Last updated: June 1, 2017

Rating Methodology for Local Public Bodies
In rating a local public body, JCR assesses each local public body’s tax-bearing capacity, fiscal
conditions, fiscal management, and so forth, along with credit enhancement provided by theJapanese government. The following is an outline of JCR’s rating methodology for local publicbodies.
1. Credit Enhancement by the Japanese Government
Creditworthiness of local public bodies is supported by the government’s credit enhancement
including local public finance program, local allocation tax system, financial reconstruction system,local bond system. With strong government’s credit enhancement, ratings for local public bodies areextremely high, but are susceptible to the government’s rating.
(1) Position of Local Public Bodies
Administrative activities that are closely related to people’s living such as development of social
infrastructure including welfare, school education, fire protection, roads, rivers, etc. are mostly
performed by local public bodies. In calculation of National Accounts of Japan, local governments
are larger final consumption expenditure bodies than the central government, accounting for 11.9%(FY2014) of gross domestic product (expenditure approach, nominal), 2.5-fold as large as that of
the central government. By body of final consumption expenditure, local governments account for
41.1% (FY2014) of the government final consumption expenditure and 69.8% (FY2014) of publicgross fixed capital formation. As shown by these figures, local public finance has important status in
the country’s economy in parallel with national finance.
(2) Local Financial System
The Japanese government guarantees revenue sources for local public bodies through local publicfinance program by way of local allocation tax and local bonds so that they can play their importantroles, regardless of gaps among regions due to differences in population and industrial
concentration and also differences in tax revenues from fiscal year to fiscal year.
The total amount of fiscal transfer from the central government to local public governments
primarily through local allocation tax is determined every fiscal year in the process of the central
government’s budgeting. The transition of total amount of general revenue sources, which consistof local tax, local allocation tax, extraordinary financial measures bonds, shows a significant drop inFY2004, reflecting the triple reforms promoted under the Koizumi administration. As a result, each
local public body struggled with budget compilation. Since FY2005, the Japanese government has
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been giving due consideration to the local bodies’ fiscal management so that they can perform
stable fiscal management, placing a great value on maintaining/ ensuring a sufficient level of thegeneral revenue sources. Following a subsequent significant worsening of economy after Lehman
Shock and the resulting considerable drop in tax revenue, the Japanese government increased
local allocation tax in addition to the already defined local allocation tax from FY2008 to FY2011. Inand after FY2011, while local tax recovered, local allocation tax has not been reduced much. As aresult, the total amount of general revenue sources has been increasing constantly since Y2005,
exceeding the level before the triple reforms. Under the initiative of unified fiscal and economic
reform, the Japanese government plans to set the total amount of general revenue sources at thesame level as the FY2015 local public finance program’s so that the total amount that is required forstable fiscal management of local public bodies receiving local allocation tax and other local publicbodies cannot fall below this FY2015 level.
(3) Act on Assurance of Sound Financial Status of Local Governments
Act on Assurance of Sound Financial Status of Local Governments (hereinafter referred to as the“Act”) became fully effective in April 2009 in order for the Japanese government to promptly takeaction in cases where financial soundness or rebuilding is required, with unified indicators clearly
showing fiscal conditions of local public bodies. The Act defines 4 indicators: real deficit ratio; realdebt service ratio; consolidated real deficit ratio; and future burden ratio, as soundness ratios for
local public bodies, and a local public body is required to formulate a financial soundness plan if any
one of the indicators exceeds a certain level (early financial soundness scheme). Using three
indicators among the soundness ratios, excluding the future burden ratio, as the ratio for
determining rebuilding, if any of the three indicators exceeds the financial rebuilding standards, afinancial rebuilding plan must be established (financial rebuilding scheme).
The central government’s involvement in the financial rebuilding scheme is clear whencomparing with the early financial soundness scheme. More specifically, under the early financial
soundness scheme, authorities responsible for receiving report of the plan and report on theprogress of implementation and making recommendations to the head in cases where such local
bodies face difficulties in achieving their plans are the Minister of Internal Affairs andCommunications and prefectural governors, but under the financial rebuilding scheme, such
authorities are limited to the Minister of Internal Affairs and Communications only. A local public
body can issue local government bonds only with consultation with the Minister of Internal Affairs
and Communications under the early financial soundness scheme, but issuance of local
government bonds is limited without the consent under the financial rebuilding scheme except incases of disaster recovery or other emergencies. Furthermore, only if a local body has obtained theconsent of the Minister of Internal Affairs and Communications, it can issue rebuilding transfer
special bonds within the range of its balance shortfall. In principle, the central government is to2/8
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provide appropriate funds for the special bonds as far as the central government’s fiscal situation
permit it to do so. In addition, the financial rebuilding scheme specifies the relationship between alocal body’s budget and its financial rebuilding plan, suggesting the influence of the central
government’s strong involvement in the financial rebuilding body’s budget compilation.
(4) Local Government Bond System
Notification system was introduced in FY2012 on behalf of the past consultation system to the local
government bond issuance for the local public bodies which meet certain requirements. In FY2016,
unnecessary criteria for the consultation were softened, expanding the coverage of notification
system and shifting the previous consultation issues in principle to the notification system’s.
The Japanese government guarantees sources for expenditure constituting the redemption ofprincipal and interest on local government bonds, through formulation of local public financeprogram and calculation of local allocation tax. It also ensures safety of redemption of principal andinterest on local government bonds by controlling bond issues in advance by a local public bodywhose debt service burdens exceed a certain limit, through a permission system of bond issuance
as a prompt corrective system, in order for each local public body not to have difficulty in its principal
redemption and interest payment.
(5) Local Administrative and Financial Systems
It is necessary to pay attention to not only local bond system and local financial system but reformof local administrative system. Given that local financial system is inextricably linked to local
administrative system, credit rating is influenced by the state of local administrative system. That is,if the local administrative system changes, then the local financial system will change, causing a
way of thinking about credit rating to change. However, there have been no important reforms andchanges in these systems to date in terms of rating decisions.
Based on Decentralization Reform Promotion Plan formulated in December 2009, the related
legislative acts were enacted and came into force 4 times. These reforms that have been made,however, are centered on revisions of the central government’s frame of responsibilities anddelegation of authority to the local bodies. The revisions of frame of responsibilities were notintended to revise administrative servicing itself, but were intended to revise control of the methodof implementation of their services, etc. These reforms were reductions and revisions of nationalsubsidies, which have not led to revisions of local financial system. In March 2013, headquarters ofDecentralization Reform Promotion was established with the Prime Minister as the head.
Based on “Basic Policy on Economic and Fiscal Management and Reform 2015” that was
decided by the cabinet in June 2015, the Minister of Internal Affairs and Communications released“Points to Consider Regarding Promotion of Local Administrative Services Reform,” requesting local
public bodies to make more efforts to promote administrative services reforms. The trend of3/8
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Decentralization Reform will remain an important factor for JCR’s ratings for local public bodies.
(6) Japanese Government’s Fiscal management Stance
It is important to look at the central government’s fiscal conditions and its stance on fiscal
management to examine local finance. It is necessary for the central government’s fiscal deficit ordebt level to remain at a sustainable level in order to maintain a sufficient level of fiscal transfer fromthe central government to local public bodies. If the fiscal transfer is significantly reduced, because
the central government loses sufficient margin of the fiscal management, gaps among local publicbodies will become clear. In particular, JCR pays attention to the financial measures for redemptionof principal and interest payment on extraordinary financial measures bonds, of which the balancehas been remarkably increasing in recent years. The central government shall transfer funds for theprincipal redemption and interest payment in full for the bonds. Meanwhile, the total amount of thecentral government’s fiscal transfer to local public bodies is decided by budget compilation every
fiscal year. If the total amount of transfer is reduced, the financial sources for the redemption ofextraordinary financial measures bonds will then be reduced.
2. Fiscal conditions of Local Public Bodies
Assessing fiscal conditions of individual local public bodies is both quantitative and qualitative.
(1) Quantitative Assessment
A quantitative assessment is based primarily on the most recent already fixed financial results using
3 criteria: (i) tax-bearing capacity; (ii) ordinary account’s status of income and expenditure; and (iii)
conditions of liabilities (including public enterprises and auxiliary organizations such as 3 public
corporations, etc.).
(i) Tax-bearing Capacity
In assessing tax-bearing capacity, JCR focuses on indicators such as financial capability indicatorand per capital gross prefectural domestic product. JCR also focuses on fixed property tax valuation
prices, etc. for cities, towns and villages. The financial capability indicator is calculated as the past
3-year average of the figures derived from dividing basic financial revenues by basic financial needs.
A higher figure of financial capability indicator means more revenue sources are reserved in thecalculation of ordinary local allocation tax, and that the local public body can be said to have agreater margin for revenue sources.
(Key indicators)-Financial capability indicator-

Per capita gross prefectural (municipal) domestic product-

Per capita fixed property tax valuation price (cities, towns and villages)
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(ii) Ordinary Account’s Status of Income and Expenditure
When assessing ordinary account’s status of income and expenditure, JCR places a great value on
factors including ordinary balance ratio, current conditions of deficit in revenue sources/ financial
measures, and balance of available reserves for the fiscal management. As for the ordinary balance
ratio, ordinary general revenue sources with a special share of revenue decrease compensation
bonds and also extraordinary financial measures bonds added to it is used as the denominator, andwhen the sinking fund to pay off bullet bonds is insufficient, the reserve method is modified if it issignificantly different from that of other organizations. At a prefectural level, the ordinary balance
ratio tends to fluctuate markedly every fiscal year due to trends in corporate and related taxes.
Therefore, JCR thinks it is appropriate to use methods like moving averages to eliminate suchfluctuations. JCR would deem a local government’s income and expenditure being in a difficult state,
if deficit in revenue sources/ financial measures need to be covered by various borrowings, such as
borrowings from funds and other accounts, or through issuance of local administrative reformpromotion bonds or other special bonds.
(Key Indicators)-

Ordinary balance ratio-

Appropriable funds for redemption of local government bonds(iii) Conditions of Liabilities (including public enterprises and auxiliary organizations such as 3 publiccorporations, etc.)
As for conditions of liabilities, JCR looks at the future burden ratio and the basis of the calculation ofthis ratio. The range of areas in the financial statements that the 4 soundness ratios cover is slightly
different from one another (see Table). The future burden ratio is the only stock index in thecalculation, which uses net indebtedness to be borne by all the accounts/ corporations of local
public bodies including public enterprises and auxiliary organizations, etc. in the future.
Regarding auxiliary organizations such as local public enterprises, 3 local public corporations,third-sector enterprises, etc., it is necessary to consider how much transfers to other accounts andadditional financing can cause burden on the ordinary account. After making analyses ofmanagement and fiscal conditions of individual public enterprises and major auxiliary organizations,
JCR examines adequacy of calculation of burden on the ordinary account for each of them.
(Key Indicators)-Future burden ratio(2) Qualitative assessment
The important points in qualitative assessment are future financial prospects and the stance of the5/8
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local public bodies on the fiscal management that forms the basis of the prospects. Even inqualitative assessment, JCR makes efforts to obtain as much quantitative information as possiblethat could help estimate the extent of an improvement or a worsening in the fiscal indicators, rather
than simply try to determine the direction alone. The key points for assessment include: (i) review ofexpenditures and debt management and other efforts aimed at financial soundness; (ii) prospects offiscal balance/ financial measures for the local public bodies’ ordinary account, etc.; and (iii) efforts
to strengthen management base of public enterprises, auxiliary organizations, etc. and their fiscal
outlook.
JCR also considers it is necessary to take into account the strength of the will of the local publicbodies in achieving financial soundness, in addition to details of administrative and financial reform
plans and other plans. This is because reforms could fail even with an outstanding plan, dependingon views of the local assembly or local residents. If JCR can confirm the strength of the will of thelocal public body, while taking into account the trends in the local assembly, JCR would be able toincorporate into ratings the efforts made toward financial soundness at least during the existing
administration. In such a case, JCR acquires as much quantitative information as possible on theprospects of improvement in fiscal indicators such as ordinary balance ratio and outstanding debt
balance and incorporates its findings into the ratings.
As for the debt management, numerical targets for the outstanding balance and issue amount oflocal government bonds should be set as clearly as possible based on the future prospects of local
government bond balance.
For the prospects of fiscal balance/ financial measures for the local public bodies’ ordinaryaccount, etc., JCR examines the details of the financial measures to find revenue sources for
expected revenue shortfalls. Any reliance on borrowings from funds or issuance of special bonds
due to failure in reducing annual expenditures will leave the burden into the future. Thus, this is notdesirable. As the prospects of fiscal balance vary significantly depending on assumption of annualrevenues and expenditures, JCR needs to verify whether the assumptions are appropriate.
JCR is particularly interested in future cash flows and outlook for debt repayment funds inassessing efforts to strengthen management base of public enterprises, auxiliary organizations, etc.
and their fiscal outlook. Since the amount of burden on ordinary account from outstanding debt
balance of these organizations is basically derived from the most recent financial results, JCR’s
quantitative assessment does not include effect of improvement in future management. An increaseof cash flow from operating activities associated with improved management of these public
enterprises, auxiliary organizations, etc. is expected to reduce the amount of burden related to theirdebt redemption on ordinary account.

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Table: Area Covered by Soundness Ratio
Previous
Reconstruction
Law

Act on Assurance ofSound Financial Status ofLocal Governments

Generalaccount

Real
deficit
ratio

Local
government

Bad debt*Calculated
for eachpublicenterpriseaccount

Generalaccount,
etc.

Realdeficit
ratio

Consolidated
real deficit
ratio

Specialaccounts

Publicenterpriseaccounts

Publicenterpriseaccounts

Real
debt
serviceratio

Futureburdenratio
Financial
shortfallratio*Calculated
for eachpublicenterpriseaccount

Partial administrative associations,wide-area local public bodies

Local public corporations,third-sector enterprises, etc.

(Source: the Ministry of Internal Affairs and Communications’ home page)

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Japan Credit Rating Agency, Ltd.
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Tel. +81 3 3544 7013, Fax. +81 3 3544 7026
Information herein has been obtained by JCR from the issuers and other sources believed to be accurate and reliable. However, because of the possibility of human or mechanical error as well asother factors, JCR makes no representation or warranty, express or implied, as to accuracy, results, adequacy, timeliness, completeness or merchantability, or fitness for any particular purpose,with respect to any such information, and is not responsible for any errors or omissions, or for results obtained from the use of such information. Under no circumstances will JCR be liable forany special, indirect, incidental or consequential damages of any kind caused by the use of any such information, including but not limited to, lost opportunity or lost money, whether in contract,tort, strict liability or otherwise, and whether such damages are foreseeable or unforeseeable. JCR’s ratings and credit assessments are statements of JCR’s current and comprehensive opinion
regarding redemption possibility, etc. of financial obligations assumed by the issuers or financial products, and not statements of opinion regarding any risk other than credit risk, such as market
liquidity risk or price fluctuation risk. JCR’s ratings and credit assessments are statements of opinion, and not statements of fact as to credit risk decisions or recommendations regarding decisions
to purchase, sell or hold any securities such as individual bonds or commercial paper. The ratings and credit assessments may be changed, suspended or withdrawn as a result of changes in or
unavailability of information as well as other factors. JCR retains all rights pertaining to this document, including JCR’s rating data. Any reproduction, adaptation, alteration, etc. of this document,
including such rating data, is prohibited, whether or not wholly or partly, without prior consent of JCR.
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