Japan Approves Record ¥122.3 Trillion Budget as Debt-Servicing Costs Surge

Japan’s government has approved a record ¥122.3 trillion ($785 billion) draft budget for the fiscal year starting April 1, 2026, pouring money into defense, social security and industrial policy even as the cost of servicing the country’s huge debt rises at its fastest pace in decades.

The fiscal 2026 general-account budget, endorsed by Prime Minister Sanae Takaichi’s Cabinet on Dec. 26 in Tokyo, is Japan’s largest ever and about ¥7.1 trillion bigger than the initial fiscal 2025 budget. It now heads to the ordinary session of the Diet in January, where the government aims for passage by the end of March.

A turning point on borrowing costs

Beyond the record headline number, the draft underscores a shift for the world’s most indebted major economy. After years of near-zero interest rates that kept borrowing costs low, Japan is budgeting for significantly higher rates—pushing annual debt-service expenses (interest and principal payments on government bonds) above ¥30 trillion for the first time.

Spending on debt service is set to rise 10.8% to about ¥31.3 trillion, according to budget documents. The Ministry of Finance raised its assumed average interest rate on government borrowing to 3.0%, from 2.0% in the current fiscal year—the highest planning rate in 29 years.

The assumption does not mirror the Bank of Japan’s short-term policy rate, which stands at 0.75%, but reflects what the ministry expects to pay on new and refinanced bonds. Yields on long-term Japanese government bonds have climbed over the past year as the central bank ended negative interest rates and reduced large-scale bond buying. The benchmark 10-year yield is around 2%, near its highest level in roughly a quarter-century, while 20- and 30-year yields hover near 3% or above.

“Interest payments are no longer something we can ignore,” a senior Finance Ministry official said in a recent briefing. “We had to reflect higher market rates in our projections.”

Debt service is now among the largest items in the budget—roughly comparable in size to social security and larger than allocations such as education or public works. Together with social security, it accounts for well over half of general-account spending.

Social security continues to expand

Social security outlays—covering pensions, medical care, nursing care and child-rearing support—are set at ¥39.06 trillion, an increase of about ¥760 billion from fiscal 2025. The rise reflects Japan’s aging population and higher medical fees.

The government approved a 3.09% increase in medical service fees—the first hike above 3% in about 30 years—while cutting official drug prices by 0.87%. For working-age households, the combination of higher fees and an expanding social security budget is expected to add pressure on insurance premiums, even as wages and consumer prices rise.

Defense budget hits another record

The draft allocates ¥9.04 trillion for defense, another record and 9.4% more than in the current fiscal year. The increase is part of a multi-year plan to roughly double defense spending to around 2% of GDP, bringing Japan closer to NATO norms and aligning with long-standing U.S. requests.

The allocation includes more than ¥970 billion to strengthen Japan’s “standoff” capability with long-range missiles. About ¥177 billion will go to upgraded Type 12 surface-to-ship missiles, expected to have a range of about 1,000 kilometers and slated for initial deployment in Kumamoto Prefecture by March 2026. Roughly ¥100 billion is earmarked for a new layered coastal defense network known as SHIELD, using unmanned aerial, surface and underwater drones, with deployment targeted by March 2028.

Officials describe the buildup as a response to increasingly assertive Chinese military activity around Japan’s southwestern islands and concerns about a potential conflict over Taiwan. Chinese officials have criticized Japan’s plans as escalatory and inconsistent with its postwar pacifist constitution.

Revenues rise, but debt load remains massive

In approving the budget, Takaichi said the plan aimed to support growth while maintaining discipline.

“This is a budget that strikes a balance between fiscal discipline and achieving a strong economy while ensuring fiscal sustainability,” she told ruling party executives, according to domestic media.

Finance Minister Satsuki Katayama has emphasized restraint in new borrowing. The draft plans for about ¥29.6 trillion in new, non-refinancing government bond issuance—slightly more than this year but below the politically sensitive ¥30 trillion threshold.

Tax revenues are projected at a record ¥83.7 trillion, up 7.6%, supported by solid corporate earnings and moderate inflation. The share of general-account revenue funded by new bonds—the debt-dependence ratio—is expected to fall to 24.2%, the lowest since fiscal 1998.

Japan’s overall debt burden remains the highest among advanced economies. Central and local government liabilities are projected to reach about ¥1,344 trillion by the end of fiscal 2026—roughly double annual economic output. International institutions estimate Japan’s gross public debt at more than 200% of GDP, with some projections in the 220% to 230% range.

Policy choices narrow as rates normalize

For decades, Japan financed its debt at extremely low cost as the Bank of Japan kept rates near or below zero to combat deflation and bought bonds on a massive scale. With inflation around the central bank’s 2% target and monetary policy gradually normalizing, economists say Japan can no longer count on near-free borrowing.

The OECD has warned that rising interest costs will eventually require primary budget surpluses—when revenues exceed non-interest spending—to put the debt-to-GDP ratio on a clearly declining path. The government projects 1.3% real growth for fiscal 2026, slightly above this year’s expected 1.1%. Some private and international forecasters are more cautious, putting growth closer to 1% or lower.

Takaichi has signaled interest in replacing Japan’s goal of achieving a primary budget surplus by a fixed year with a looser, multi-year framework allowing continued “strategic” investment in areas such as defense, semiconductors and artificial intelligence. Business groups have generally welcomed the focus on growth, while investors are watching how strictly any new fiscal rules will be applied.

Infrastructure, reserves and industrial policy

The budget includes about ¥6.11 trillion for public works, including upgrades to aging water and sewer systems, and ¥1 trillion in reserve funds for emergencies such as natural disasters or energy price shocks. Around ¥1.24 trillion is allocated to a special account supporting semiconductor and AI industries, complementing a separate stimulus package approved in November focused on advanced technologies and relief for households facing higher living costs.

Political test in the Diet

Politically, the fiscal 2026 draft is the first full-year budget assembled under both Japan’s first female prime minister and first female finance minister. Still, the plan reflects the enduring pillars of Japanese public finance: pensions and medical care for an aging population, a growing defense establishment—and now a rising bill for past borrowing.

The governing Liberal Democratic Party and its junior partner, the Japan Innovation Party, control the more powerful lower house but lack a majority in the upper house, leaving Takaichi dependent on smaller opposition parties for passage. That could produce marginal adjustments, including concessions on social spending or tax thresholds, though the budget’s core features are unlikely to change.

As lawmakers debate the numbers next year, Japan faces a familiar but newly urgent question: how to fund security, social welfare and long-term investment when the price of money is no longer close to zero. The answer will shape not only Japan’s economy and bond market, but financial conditions and security dynamics beyond its shores.