Japanese Prime Minister Sanae Takaichi’s proposal to suspend the sales tax on food has unsettled bond markets, highlighting concerns that she lacks a clear funding plan and may push fiscal policy in a more expansionary direction.
Sales tax cut raises funding questions
Takaichi has proposed a two-year suspension of the sales tax on food and beverages, a measure expected to cost about ¥5 trillion ($31.6 billion) per year, according to the Finance Ministry.
That figure is only slightly less than Japan’s total spending on education, science, and culture combined.
While Takaichi has said the cut would be implemented without issuing additional deficit-covering government bonds, analysts say it remains unclear how the shortfall would be financed.
“It remains highly uncertain whether the consumption tax cut can be implemented without relying on government bond issuance,” said Ataru Okumura, a senior interest-rate strategist at SMBC Nikko Securities, in a Bloomberg report.
Analysts also question whether the measure would truly be temporary.
With a general election due in 2028, many believe restoring the tax would be politically difficult.
The proposal was announced on Monday as Takaichi seeks to shore up voter support ahead of the February 8 lower-house election, where inflation is expected to be a central issue.
Bond market reacts sharply
Investor concerns have already been reflected in government bond markets.
Japan’s 40-year government bond yield hit 4% on Tuesday, the highest level since the maturity was introduced in 2007 and the first time any Japanese sovereign yield has reached that level in more than three decades.
Yields across the curve rose sharply, with the 10-year yield climbing above 2.3%, its highest since 1999, and the 20-year yield jumping to around 3.35%.
“Markets are becoming more conscious of fiscal expansion,” said Takuya Hoshino, chief economist at Dai-ichi Life Research Institute.
“They are finding it harder to buy when they worry about a possible acceleration of expansionary fiscal policy going forward.”
Masahiko Loo, senior fixed income strategist at State Street Investment Management, said in a CNBC report, “Ultra-long JGB yields are being pushed higher not only by the structural supply–demand imbalance but also by a fresh re-pricing of term and risk premium as markets absorb a more expansionary fiscal stance and persistent inflation.”
He added, “This has revived the classic ‘Takaichi trade’ dynamic of stronger Nikkei, weaker JGBs and yen.”
Fiscal room debated amid elections
Supporters of Takaichi’s agenda argue Japan has more fiscal space than in the past, as inflation has lifted nominal growth and lowered the debt-to-GDP ratio.
Takaichi has stated that she aims to increase tax revenue without raising tax rates by promoting economic growth.
Inflation has already increased tax receipts, with Okumura estimating an annual boost of more than ¥2 trillion.
However, higher interest rates would also lift government debt-servicing costs by around ¥2 trillion, leaving only a limited net gain.
“New funding sources must be secured, or else the bulk of the funding will need to rely on new government bond issuance,” Okumura said.
Japan’s Growth Strategy Minister Minoru Kiuchi sought to calm markets on Tuesday, saying the administration would keep fiscal discipline in mind.
“We’ll continue to watch market moves with a high sense of urgency,” he said. “We’ll keep up efforts to maintain market trust.”
Meanwhile, opposition parties are pressing for even looser policies.
Japan’s largest opposition bloc is calling for a permanent elimination of the food sales tax, while the Centrist Reform Alliance has floated funding the cut through a sovereign wealth fund, though details remain unclear.
With Takaichi set to dissolve parliament and campaign on economic policy, investors are bracing for continued volatility as markets assess whether Japan is entering a more aggressive fiscal phase.
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