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By Joseph Moss, International Banker<\/p>\n
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The landslide election win for incumbent Prime Minister Sanae Takaichi and her Liberal Democratic Party (LDP) on February 8 represented a hugely significant development for Japan. The victory saw the LDP secure 316 out of 465 seats in the lower house\u2014the largest result for a single party in post-war Japanese history\u2014granting Takaichi a two-thirds supermajority, while its coalition partner, the Japan Innovation Party (JIP, or Ishin), claimed an additional 36 seats to give the ruling coalition an unusually strong governing mandate. But with the war in the Persian Gulf gravely affecting Japan\u2019s energy security and Takaichi strongly pushing for fiscal expansion, concerns about Japan\u2019s economic health over the coming months are becoming increasingly well founded.<\/p>\n
Dubbed \u201cSanaenomics\u201d, the new Takaichi administration seeks to implement a pro-growth agenda, largely through significant public spending and investment in key strategic industries. Indeed, it is the pronounced fiscal expansion that has most clearly defined Takaichi\u2019s economic stance since taking office last October as Japan\u2019s 104th prime minister. Of the \u00a521.3 trillion ($135.5 billion) economic-stimulus package (approximately 3.7 percent of gross domestic product [GDP]) that was approved in November, \u00a517.7 trillion has been earmarked for direct spending.<\/p>\n
Japan\u2019s industrial sector is the main recipient of this spending boost, with artificial intelligence (AI), semiconductors, quantum technology and shipbuilding all beneficiaries as Tokyo seeks to unleash a massive wave of public investment. Companies are likely to be offered various incentives through these spending measures to facilitate that investment surge.<\/p>\n
Government expenditure on defence is also expected to be significantly bolstered. The 2021-24 administration of Fumio Kishida pledged to boost spending in this area from around 1 percent of GDP to 2 percent, with overall figures rising from \u00a55.2 trillion in fiscal year 2022 to \u00a58.9 trillion by 2027. Now, Takaichi looks set to further bolster the defence budget, although exact figures have not yet been published.<\/p>\n
\u201cIn January this year, the United States issued its own National Defense Strategy that urges allies to raise security-related spending to 5 percent of GDP and \u2018core\u2019 military spending to 3.5 percent of GDP,\u201d the Carnegie Endowment for International Peace recently noted. \u201cIf, taking US expectations into account, Takaichi were to aim\u2014ten years from now, in the FY2036 budget\u2014for \u2018core\u2019 defence spending equal to 3.5 percent of GDP, then with Japan\u2019s nominal GDP in 2025 at roughly \u00a5630 trillion, 3.5 percent would amount to about \u00a522 trillion.\u201d<\/p>\n
What\u2019s more, the new government is planning to introduce legislation this coming autumn to suspend the 8-percent consumption tax on food for two years to ease inflationary pressures on households and thus alleviate the soaring cost-of-living. The policy is estimated to cost around 0.7 percent of GDP per year, if approved.<\/p>\n
This series of unambiguously expansionist fiscal measures has raised much concern in Japan, the world\u2019s most indebted advanced economy, with public debt currently exceeding 235 percent of GDP. If fully implemented, Sanaenomics\u2019 policies will substantially increase that burden, particularly if growth does not accelerate sufficiently to offset higher borrowing and\/or reduced tax revenues.<\/p>\n
\u201cJapan\u2019s fiscal stance could loosen further because the LDP\u2019s supermajority will enable the new government to implement policies with few obstacles. In particular, the two-thirds majority will enable the LDP to override Upper House vetoes where its coalition is in the minority,\u201d Fitch Ratings warned in a February 9 report. \u201cOur fiscal deficit forecast widens from 1.4 percent of GDP in FY24 to 2.4 percent in FY25 (year ending March 2026) and rises towards 3.7 percent by FY27. A larger fiscal package would be the main channel for deficits to overshoot our forecasts.\u201d<\/p>\n
January saw clear signs of market panic in response to Takaichi\u2019s ambitious fiscal agenda, as a selling frenzy of longer-dated government bonds spiked yields. The 30-year JGB (Japanese Government Bonds) Treasury yield, for instance, skyrocketed from around 3.48 percent on January 16 to an all-time high of almost 3.88 percent on January 20, while the 40-year surged by more than 25 basis points to reach a record above 4.21 percent. And with fiscal worries still far from over, the 10-year yield touched its highest level since 1998 on April 10, above 2.44 percent.<\/p>\n
The interaction between fiscal policy and monetary policy will also be central to Japan\u2019s economic prospects during the Takaichi era. While fiscal policy is expanding, the Bank of Japan (BoJ) is seeking to tighten monetary conditions, having raised rates on four separate occasions since March 2024 to leave its benchmark short-term rate at 0.75 percent\u2014the highest level since September 1995. Indeed, a widening divergence between the government\u2019s and central bank\u2019s policies could add upward pressure on bond yields, further inflating the cost of Japan\u2019s public debt, especially given that its average residual maturity is estimated at around nine years.<\/p>\n
\u201cIn other words, approximately one-ninth of Japan\u2019s debt matures each year and will have to be refunded at higher yields. For the fiscal year ending March 31, 2026, Japan\u2019s Ministry of Finance estimates that \u00a5135.8 trillion of JGBs will need to be issued to finance maturing debt,\u201d according to Erik Norland, managing director and chief economist of CME Group. \u201cThis amounts to 20.4 percent of GDP worth of debt\u2014in a single year. For every 1 percent rise in the average interest rates, this automatically adds 0.2 percent of GDP to Japan\u2019s cost of funding and budget deficit.\u201d<\/p>\n
The Takaichi administration\u2019s pro-growth policies should temper Japan\u2019s debt woes, which Fitch predicted would help contain any near-term deterioration in the country\u2019s sovereign rating. \u201cJapan\u2019s fiscal position has improved materially in the past several years, with narrowing fiscal deficits and higher nominal GDP growth reducing government debt to a forecast of just under 200 percent of GDP in the current FY25 from 222 percent in FY20,\u201d the credit-ratings agency added. \u201cWithout new major fiscal packages, we forecast general government debt to GDP to decline further to around 195 percent over the next five years, even accounting for higher post-election deficits. A sharper rise in yields or weaker nominal growth would erode that buffer, particularly if combined with more expansionary fiscal settings than we currently expect.\u201d<\/p>\n
Japan\u2019s weak currency remains a distinct challenge, one which Takaichi will be keen to address. Given the significant gap between US and Japanese interest rates, however, this may prove difficult to resolve. This gap has been instrumental in prompting investors to engage in the \u201cyen carry trade\u201d, whereby they borrow in Japan at a low rate and invest in the United States to earn a much higher return.<\/p>\n
While that gap has narrowed over the last year, as the BoJ has continued to raise interest rates and the Federal Reserve (the Fed) has eased its monetary policy, the yen nonetheless weakened to multi-year lows during the first quarter. As the Japan Times recently noted, a stable currency is key to a strong and stable economy. \u201cHistorically, Japan has welcomed a weaker yen since that made its exports more competitive,\u201d an editorial by the paper stated. \u201cAs the country has moved more of its supply chains overseas, however, a weak yen has become a drag on growth since it raises the price of imports. This has squeezed households as well, as they have faced stagnant wages.\u201d<\/p>\n
The most concerning of those imports at present is energy, with Japan dependent on overseas sourcing for around 85 percent of its energy consumption. With the Middle East responsible for a staggering 94 percent of Japan\u2019s crude-oil imports (including the United Arab Emirates [UAE] at 43 percent and Saudi Arabia at 39 percent)\u2014and with the closure of the maritime Strait of Hormuz, which crucially moves the overwhelming bulk of energy out of the region and into Asia and Europe\u2014the resulting price spikes in oil and gas will almost certainly push inflation higher, adding further upward pressure on bond yields.<\/p>\n
Takaichi has already approved the release of 50 days\u2019 worth of oil and recently confirmed an additional release next month. \u201cTo ensure the stable supply of crude oil, we will release, starting in early May, the equivalent of roughly 20 days\u2019 worth from the national reserves,\u201d she said on April 10.<\/p>\n
While Japan\u2019s inflation slowed in February to 1.3 percent from 1.5 percent in January, the country\u2019s central bank warned that inflation will likely increase due to sharply rising crude-oil prices. \u201cGovernment support was a key factor in February\u2019s dip,\u201d according to Stefan Angrick of Moody\u2019s Analytics, who also cautioned that \u201cthe relief likely won\u2019t last\u201d.<\/p>\n
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