Japan’s Prime Minister Sanae Takaichi ran on election policies of economic growth and cost-of-living support. With a supermajority in the Lower House and the ability to implement fiscal policies with little contention, the possibility of looser policies has been met with mixed reviews.
In a recent International Monetary Fund (IMF) conclusion statement, the organisation recognises the country’s financial system as “broadly resilient”, pointing to gradual policy rate hikes, banks’ capital buffers and well-managed interest rate risks across banks.
However, it observed, “near-term fiscal policy should refrain from further loosening, preserving recent gains in fiscal consolidation”.
Preventing the erosion of buffers should be a focus, it added, encouraging fiscal restraint to ensure that the country can maintain JGB stability and weather shocks.
“High and persistent debt levels, together with a deteriorating fiscal balance, leave Japan’s economy exposed to a range of shocks,” the organisation warned, advising that supplementary budgets should be restricted for use in responding to such incidents.
Fitch Ratings expects the new government to focus on policies around tax relief and growth-oriented investment spending, and to increase investment in high-tech sectors. It anticipates that fiscal stimulus measures in the country will put pressure on its fiscal trajectory and credit profile.
The Liberal Democratic Party’s 68% majority in the Lower House allows it to override Upper House vetoes and introduce economic policies with little contention, which could limit some fiscal risks, Fitch Ratings suggests – the demands of other parties will not have to be acceded to.
However, reactions to fiscal plans could influence the extent of their implementation, the agency noted – concerns of higher government bond yields, for example, could temper governmental plans.
The IMF advocates for close monitoring of JGB market liquidity and investor positioning in light of increased yield volatility and changing investor demand. It also notes the increased presence of foreign investors in the bonds, which both improves market functioning but opens up the market to global risks.
“If heightened volatility undermines market liquidity, the BOJ should be prepared to make exceptional targeted interventions – such as temporary JGB purchases – which should be clearly communicated to avoid weakening market functioning. Flexibility should be maintained to further rebalance JGB issuance toward shorter maturities if demand at the long end weakens further,” the fund advises.
Debt dynamics in Japan will be supported by nominal GDP growth, reducing the risk to the country’s sovereign rating for now, Fitch expects.
“Without new major fiscal packages, we forecast general government debt to GDP to decline to around 195% over the next five years, even accounting for higher post-election deficits. A sharper rise in yields or weaker nominal growth would erode that buffer, particularly if combined with more expansionary fiscal settings than we currently expect,” Fitch’s report predicted.
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