Japan's Budget Drafting Faces Higher Debt-Service Cost Assumption

Japan's finance ministry is weighing a significant increase in the assumed interest rate used to calculate debt-servicing costs for the next fiscal year's budget request. According to two government sources, the rate under consideration is 3.8%, which would be the highest in 29 years and a notable jump from the 3.0% assumption in the current fiscal 2026 budget.

The potential change underscores the growing financial strain on Japan's public finances as long-term interest rates climb. The benchmark 10-year Japanese government bond yield recently touched a three-decade high of 2.945%, driven by market concerns over the pace of interest rate hikes and the expansionary fiscal policies of Prime Minister Sanae Takaichi.

The rise in yields poses a critical challenge to the government's economic strategy. Higher debt-financing costs threaten to undermine the prime minister's flagship initiative to channel investment into growth sectors, as a larger portion of the budget would be consumed by interest payments on the country's substantial public debt.

The sources, who spoke on condition of anonymity due to the sensitivity of the matter, confirmed an earlier report by the Nikkei newspaper about the likely rate setting. The final decision will be part of the budget request process for the upcoming fiscal year.