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Last Wednesday, while markets were busy selling the dollar like crazy, ratings agency S&P downgraded Japan’s credit rating outlook from “stable” to “negative.”

If you remember, the agency had already downgraded Japan’s sovereign debt rating from AA to AA- in January. Is it just picking on Japan or is there more to the story?

Before you say “S&P y u pick on Japan?,” you should know that S&P is actually worried about the impact of the earthquake, tsunami, and the nuclear power plant glitches on the Japanese economy.

Word around the forex hood is that rebuilding efforts can cost as much as 50 trillion JPY, or 611 billion USD.

The figure certainly doesn’t bode well for the government as it will most likely issue more debt to get funds, which could inflate public debt to a ginormous 145% of GDP by 2014.

The number will not only represent almost twice the economy, but it will also set Japan as one of the countries with the largest debt amongst developed nations.

But if you’re anything like Pip Diddy who likes to look at recent events instead of worrying about the far future, you’ll see that natural calamities in Japan have already taken its toll on economic growth.

Last week alone we saw that retail sales in Japan fell by 8.5% in March from a year earlier, its largest drop since 1998. Then, household spending figures also decreased by 8.5% in the same month, disappointing expectations of only a 6.4% decline.

Lastly, the industrial production report for March printed a 15.3% drop, the steepest plunge on record. With record-breaking numbers like that, it’s no wonder that EUR/JPY rocketed by 200 pips in one day!

As bad as Japan’s economic figures are though, I’m betting my annoying neighbor’s cat that the outlook downgrade is also meant to wake-up the Japanese officials, much like the U.S. S&P downgrade that I discussed a few days ago.

Good thing that in its recent monetary policy, the Bank of Japan has already specified some of its plans to aid recovery. First, the BOJ gang unanimously decided to keep its interest rates at a record low below 0.10%.

This surprised market junkies who were expecting an easier monetary policy from the guys. Apparently, the BOJ wants to wait for previous easing efforts to take effect before they take on new ones.

Aside from holding on to its current interest rate levels, the BOJ also decided to make 1 trillion JPY worth of one-year loans at a 0.1% interest rate available to financial firms in disaster-affected areas.

Lastly, it plans to broaden the range of financial assets that it accepts as collateral so institutions affected areas could borrow more easily. I don’t think they accept your mother-in-law as collateral though. Hey, they have to draw a line somewhere, right?

Of course, the BOJ’s policies alone will not be enough to solve Japan’s economic problems. In order for the economy to survive its latest trials, among other things it should have a government that’s at least as tight as the FX-Men.

After all, how could the government decide on an effective fiscal consolidation plan if they can’t even agree on who gets to be the leader? Recall that political parties in Japan (including Prime Minister Naoto Kan’s DPJ) have been bickering on who gets the seat of power in the country.

I guess we’ll have to wait and see if Naoto Kan and his gang will behave themselves long enough to decide how much the government is willing to spend in order to turn their economy around.

I hope they get started soon though, because the S&P has already warned that it might actually downgrade Japan’s credit rating if the country’s fiscal condition worsens on lack of a solid game plan.