Japan’s 30-year government bond yield rose to around 3.3 percent last month, the highest level in decades. The surge in long-term bond yields signals that growth without structural reform is no longer sustainable at today’s borrowing costs, a reality overlooked by new Prime Minister Takaichi Sanae’s plan to revive growth through fiscal expansion and tax relief.
For decades, Japan has sustained the world’s highest public debt ratio, around 233 percent of GDP, without triggering another Greece-like crisis in Asia.
How? Its resilience stems from its debt structure: dominated by yen and owned by domestic creditors, with an average maturity of nine years. The Bank of Japan (BOJ), along with banks, insurance companies, and pension funds, hold over 80 percent of all Japanese government bonds (JGB). To allow the government to borrow cheaply and sustain its increasing government spending throughout decades of deflation, the BOJ continued to buy large shares of bonds from the market, eventually accumulating about half of all JGBs. This structure has saved Japan from currency fluctuations and refinancing pressure – miraculously without much inflation.
But those conditions are changing. Inflation has returned at 2 percent, and looks more lingering than in previous cycles. As a result, the BOJ has begun withdrawing its decade-long support for the bond market, cutting planned purchases by 11 percent in its latest quarterly plan. In a system where the central bank was the largest buyer, even a small pullback can lead to a visible rise in yields.
Japan is not facing an immediate financing crisis as its debt is domestically held, institutions are stable, and the BOJ retains the ability to intervene if needed. However, the BOJ cannot simultaneously sustain the government’s borrowing and tackle lasting inflation.
Had domestic investors stepped in to replace the BOJ, the transition might have been smooth, but few seem willing to do so. Regional and megabanks fear losses if interest rates rise and prefer to wait for clarity on the BOJ’s terminal rate. Life insurers have cut purchases of long-term JGBs by about 35 percent this fiscal year. With annual issuance projected to exceed 60 trillion yen at the current pace through 2027, weak domestic demand risks widening the void left by the BOJ’s retreat.
These decisions, however, reflect deeper structural constraints. Commercial banks’ remaining capacity is estimated at only about 120 trillion yen, far short of the 220 trillion yen the market would need to absorb if the BOJ offloaded even half its holdings, because rising rates would reduce the market value of their JGB portfolios and push them closer to regulatory interest-rate risk limits. Under Japan’s new economic-value-based solvency regime, life insurers must measure the asset-liability impact of interest-rate shocks and holding very long-duration JGBs raises their asset and liability management (ALM) risk and capital requirements, sharply limiting their willingness to buy more. With both banks and insurers constrained by risk and solvency rules, the gap left by the BOJ’s retreat will only be closed at higher long-term yields.
Takaichi’s government, meanwhile, is planning to pursue a fiscal strategy aimed at invigorating the economy: tax cuts to boost consumption, subsidies for industry, and expanded spending in defense and caregiving. The idea is that increasing government spending can reignite growth, making Japan’s debt burden more manageable.
Takaichi’s plan is not new. She has made clear her intention to revive Abenomics, the policy framework introduced under former Prime Minister Abe Shinzo. But Abenomics was built for a deflationary era – one of excess savings, weak demand, and stagnant prices. Applying it in today’s environment of persistent inflation and rising yields risks the opposite effect. The policy that once boosted exports and asset prices also undermined the BOJ’s independence and bloated its balance sheet. Continuing this playbook without adapting to new realities would be a costly mistake.
The fiscal burden will also only grow heavier. Japan’s aging population is putting pressure on the pension system and social spending. Takaichi and her supporters continue to cite “net debt,” a measure that subtracts the assets of social security funds, such as the Government Pension Investment Fund (GPIF), from total liabilities to claim Japan’s debt is less severe. However, assets such as GPIF assets are significant sources for future pension payments and cannot realistically be used to repay government debt.
The deeper problem is also being overlooked: Japan’s labor productivity ranks among the lowest in the OECD. Its lifetime employment system locks workers into firms and restricts mobility. What once supported stability now prevents labor from moving to more productive sectors. To reduce costs, firms increasingly rely on non-regular workers such as part-time and contract employees, who now account for nearly 40 percent of total employment. Despite efforts to integrate more women into the workforce, much of the increase has come through non-regular, low-skill positions. Japan needs to confront its labor shortage directly and accelerate reforms to end its lifetime employment system to expand the economy’s overall output. Without more workers or higher productivity, such policies risk pushing up prices rather than real output in the long run.
Japan now stands at a crossroads. One path combines rational fiscal expansion with structural reforms: embracing immigration, promoting skill- and talent-based hiring, further supporting and protecting women in the labor force. This is the path where public spending can genuinely raise future output. The other – reckless government spending without reform – leads to higher yields, rising interest payments, shrinking fiscal space, and slower growth. The long end of the yield curve will continue to steepen, and passing the debt burden to the future generation is nothing more than a pain relief.
Image credit: Shutterstock ID 2473043309. This article was originally published in The Diplomat.
Yoshihiro Komori
Yoshihiro Komori is a Master of Science in Foreign Service candidate at Georgetown University, specializing in international development. He is broadly interested in international development and the macroeconomic forces that shape long-term growth, fiscal sustainability, and economic resilience.