【Text by Yoshimori Koyama, Translation by Whale Life】

In October 2025, the yield on Japan's 30-year government bond rose to about 3.3%, reaching a high not seen in decades. The sharp increase in long-term bond yields indicates that the model of economic growth driven solely by spending increases, without structural reforms, has become unsustainable — a reality that the economic plan of Japan's new Prime Minister, Taro Kono, which aims to revive growth through fiscal expansion and tax cuts, ignores.

For decades, Japan has maintained the highest public debt ratio in the world — approximately 233% of GDP — yet it did not trigger a debt crisis similar to Greece's in Asia.

Why? A large part of Japan's resilience depends on its debt structure: denominated in yen, mainly held by domestic creditors, with an average maturity of about nine years. The Bank of Japan (BOJ) and institutions such as commercial banks, insurance companies, and pension funds jointly hold more than 80% of Japanese government bonds. To allow the government to borrow at extremely low costs and maintain growing fiscal expenditures under prolonged deflation, the BOJ has continuously purchased large amounts of bonds from the market, accumulating nearly half of the total bond stock so far. This structure has allowed Japan to avoid exchange rate fluctuations and refinancing pressures — even miraculously avoiding significant inflation.

But this foundation is beginning to shake. Japan's economy has re-entered an era of inflation, with a rate of 2% that appears to be more persistent than previous cycles. In response, the BOJ has started to withdraw from its decade-long bond market support policy, cutting its bond purchase plan by 11% in the last quarter. In a system where the central bank was once the largest buyer, even a small withdrawal can cause a significant rise in yields.

Because the debt is mainly held domestically, the financial institutions are stable, and the central bank retains the necessary intervention capacity, Japan has not faced an immediate financing crisis. However, the BOJ can no longer simultaneously meet the government's borrowing needs and suppress ongoing inflation.

If domestic investors are willing to take over the role of the BOJ, this transition could proceed smoothly, but the reality is that there are few takers. Local and major banks are wary of losses from rising interest rates and prefer to wait for the final interest rate target to become clearer; life insurance companies reduced their purchases of long-term government bonds by about 35% this fiscal year. At the current rate of bond issuance, it is estimated that Japan's annual bond issuance will exceed 60 trillion yen by 2027, and the weakness in domestic demand may amplify the vacuum left after the BOJ's exit.

On November 21 local time, the Japanese cabinet approved an economic stimulus package worth 21.3 trillion yen.

These decisions also reflect deep-seated structural constraints. It is estimated that the remaining debt capacity of commercial banks is only about 120 trillion yen, far below the approximately 220 trillion yen required if the BOJ were to sell off half of its holdings. The reason is that as interest rates rise, the market value of the bonds they hold will fall, bringing them close to the risk limit of regulatory interest rates. Under Japan's newly introduced capital adequacy regulation based on economic value, life insurance companies must assess the impact of interest rate shocks on their balance sheets, and holding ultra-long-term government bonds significantly increases their asset-liability management (ALM) risks and capital requirements, greatly suppressing their willingness to purchase long-term bonds. Since banks and insurance companies are constrained by risk and solvency rules, the gap left by the BOJ's withdrawal will ultimately have to be filled by higher long-term yields.

At the same time, the Kishida administration is planning to implement a fiscal strategy aimed at revitalizing the economy: stimulating consumption through tax cuts, providing industry subsidies, and expanding defense and care spending. Its logic is that increasing government spending will activate growth, thereby enhancing the sustainability of Japan's debt.

But this approach is nothing new. Kishida has clearly stated that he wants to restart "Abenomics" — the policy framework proposed by former Prime Minister Shinzo Abe. However, Abenomics was designed for the deflationary era: a period characterized by excess savings, insufficient demand, and stagnant prices. Applying this strategy to the current environment of sustained inflation and rising interest rates may backfire.

The policies that once stimulated exports and raised asset prices may now erode the independence of the BOJ and inflate its balance sheet. If old strategies continue to be used without adjusting to the new reality, the cost could be severe.

Japan's fiscal burden will only grow. An aging population continues to squeeze the pension system and social spending. Kishida and his supporters frequently cite the "net debt" indicator — which subtracts the assets of social security funds (such as the Government Pension Investment Fund, GPIF) from total liabilities — to downplay the severity of the debt problem. However, assets like those of GPIF are essential sources for future pension payments and cannot be used to repay government debt.

Deeper structural issues are also being ignored: among OECD countries, Japan's labor productivity is at the bottom, and lifetime employment locks workers into companies. While it once provided stability to the labor market, it now hinders the movement of labor to high-productivity sectors.

To cut costs, Japanese companies increasingly rely on non-regular employees, such as part-time and contract workers, who now account for nearly 40% of the total workforce. Although the Japanese government has made significant efforts to bring more women into the labor market, most of the new jobs added are concentrated in informal, low-skill positions. Japan must confront the reality of labor shortages, accelerate the dismantling of the lifetime employment system, and push for structural reforms to expand overall economic output. Otherwise, implementing such fiscal policies without labor growth or productivity improvements may result in rising prices rather than actual output in the long run.

Japan stands at a crossroads: one path combines rational fiscal expansion with structural reforms — including opening up to immigration, promoting recruitment models based on skills and talent, and strengthening women's labor rights — a path that could truly enhance future output through public spending; the other path is to continue uncontrolled government spending without reform, leading to rising yields, heavier interest burdens, shrinking fiscal space, and further slowing economic growth. The long-term yield curve will continue to steepen, and shifting the debt burden onto future generations is merely a temporary painkiller.

(The original article was published on the Japanese "Foreign Policy" comment website, titled "Taro Kono's Economic Growth Gamble: 30-Year Treasury Bonds Sound the Alarm." The translation is for readers' reference only and does not represent the views of Observer Net.)

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