Japan Approves Record ¥122.3 Trillion Budget as Rising Rates Push Debt Costs Past ¥30 Trillion

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 accelerates at the 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.

Debt service passes a milestone as rates rise

Beyond the record headline number, the draft underscores a turning point 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, including interest and principal payments on government bonds, above ¥30 trillion for the first time.

According to budget documents, spending on debt service will rise 10.8% from this year to about ¥31.3 trillion. The Ministry of Finance has raised the 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 reflect the Bank of Japan’s short-term policy rate, which stands at 0.75%, but rather what the ministry expects to pay on new and refinanced government bonds. Long-term Japanese government bond yields have climbed sharply over the past year as the central bank ended negative interest rates and eased back from 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 are 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 one of the largest single items in the budget, roughly comparable in size to social security and far larger than individual ministry allocations such as education or public works. Together with social security, it accounts for well over half of general-account spending.

Social security grows with aging population

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 the continued aging of Japan’s population and higher medical fees.

The government has 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 likely to add pressure on insurance premiums, even as wages and consumer prices rise.

Defense spending hits another record

On defense, the draft budget allocates ¥9.04 trillion, another record and about 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 gross domestic product, bringing Japan closer to NATO norms and meeting long-standing requests from the United States.

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, which are expected to have a range of about 1,000 kilometers and are 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, designed to use unmanned aerial, surface and underwater drones, with deployment targeted by March 2028.

Officials say the buildup responds to what they describe as increasingly assertive military activity by China 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.

Revenue rises, but debt remains massive

In approving the budget, Takaichi said the plan was designed 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 remarks reported by domestic media.

Finance Minister Satsuki Katayama has stressed that the government is keeping new borrowing in check. 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.

With tax revenues projected at a record ¥83.7 trillion—up 7.6% from this year, helped by solid corporate earnings and moderate inflation—the share of general-account revenue funded by new bonds, known as the debt-dependence ratio, will fall to 24.2%, the lowest level 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 the size of the country’s annual economic output. International institutions estimate Japan’s gross public debt at more than 200% of GDP, with some recent projections putting it in the 220% to 230% range.

For much of the past three decades, that debt was financed at extremely low cost, as the Bank of Japan kept rates near or below zero to combat deflation and engaged in massive bond purchases. With inflation now around the central bank’s 2% target and monetary policy gradually normalizing, economists say Japan can no longer count on near-free borrowing.

Growth bets, industrial policy—and political math

The Organization for Economic Cooperation and Development has warned that as interest costs rise, Japan will eventually need to run primary budget surpluses—where revenues exceed non-interest spending—to put its debt-to-GDP ratio on a clearly declining path.

The government’s own projections assume real economic growth of 1.3% in fiscal 2026, slightly above this year’s expected 1.1%, supported by domestic demand and earlier stimulus measures. Some private and international forecasters are more cautious, seeing growth closer to 1% or lower.

Takaichi has signaled she wants to replace Japan’s longstanding goal of achieving a primary budget surplus by a fixed year with a looser, multi-year framework that allows for continued “strategic” investment in areas such as defense, semiconductors and artificial intelligence.

The budget sets aside about ¥6.11 trillion for public works, including upgrades to aging water and sewer infrastructure, 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 hit by higher living costs.

Politically, the fiscal 2026 draft is the first full-year budget prepared under both Japan’s first female prime minister and first female finance minister. 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 support from smaller opposition parties to pass the budget. That could lead to changes at the margins, including concessions on social spending or tax thresholds, though the core structure is unlikely to shift.

As lawmakers begin debating the numbers early next year, Japan faces a newly urgent version of a familiar 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 the country’s economy and bond market, but also financial conditions and security dynamics far beyond its shores.