Takaichi’s fiscal push could lift growth — and Japan’s already-rising interest bill

Japanese Prime Minister Sanae Takaichi is pushing ahead with her ambitious plan to cut the consumption tax on food, a move that could potentially stimulate economic growth. If successful, this policy would mark the first reduction in the tax since its inception in 1989. Takaichi aims to have cabinet approval by this month, with the bill to be introduced in parliament during the autumn of the same year.

The proposed tax cut would reduce the rate from 8% to 1% for food items, effective from April 2027, with cash payments to offset the impact for specific groups.

The crux of Takaichi's economic strategy lies in this food-tax cut, which she believes could encourage stronger consumption and ultimately boost growth. The plan has an estimated value of 370 trillion yen (2.35 trillion) in public-private investment through 2040 fiscal year, with the government shedding 4.4 trillion yen in revenue as a result.

However, the plan has drawn criticism from within her own party, former ministers Taro Kono and Takeshi Iwaya, as well as former Prime Minister Shigeru Ishiba, who walked out of the meeting.

Former defense minister Taro Kono warns that the plan could potentially undermine Japan's fiscal position, leading to higher interest rates and a weaker yen. The International Monetary Fund has also expressed concerns, stating that the tax cut is an untargeted measure that would erode fiscal space and increase fiscal risks. Despite these concerns, Takaichi is resolute in her stance, pledging not to use deficit-financing bonds to fund her initiatives, instead relying on budget adjustments, tax breaks, and public funds.

Japan, already grappling with one of the highest public debt levels in the world, with the IMF projecting government debt at roughly 204% of GDP in 2026, the additional borrowing could prove detrimental to its fiscal health. Analysts caution that long-end Japanese government bond yields are likely to remain elevated, given the inflationary nature of Takaichi's program and the Bank of Japan's continued commitment to raising interest rates and reducing JGB purchases. Japan's 10-year government bond yield is currently around 2.85%, close to multi-decade highs.

While the government's target of over 370 trillion yen in investment could potentially bolster fiscal health, higher yields might draw some investors. If the plan successfully draws in investment, raises productivity, and expands the tax base, stronger growth could make Japan's debt burden more manageable.