Japan seeks growth without more debt in record budget gamble

On December 26, Japan’s government unveiled a record budget for the next fiscal year while seeking to curb debt issuance, underscoring the challenge Prime Minister Sanae Takaichi faces in stimulating growth as inflation remains above the central bank’s target.

The cabinet approved a draft budget of 122.3 trillion yen ($783 billion) for the fiscal year starting in April, per Reuters.

The plan caps new bond issuance and cuts the share of spending financed by fresh debt to the lowest level in nearly three decades, in an effort to calm market concerns over Japan’s heavy debt burden.

The policy backdrop remains complex. Core inflation in Tokyo stayed above the Bank of Japan’s 2% target in December, even as the yen remained weak, reinforcing expectations that the central bank will continue raising interest rates. The budget, a cornerstone of Takaichi’s “proactive” fiscal policy, is expected to support consumption but also risks fuelling inflation and further straining public finances.

Investor unease over fiscal expansion has pushed super-long government bond yields to record highs and weighed on the yen. Finance Minister Satsuki Katayama said the draft budget balances spending priorities with fiscal discipline. “We believe we have been able to draft a budget that not only increases allocations for key policy measures but also takes fiscal discipline into account, achieving both a strong economy and fiscal sustainability,” she said.

Katayama added that new bond issuance will be kept below 30 trillion yen ($190 billion) for a second consecutive year, with the debt-dependence ratio falling to 24.2%, the lowest since 1998. Signs of fiscal restraint helped ease market pressure, with the 30-year Japanese government bond yield retreating from a record 3.45% after reports that issuance of super-long bonds next year may be cut to the lowest level in 17 years.

While the budget was smaller than initially feared, Saisuke Sakai of Mizuho Research & Technologies warned that political fragmentation could prompt a large supplementary budget next year, reviving concerns over yen weakness and rising inflation. “It’s too optimistic to assume that the current environment will persist,” he said.

Spending is also being driven up by higher debt-servicing costs and a 3.8% increase in military outlays to 9 trillion yen ($60 billion), reflecting Takaichi’s more assertive defense policy and US calls for allies to spend more on security.

Data released on Friday showed Tokyo’s core consumer price index, excluding fresh food, rose 2.3% in December from a year earlier, below expectations for 2.5% and down from 2.8% in November. Another closely watched index excluding both fresh food and fuel eased to 2.6% from 2.8%, supporting the BOJ’s view that inflation may dip below target before picking up again on stronger demand.

However, some analysts cautioned that renewed yen weakness could keep price pressures elevated. “Today’s data suggests food inflation may be peaking. But the weak yen may give firms an excuse to resume price hikes for food, which may keep inflation elevated,” said Yoshiki Shinke of Dai-ichi Life Research Institute.

Separate data showed factory output fell 2.6% in November, worse than forecasts for a 2.0% decline, due to cuts in automobile and lithium-ion battery production.

Last week, the BOJ raised its policy rate to 0.75%, a 30-year high, as it continues to unwind years of aggressive monetary easing. Governor Kazuo Ueda has signaled readiness to raise rates further if economic conditions improve, backed by solid wage growth. Even so, persistent selling of the yen has prompted Katayama to warn of possible currency intervention, saying the government was “alarmed as we are clearly seeing one-sided, sharp moves” in the yen.

By Tamilla Hasanova