Japan’s sovereign-credit rating was lowered by Moody’s Investors Service, which cited “weak” prospects for economic growth that will make it difficult for the government to rein in the world’s largest public debt burden.

Moody’s lowered the grade by one step to Aa3, with a stable outlook, it said in a statement released today. The company put the nation’s rating on review for a downgrade in May, calling on the government to step up its efforts to narrow the budget gap.

The move follows the first cut of the U.S.’s sovereign grade this month by Standard & Poor’s and comes as concern deepens on whether the euro area’s debt crisis may worsen. Japan’s public debt is projected to reach 219 percent of gross domestic product next year even before accounting for borrowing to fund reconstruction after the March 11 earthquake, according to the Organization for Economic Cooperation and Development.

Japan’s government has amassed a debt of 943.8 trillion yen, according to the Finance Ministry, after two decades of fiscal spending to energize an economy hobbled by the collapse of an asset bubble in 1990 and lingering deflation that’s sapped private demand. The yen’s advance to a post World War II high this year also threatens exports, a main driver of the nation’s economic growth.

Prime Minister Naoto Kan’s efforts to reduce Japan’s debt have been stymied by opposition within his party to tax increases. Kan has also said he would step down once a second extra budget and bills for renewable energy and deficit-bond funding are passed, reducing his authority.

IMF’S Call

The International Monetary Fund said on July 19 that Japan needed to push forward with new tax measures and limit bond issuance to pare its debt. It recommended raising the sales tax to 7 percent to 8 percent in 2012 from 5 percent, then gradually increasing it to 15 percent over several years.

"Insufficient fiscal adjustment could lead to a spike in JGB yields which, even if the effects were contained, could trigger financial volatility and prove highly disruptive,” according to the IMF, referring to Japanese government bonds.

The IMF also said that outstanding government bonds could exceed total financial assets owned by households in five to 10 years barring policy changes, suggesting the government may need to rely more on foreign investors to fund its deficits.

The government has pledged to raise the sales tax to 10 percent by the middle of the decade, a rate that would still be below the IMF’s recommendations. The additional revenue is intended to pay for social welfare for the aging population.

Spending Plans

Japan's government plans total spending of 19 trillion yen over five years to rebuild after a magnitude-9 temblor and tsunami devastated the northeast coast of Japan and triggered the worst nuclear crisis since Chernobyl.

The world’s third-largest economy has shown signs of overcoming its slowdown after the quake, with industrial production rising at the fastest pace in more than 50 years in May. Companies are saying they plan to increase capital spending despite damage they incurred from a temblor that has left around 20,000 people dead or missing.

The yen’s advance against the dollar and signs of a slowdown in the global economy pose risks for Japan’s rebound after the quake. Japanese authorities intervened in the currency market for the first time since March on Aug. 4 to try to stem the yen’s gains.