Japan has once again taken a familiar and inherently risky route: underwriting economic and political ambition through large-scale sovereign borrowing. In its latest supplementary budget, Tokyo authorized the issuance of roughly 18 trillion yen (US$117.5 billion) in new government bonds.
For an economy of Japan’s scale, the figure may not appear extraordinary. Yet placed against a public debt burden that last December surpassed 1.3 quadrillion yen — more than twice the nation’s gross domestic product — it is structurally consequential, warranting the potentially punitive attention of so-called “bond vigilantes.”
For decades, Japan functioned as though debt carried negligible cost. Ultra-low interest rates, massive bond buying by the Bank of Japan and a dependable domestic investor base insulated the government from conventional market discipline.
That protective architecture is now eroding. The BOJ has raised its policy rate to the highest level in 30 years, formally closing the era of ultra-cheap money that underpinned fiscal stability since the 2008 global financial crisis. The bond market has reacted accordingly.
Yields on 10-year Japanese government bonds have climbed to levels not seen since before the 2008 global financial crisis. This shift is more than a mechanical response to tighter monetary policy. It reflects a psychological recalibration among investors reassessing Japan’s fiscal trajectory.
Each additional yen of borrowing now carries a higher marginal cost. With debt already immense in scale, even modest interest rate adjustments can magnify into material fiscal pressure over time.
Conflicting market signals
This is where fiscal strategy intersects directly with political calculation. The administration of Sanae Takaichi has framed expanded borrowing and elevated spending as part of a broader national project to shield household purchasing power, reinforce domestic industry, and restore Japan’s economic self-confidence.
The language is suffused with economic nationalism, asserting that the state must act decisively and resist what it portrays as excessive deference to market anxieties. Sovereign bonds, in this narrative, are not merely financing tools but expressions of national resolve.
Yet fiscal nationalism invariably has a more opaque side. When expansive state spending is accompanied by populist overtones, wide-ranging subsidies, incentives lacking rigorous targeting and rhetorical resistance to budgetary restraint, financial markets interpret the signal differently.
Investors do not underwrite intention; they evaluate consistency, institutional credibility and medium-term sustainability. At this juncture, Japan risks entering more delicate market territory.
The Takaichi government is effectively sending two messages at once. To domestic audiences, it signals protection against economic strain and a willingness to deploy public resources assertively. To global markets, it insists fiscal responsibility remains intact.
Verbal commitments against “irresponsible bond issuance” lose coherence when supplementary budgets rely heavily on new debt. Markets, of course, assess direction as much as data.
When fiscal policy appears increasingly shaped by short-term political imperatives — preserving approval ratings, calming social unease and invigorating nationalist sentiment — confidence can erode either incrementally or in a flash.
To be sure, Japan is not facing an imminent crisis. However, it is gradually testing the durability of its most valuable asset: its reputation as a heavily indebted yet disciplined sovereign borrower. Rising bond yields function as a form of market referendum. Higher yields indicate investors are demanding greater compensation for perceived risk.
Should this trajectory continue, fiscal space will narrow automatically, compelling the government to choose between expenditure restraint and escalating debt-servicing costs. In that environment, fiscal populism ceases to be a stabilizer and becomes a risk accelerant.
Regional implications and systemic risk
Developments in Japan’s bond market quickly impact local currency markets. In theory, higher policy rates and bond yields should support the yen. In practice, the outcome is less straightforward.
If markets interpret rising yields as evidence of orderly normalization, the currency could strengthen. If, however, the increase is viewed as symptomatic of fiscal strain or policy inconsistency, the yen may weaken instead.
In recent months, the yen has traded without clear direction, reflecting uncertainty over Japan’s macroeconomic strategy. A softer currency may aid exporters, but it simultaneously raises import costs and exacerbates inflationary pressures — an uncomfortable irony for a government positioning itself as guardian of purchasing power.
Beyond domestic considerations, yen volatility carries regional ramifications. Japan remains a financial anchor for Asia, serving as a principal funding currency for carry trades and underpinning capital flows to Southeast Asia, South Korea and other Asian markets.
If confidence in Japan’s policy coherence falters and currency volatility intensifies, the effects will reverberate far and wide. Capital flows could reverse course. Regional bond markets may churn with turbulence. Overall market volatility could increase at a moment when the global economy is especially jittery and fragile.
That is to say, Japan’s fiscal trajectory is not a purely domestic concern. It constitutes a systemic variable for Asia’s broader financial stability. Economic populism articulated in Tokyo resonates in Jakarta, Seoul and Bangkok with tangible consequences. That sensitivity explains why markets react so swiftly to every signal from the Japan’s government and central bank.
Ultimately, the central wager facing the Takaichi administration is not whether added stimulus proves politically advantageous. It is whether Japan can sustain market trust while navigating domestic political pressures.
Sovereign bonds have become the arena where politics and markets are confronting each other directly. Historical precedent suggests that over the long term, markets tend to assert the final judgment.
Japan still possesses both time and residual credibility to recalibrate its fiscal course. The warning, however, is unmistakable: the longer fiscal populism is intertwined with economic nationalism, the greater the eventual cost borne not only by Japan, but by Asia writ large.
Ronny P Sasmita is senior international affairs analyst at the Indonesia Strategic and Economics Action Institution, a Jakarta-based think tank.
