The Japanese government has approved its largest-ever initial budget for the upcoming fiscal year, balancing a massive military buildup and ballooning social security costs against the reality of rising interest rates.
Prime Minister Sanae Takaichi’s Cabinet approved a record ¥122.31 trillion ($783 billion) draft budget for fiscal 2026 on Friday (26 December). The plan, which marks the first full-scale budget under Takaichi’s administration, represents a 6.3% increase over the current year. While the government projects record tax revenues, the budget still relies heavily on new debt, reflecting the Prime Minister’s “proactive” fiscal stance aimed at spurring growth despite Japan being the world’s most debt-burdened advanced economy.
The budget is built around three major pillars: social welfare for an aging population, a historic defense expansion, and the soaring cost of servicing the nation’s debt.
- Social Security: Spending will hit a record ¥39.06 trillion, driven by rising medical costs and the needs of a shrinking workforce.
- Defense Spending: A record ¥9.04 trillion ($58 billion) has been set aside for the military. This includes funding for the “SHIELD” coastal defense system, long-range missiles to deter regional threats, and the purchase of unmanned drones.
- Debt Servicing: For the first time, debt-related costs will exceed ¥30 trillion, reaching an estimated ¥31.3 trillion. This surge comes from the Bank of Japan’s shift away from ultra-loose monetary policy, with the Finance Ministry raising the provisional interest rate used for budget calculations to 3.0%, the highest since 1997.
On the revenue side, the government expects tax receipts to reach a record ¥83.74 trillion thanks to solid corporate earnings. But to cover the remaining gap, Japan will issue ¥29.58 trillion in new government bonds. While this keeps new debt below the ¥30 trillion mark for a second year, the total outstanding debt is projected to hit ¥1,344 trillion by the end of March 2027, nearly double Japan’s GDP.
“I believe this budget strikes a balance between strengthening the economy and ensuring fiscal sustainability,” Prime Minister Takaichi said after the Cabinet meeting. She emphasized the spending is “responsible and proactive” to help households cope with persistent inflation.
“The size of the initial budget is a record, which is negative for yields,” noted Koji Takeuchi, Senior Research Fellow at Itochu Research Institute. “However, keeping new bond issuance in check suggests the government is wary of further market turmoil.”
The budget reflects a major shift in Japan’s post-war security posture. The 9.4% jump in defense spending marks the fourth year of a five-year program to double the military budget to 2% of GDP. This acceleration is largely seen as a response to China’s “strategic challenge” and follows a pledge Takaichi made to boost capabilities during high-level talks with US officials earlier this year.
The draft budget will be submitted to the Diet (parliament) in January, with the government aiming for approval before the new fiscal year begins on April 1, 2026. Investors remain cautious. With the 10-year bond yield recently touching 2.1% (a 26-year high), any perceived slip in fiscal discipline could trigger more volatility in the Japanese bond market.
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