After the largest budget in history was passed, Japan announced it will achieve its first fiscal surplus in 28 years next year.

Japan expects to achieve a basic fiscal surplus in the 2026 fiscal year for the first time since 1998. On Friday, the Japanese cabinet approved an annual budget of 122.3 trillion yen, the largest fiscal plan in the country's history. Prime Minister Sanae Takaichi emphasized that the budget "balances strong growth with fiscal discipline."

On December 26, after the cabinet approved the 2026 fiscal year budget, Sanae Takaichi stated, "The government's initial budget is expected to achieve the first basic fiscal surplus since 1998. I believe we have formulated a budget that balances robust economic growth and fiscal sustainability." According to the Ministry of Finance's forecast, the basic fiscal surplus at the national level is expected to reach 1.34 trillion yen.

Achieving a fiscal surplus has been a goal of the Japanese government for over twenty years. The basic fiscal balance is a key indicator of the government's financial health, referring to the difference between government revenues and expenditures excluding debt repayment costs. Although the government has increasingly focused on other fiscal indicators, achieving a basic fiscal surplus supports its expansive fiscal policy.

This development comes as Japanese government bond yields continue to climb. Partly due to market concerns about runaway spending and heavy debt, the benchmark 10-year government bond yield once rose to 2.1%, the highest in 27 years. In response, the government plans to cut ultra-long-term bond issuance and strengthen overall control of new debt issuance in the budget.

Uncertainties Remain in Achieving Fiscal Surplus Target

Japan has been on the path towards a basic fiscal surplus for nearly thirty years, originally setting the goal for the 2011 fiscal year, which was then postponed for over a decade. The Cabinet Office will announce comprehensive data, including local governments, next month, at which point this milestone may be confirmed. In recent years, local governments in Japan have already achieved a basic fiscal surplus.

However, this progress may still be affected by subsequent fiscal arrangements. If the Japanese government launches an additional supplementary budget in the next fiscal year, there may be changes in achieving the target.

It is worth noting that the government has gradually downplayed the basic fiscal balance as the core indicator of fiscal health, focusing more on reducing the debt-to-GDP ratio. In an inflationary environment, this target is relatively easier to achieve. According to Bloomberg, Finance Minister Katsuki Katayama pointed out, the government has not completely abandoned the basic fiscal balance as a reference for fiscal discipline, but is evaluating it within a multi-year framework, rather than focusing solely on single-year data.

Significant Cut in Ultra-Long Bond Issuance to Soothe Market

In response to the pressure of rising government bond yields to multi-year highs, the Ministry of Finance will cut the issuance of ultra-long-term government bonds to 17.4 trillion yen in the new fiscal year, nearly a 20% reduction from the previous year, marking the lowest level in seventeen years.

As the major developed country with the highest debt burden, Japan's government debt now exceeds twice its economic size, making it especially sensitive to rising borrowing costs. The recent yield increase mainly reflects market concerns that expansive fiscal policies may further exacerbate debt sustainability risks.

To address market concerns and enhance policy transparency, the Ministry of Finance announced that starting next fiscal year, market participant hearings will be held annually around June to collect feedback and adjust issuance plans as needed. This arrangement stems from debt sell-off pressures in June this year, when the ministry unusually revised plans, reducing ultra-long bond issuance from 24.6 trillion yen to 21.4 trillion yen.

Overall, the total government bond issuance (including ultra-long bonds) for the new fiscal year is set at 180.7 trillion yen, nearly 5% lower than the total for the current fiscal year including supplementary budgets. In terms of maturity structure, the ministry will keep the 10-year benchmark bond issuance stable, while increasing combined 2-year and 5-year bond issuance by 2.4 trillion yen.

Debt Dependence at Lowest Level Since 1998

Amid a record-high total budget for the new fiscal year, the government has managed to keep new bond issuance at 29.6 trillion yen, a mere 1 trillion increase over the current year, marking the first time new bond issuance has remained below 30 trillion yen. This reduces debt dependence to 24.2%, the lowest since 1998.

Finance Minister Katsuki Katayama noted that although the total budget hit a new high, its ratio to nominal GDP has remained stable for three consecutive years, showing that, relative to the size of the economy, budget expansion is not excessive. Tax revenues are expected to grow by 7.6% to a record 83.7 trillion yen, providing a key source for increased expenditures.

Nevertheless, tax revenue growth is still insufficient to cover fiscal pressure. Debt repayment costs are projected to surge 10.8% to 31.3 trillion yen; assuming an interest rate of 3.0%, this would be the highest in twenty-nine years, reflecting the repayment pressure Japan faces as it exits ultra-loose monetary policy. Meanwhile, rigid expenditures such as social security and defense continue rising.

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