Japan Wants to Cap New Debt at ¥40 Trillion — But Its Interest Bill Is Becoming the Bigger Problem

TOKYO — Japan is trying to draw a line under how much new debt it takes on next year, but rising borrowing costs and an ambitious spending agenda could make that promise increasingly difficult to keep.

Prime Minister Sanae Takaichi said her government aims to hold new government bond issuance to around ¥40 trillion, or roughly US$251 billion, in the fiscal 2027 budget, according to an interview with Japan’s Yomiuri newspaper reported by Reuters.

The target comes at a critical moment for the world’s most indebted major economy, as government ministries seek record spending and higher interest rates make Japan’s enormous debt stock increasingly expensive to finance.

Record Budget Requests Are Adding Pressure

Japan’s fiscal 2027 budget requests from ministries and government agencies are expected to exceed ¥130 trillion for the first time, marking a record for a fourth consecutive year.

That would be substantially higher than roughly ¥122 trillion in requests for the current fiscal year.

But the headline increase does not necessarily mean government spending is expanding by the same amount.

Takaichi’s administration is attempting to move spending that has frequently been added later through supplementary budgets into the main annual budget from the beginning. That could make the initial budget appear much larger while providing a clearer picture of the government’s actual spending plans.

Takaichi pointed to fiscal 2025 as evidence that the government could control borrowing even when spending increased.

Higher-than-expected tax revenue that year helped absorb some additional expenditure, allowing new bond issuance to remain at around ¥40 trillion.

“We will continue with the same approach going forward,” Takaichi told Yomiuri, according to Reuters.

But ¥40 Trillion Would Still Be a Significant Increase

There is an important catch.

Japan currently plans to issue about ¥32.7 trillion in new debt in fiscal 2026.

A return to roughly ¥40 trillion in fiscal 2027 would therefore represent a sizable increase in new borrowing compared with the current budget.

Toru Suehiro, chief economist at Daiwa Securities, said that if Takaichi is using the roughly ¥40.3 trillion issued after the fiscal 2025 budget as her benchmark, the new target could be regarded as somewhat expansionary rather than a major step toward fiscal tightening.

And borrowing volumes are only part of Japan’s challenge.

Japan’s Interest Bill Is Surging

For years, Japan was able to carry an extraordinary amount of government debt partly because interest rates remained extremely low.

That environment is changing.

Japan’s Finance Ministry is expected to seek around ¥36.6 trillion for debt-servicing costs in fiscal 2027, which would be a record and about 17% higher than the amount allocated in the current fiscal year’s initial budget.

Around ¥16.6 trillion would go toward interest payments, while approximately ¥20 trillion would be allocated for debt redemptions, according to Bloomberg reporting carried by The Japan Times.

The Finance Ministry has been considering an assumed interest rate of 3.8% when calculating future debt-servicing expenses — the highest such assumption in 29 years.

Japanese government bond yields have also climbed sharply, with the benchmark 10-year yield recently reaching around 2.945%, near a three-decade high.

That matters because every increase in refinancing costs gradually feeds into a much larger interest bill for the government.

Japan Is Already Carrying More Than ¥1,300 Trillion in Government Debt and Borrowings

Official Finance Ministry figures show just how large the numbers have become.

As of June 30, 2026, Japan had approximately ¥1,346.7 trillion in outstanding central-government bonds and borrowings.

Government bonds alone accounted for about ¥1,211.7 trillion of that total.

Even relatively modest increases in borrowing costs can therefore have enormous budgetary consequences over time.

That could complicate Takaichi’s effort to combine aggressive economic support with assurances that Japan will maintain fiscal discipline.

The Food Tax Cut Creates Another ¥5 Trillion Question

Another major issue is Takaichi’s plan to cut Japan’s consumption tax on food as part of her response to rising household living costs.

The government has backed a proposal that would reduce the food consumption-tax rate from 8% to 1% for two years beginning in April 2027, with a benefit designed to compensate households for the remaining tax burden.

The measure is expected to reduce government revenue by approximately ¥5 trillion per year.

That leaves Tokyo with a politically difficult question: where will the missing money come from?

Takaichi told Yomiuri that Japan could potentially tap assets associated with its massive foreign-exchange reserves as part of the funding solution.

Japan holds a foreign-exchange reserve war chest worth around US$1.3 trillion, assets that also play a critical role in the government’s ability to intervene in currency markets when the yen comes under extreme pressure.

Any move involving those assets is therefore likely to attract close scrutiny from investors.

Why Markets Will Be Watching Japan’s Budget Closely

The debate surrounding Japan’s fiscal 2027 budget is no longer simply about whether Tokyo spends more or less.

Investors will be watching whether the government can simultaneously finance new economic programmes, deliver tax relief, contain new borrowing and reassure bond markets that Japan’s debt trajectory remains manageable.

That balancing act has become more difficult as interest rates rise.

Japan spent decades operating in an environment where extremely cheap borrowing softened the immediate consequences of its growing debt pile.

Now, higher bond yields mean fiscal decisions can have a much faster impact on debt-servicing costs, investor confidence and potentially the yen.

Takaichi’s ¥40 trillion bond target is intended to demonstrate that her government can pursue expansionary policies without allowing borrowing to spiral.

But the coming budget negotiations will determine whether that number represents a genuine fiscal ceiling — or simply a target that becomes harder to defend as spending demands and interest costs continue climbing.

And that may ultimately be the bigger test for Japan: not how much new debt it issues next year, but how expensive its existing mountain of debt becomes to carry.