Japan's Fiscal Expansion Unleashes Debt Spiral

Japan's government debt-servicing costs are set to reach an all-time high next fiscal year, consuming nearly 30% of the total budget. The country's enormous public debt, accumulated during the era of ultra-low interest rates, has become a major concern for policymakers. As interest rates rise amid the government's continued fiscal expansion, the assumed interest rate used to calculate government bond interest payments has been raised from 3.0% in the fiscal 2026 budget to 3.8%. This reflects the recent steep rise in long-term Japanese government bond yields.

The Ministry of Finance plans to include a record $230 billion in debt-servicing costs in its budget request for fiscal 2027, which runs from April 2027 through March 2028. This would be an increase of $33.3 billion over the previous record set in the initial fiscal 2026 budget, with the largest increase in 20 years at 17%. The total budget requests from government ministries are also expected to surpass $817 billion for the first time.

The rising interest rates and increasing debt-servicing costs have created a vicious cycle, where fears of fiscal deterioration drive long-term rates higher, and those higher rates increase debt-servicing costs further. This has raised concerns over Japan's ability to allocate funds to other areas, including growth-oriented investment. The Bank of Japan may face a constrained ability to tighten monetary policy due to the government's interest burden.