By Paul Blustein
Washington Post Staff Writer
Saturday, April 4, 1998; Page A01

Japan came under intensified pressure yesterday to rescue its faltering economy as the country's gold-plated credit rating was called into question. Tokyo stocks fell anew and President Clinton warned that Japanese officials "have to make a break" with their past policies.

Moody's Investors Service, an influential bond rating firm, delivered a stinging psychological blow to Tokyo by announcing that it had changed its outlook on Japan's government debt to "negative" from "stable." Although the New York-based company maintained its triple-A rating on Japanese government-backed bonds, even the hint that it might downgrade Tokyo's government obligations underscored the mounting sense of pessimism over Japan's prospects.

The announcement came one day after Sony Corp. Chairman Norio Ohga voiced fear that the Japanese economy is "on the verge of collapsing," and a quarterly survey of Japanese business sentiment found that confidence had plunged in late March compared with three months earlier.

The cascade of bad news sent the Nikkei 225-stock average tumbling 185.12 points, or 1.18 percent, to 15,517.78. That drop, capping a 7.3 percent decline for the week, put stock prices uncomfortably close to levels at which Japanese banks will find it tough to meet international capital requirements, because a significant portion of their capital is invested in the stock market. The yen fell to a 6 1/2-year low against the U.S. dollar, closing at 135.10.

The deepening gloom in Tokyo reflected worries that the government of Prime Minister Ryutaro Hashimoto is unprepared to take the sort of forceful actions necessary to keep Japan from a recession that would be even worse than the stagnant growth it has experienced for most of the past seven years. The government has followed the pattern of its predecessors by announcing one package after another of public works projects, but these have proved insufficient at lifting the economy out of the doldrums, and promises of new packages are starting to ring hollow to jaded investors.

In its announcement yesterday, Moody's said its decision to change its outlook on Japanese debt was based on "uncertainty about the ability of the authorities to achieve a policy consensus that would help promote a return to economic growth and fiscal balance." The Japanese government, it noted, "has sought unsuccessfully to place the economy on a path of sustained growth since the early 1990s."

In London, where he is attending a meeting of European and Asian leaders, Hashimoto vowed: "We will do what we must do and take bold action," and he reiterated past pledges to begin work on new steps later this month once the legislature passes the budget for the current fiscal year.

The prospect of a downturn in Japan is disturbing to the Clinton administration partly because it would come at a particularly inopportune time for crisis-stricken Asian countries, which depend on Japan as a market for their exports.

U.S. officials also fear that unless Japan boosts its own internal demand, it will continue trying to export its way out of its troubles, which will impose a drag on the global economy and hurt some U.S. industries that compete with Japanese firms.

Clinton's comments reflected U.S. concerns that with the Tokyo markets sinking, time is rapidly running out on Hashimoto, who is struggling to mobilize a consensus among ruling party politicians and the powerful bureaucracy about what sort of measures should be taken to stimulate the economy.

"We need to be both respectful but firm in urging the Japanese to take a bold course," Clinton said during a question-and-answer session with reporters at the White House. "The people within the permanent government there, who have always enjoyed great power, have to realize that the strategies that worked in the past are not appropriate to the present. They have to make a break now."

The president, obviously aware of the resentment that U.S. complaints have aroused in Japan, sought to take the edge off his remarks by adding praise for Hashimoto and his country. "Japan is a very great country, full of brilliant people who have a great understanding of economics," he said.

Actually, the reasons for Japan's predicament are more complicated than the resistance of bureaucrats to enlightened policies. Hashimoto has staked his political fortunes on a policy emphasizing tight control over government budget deficits on the grounds that a rapidly aging Japan needs to avoid borrowing and to increase saving to prepare for retirement costs in the next century.

That approach has made it awkward for Hashimoto to reverse course even after it became clear that a consumption tax increase he promoted a year ago was causing the already-fragile economy to lose steam.

In keeping with Hashimoto's promise of fiscal discipline, an emergency income tax cut announced in December was limited to one year, and Japanese consumers are apparently salting away their tax savings, as often happens when tax cuts are temporary. The government has launched an advertising campaign urging people to loosen their wallets, with cartoon characters saying, "Hooray! Let's spend some money!"

Beyond tax cuts, U.S. administration officials and many private analysts argue that Japan must take drastic action to rid its banks of their hundreds of billions of dollars in bad loans so they can lend again more freely. The country has a long tradition of banks keeping weak borrowers alive.

Moody's and other credit-rating agencies have been heavily criticized for failing to anticipate the crisis in other Asian countries, and some analysts speculated yesterday that Moody's was unduly eager to ensure that it didn't make the same mistake with Japan. No country holds more reserves of foreign currencies -- at last count, Tokyo held $223 billion -- so its ability to honor its obligations shouldn't be doubted, analysts said.

"I don't think anybody seriously thinks that Japanese sovereign debt won't be repaid," said James Kemp, head of foreign exchange trading at Citibank in New York. "But this is confirmation of the weakness and lack of confidence in the Japanese economy generally."

Russell Jones, chief economist at Lehman Brothers Japan Inc., said Moody's announcement was "a very powerful and symbolic wake-up call," according to Dow Jones News Service.

Takatoshi Ito, a professor at Hitotsubashi University in Tokyo, said that the rating agency's move, combined with the slide in Tokyo stock prices and deterioration in business confidence, would help force Hashimoto's hand. "I think the government will take it seriously," he said. "It's the market, and the businesses, pressing the government to do something -- I think the government will respond to it. I hope they do."