HONG KONG (MarketWatch) — Global sovereign-debt concerns shifted to Japan’s shores Wednesday, as credit-rating firm Moody’s Investors Service downgraded the nation’s credit rating one notch, saying Tokyo needs to begin turning its debt situation around.

Moody’s lowered Japan’s rating to Aa3 from Aa2, citing large deficits and the buildup in government debt since the global recession in 2009.

Moody’s said in May it was putting Japan’s local and foreign- currency bond ratings on review for possible downgrade. At the time it cited long-term fiscal concerns as well as costs related to rebuilding efforts in the wake of the devastating earthquake and tsunami in March.

Moody’s noted that Japan’s debt situation looked bad when measured against international standards. The International Monetary Fund’s projections for 2011 put Japan’s debt-to-GDP ratio at 233%, while home-grown estimates put out by the Cabinet Office put the level at 181%.

“Several factors make it difficult for Japan to slow the growth of debt-to-GDP and thus drive this rating action,” Moody’s said.

It noted that neither the Cabinet Office nor the IMF sees progress toward the kind of policy that could contain or curb the debt burden over the next decade.

`Funding-cost advantage’

Despite the downgrade, Moody’s didn’t view a debt crisis as imminent. In fact, the ratings firm said the outlook was stable thanks largely to the “home bias” of Japanese investors, whose preference for Japanese government bonds meant bond yields were the lowest worldwide.

“We believe that this funding-cost advantage will be sustained by considerable institutional and structural strengths, which will prevail even with large budget deficits in 2011 and 2012,” Moody’s said.

Moody’s also criticized “frequent changes in administrations” as holding back development of the long-term policies needed.

In a coincidental development, Japanese Prime Minister Naoto Kan told his cabinet on Tuesday he plans to step down once lawmakers pass two key pieces of legislation, adding that he expected a new leader to be chosen on Aug. 30.

Banks downgraded

Moody’s also downgraded the Japanese banks it rates by an average of one notch.

Because banks are dependent upon government support in the event of a financial crisis, Moody’s had little choice in lowering their ratings to reflect it cut to the government’s credit rating.

The move sent Japanese banking shares lower in Tokyo stock trading on Wednesday, even though analysts said there was little significance owing to the stable outlook on the sector by Standard & Poor’s. Asia Markets

“We think this will have little impact on banks in terms of capital procurement costs and derivative and other transactions,” Citigroup said in a note.