Japan’s rating in the future if the government is unable to implement effective tax reform or if domestic funding dries up — a situation that might arise if household savings rates turn negative.

Moody’s announcement weighed on an already weak stock market Tuesday. Banking shares came under selling pressure, with Mitsubishi UFJ Financial Group Inc. down 3.4 per cent and Sumitomo Mitsui Financial Group Inc shedding 4.4 per cent.

Associated Press Writer Shino Yuasa contributed to this report.