FOCUS: Japan’s Fiscal Policy Shift Hinges on Strong Growth

Tokyo, Sept. 2 (Jiji Press)–The government of Prime Minister Sanae Takaichi marked a major shift in Japan’s fiscal management strategy with its first Basic Policy on Economic and Fiscal Management and Reform, adopted in July. The government said it would tolerate a temporary deterioration in the primary budget balance, moving away from its previous emphasis on achieving a surplus in a single fiscal year. Instead, it has adopted a steady reduction in the ratio of combined central and local government debt to gross domestic product as its main fiscal target. Takaichi aims to create room for proactive government spending as part of her broader drive to strengthen the economy. However, an approach that depends heavily on expansionary fiscal measures–and on the assumption that strong economic growth can be sustained–carries significant risks. Policy Reversal Japan’s combined central and local government debt is projected to reach 1,293 trillion yen at the end of fiscal 2026. The debt-to-GDP ratio is expected to stand at 187.6 pct, remaining the highest among major advanced economies. To reduce the ratio, previous governments prioritized achieving a primary budget surplus, which would enable the government to finance policy spending, excluding debt-servicing costs, without issuing new debt. In the previous fiscal year’s basic policy, the government said it would seek to meet the target “as early as possible during fiscal 2025-2026.” Cabinet Office estimates, however, projected primary budget deficits of about 200 billion yen in fiscal 2025 and around 1.2 trillion yen in fiscal 2026, suggesting that the target is difficult to achieve. Against this backdrop, the latest basic policy dropped the goal of achieving a primary budget surplus in a single fiscal year, a benchmark that had been central to Japan’s fiscal consolidation efforts for about a quarter of a century. Instead, the government will “assess the (primary budget) balance over multiple years.” As part of its growth strategy, the Takaichi administration has unveiled plans for more than 370 trillion yen in public- and private-sector investment through fiscal 2040. To help finance the ambitious initiative, the government accepted a temporary deterioration in the primary budget balance. Reflecting this shift, the term “fiscal consolidation” was removed from the basic policy. “Wishful Thinking” Previously, the government’s objective was to “steadily reduce” the debt-to-GDP ratio, “initially toward its pre-COVID-19 pandemic level,” after achieving a primary budget surplus. Under the latest policy, however, reducing the ratio has been elevated to the government’s main fiscal target, taking precedence over balancing the budget. As nominal GDP serves as the denominator, the ratio can decline even if outstanding debt continues to grow. The government aims to expand nominal GDP to around 1,100 trillion yen by fiscal 2040 through growth fueled by public- and private-sector investment. Cabinet Office estimates show that under the growth strategy realization scenario, which assumes the strongest economic growth, the debt-to-GDP ratio would continue to decline through fiscal 2040. Daiwa Institute of Research Ltd., however, warned that the scenario assumes productivity growth exceeding that of the United States. Under a scenario that takes technological and market uncertainties into account, the ratio would turn upward from fiscal 2037. Under another scenario, which assumes that current trends continue without generating robust private investment, it would start climbing in fiscal 2032. Opposition parties have harshly criticized the policy. In a joint statement, the Centrist Reform Alliance, the Constitutional Democratic Party of Japan and Komeito said: “No target year has been set. It is entirely unclear what criteria will be used to determine whether the target has been achieved.” At a meeting of the House of Representatives Budget Committee, CRA Secretary-General Takeshi Shina denounced the government’s approach. “The debt-to-GDP ratio changes depending on GDP growth and increases in long-term interest rates, but the government cannot control these factors,” he said, adding that the projection of a steady decline in the ratio amounted to “wishful thinking.” Daiwa noted that, under all three scenarios presented by the Cabinet Office, the effective interest rate on government debt would exceed the nominal economic growth rate sometime in the early to mid-2030s. Outstanding debt could swell to between 1,772 trillion yen and 1,832 trillion yen by fiscal 2040. “It is necessary to bring the underlying primary budget balance into equilibrium or surplus during the 2020s, while the debt-to-GDP ratio may still decline despite a primary budget deficit,” the institute warned. Doing so, it said, would leave Japan better “prepared for the 2030s.” END [Copyright The Jiji Press, Ltd.]