Japanese government bond yields surge: A difficult trade-off between fiscal difficulties and public spending

Editor's note: Tang Jie is a researcher at the Chinese Academy of International Trade and Economic Cooperation, the China's Ministry of Commerce. The article reflects the author's opinions and not necessarily the views of CGTN. 

In the first full trading week after the New Year, the yield on Japanese 10-year government bonds surged and stabilized above 2.1 percent (compared to 1.18 percent in the same period of 2025, a 78 percent increase). On Tuesday, long-term interest rates rose sharply after the Japanese bond market opened, with the yield on newly issued 10-year government bonds briefly surging to 2.14 percent, the highest level since February 1999. This change in financial indicators is raising deep concerns about the sustainability of Japan's fiscal policy. Faced with a massive government debt exceeding 250 percent of its GDP, the surge in financing costs could push Japan's finances into a systemic predicament by crowding out spending on people's livelihoods and weakening its macroeconomic control capabilities.

Japan's fiscal tightrope – the high price of rising yields

For decades, Japan operated under the "safe harbor" of near-zero interest rates. However, as the Bank of Japan retreats from its yield curve control policy to combat persistent inflation, the reality of Japan's 250 percent debt-to-GDP ratio – the highest in the developed world – is finally coming home to roost. According to the Japanese Ministry of Finance (MOF) and the latest financial data (as of the fourth quarter of 2025), as of October 2025, Japan's total government debt, including government bonds, loans, and short-term securities, reached approximately 1,341.7 trillion yen (approximately $9 trillion), representing about 240 percent to 250 percent of its nominal GDP. The Japanese government has just approved the draft budget for fiscal year 2026, totaling 122.3 trillion yen (increasing the ratio from 22.4 percent in 2024 to 25.6 percent currently), a record high. Of this, "government debt expenses" (interest payments and repayment costs) alone will amount to 31.3 trillion yen.

This means that about a quarter of Japan's annual fiscal expenditure will be used for debt repayment. This ratio will not only double what it was 10 years ago but also approach its historical peak, severely squeezing defense spending and social security expenditures to address the declining birthrate. It is worth noting that the increase in interest payments did not occur suddenly but has accumulated year by year as old debt matures and new debt is issued. Since the average remaining maturity of Japanese government bonds is about nine years, the current rise in interest rates will cause extremely severe "financial pain" in the next three to five years.

Zero-sum game – a looming social contract crisis

The "systemic predicament" Japan faces is not just financial; it is existential. In an era of shrinking labor forces, the government cannot easily tax its way out of this hole. If the interest burden continues to swell, the state may be forced to choose between defaulting on its promises to the youth (infrastructure, education) or failing its seniors (pensions, care). The fundamental dilemma facing Japan's finances lies in the rigid constraints of its budget. With limited revenue growth, increased payments on national debt interest will inevitably lead to cuts in other expenditures. This "zero-sum game" is particularly evident in the area of people's livelihoods. When trillions of yen are diverted to pay interest to creditors, funds are effectively stolen from healthcare, a pillar of society's normal functioning. Not only that, 2025-2026 will be a turning point for Japan's finances, as the doubling plan for defense spending and rising interest payments will create a double squeeze, and the sustainability of the social security system will face unprecedented challenges.

A. Healthcare and social security: Japan's National Institute of Population and Social Security Research predicts that social security spending will reach 190 trillion yen by 2040. With soaring interest payments, the growth rate of social security spending in the 2024 budget fell to approximately 2 percent, the lowest in a decade, far below the expected core CPI (above 2.5 percent). This means that the increase in government funding for hospitals and nursing homes is not keeping pace with inflation, leading to a shrinking of these institutions' actual operating funds. As one of the world's most aged countries, Japan's social security spending has exceeded 35 trillion yen. Rising debt costs threaten the sustainability of the National Health Insurance. The Japan Medical Association's "Monthly Survey of Hospital Management Dynamics" has pointed out that "interest payments not only steal from the healthcare budget but also directly 'squeeze' hospital liquidity by suppressing treatment fees (medical insurance pricing)," with nearly half of local medical institutions facing operational difficulties.

B. Education: According to the final approved general accounting budget for fiscal year 2025 by the MOF, the actual growth rate of the education budget in 2025 was -1.4 percent to -1.9 percent (nominal growth rate of 3 percent), far below the core CPI for that year, indicating a contraction in the actual purchasing power of the education sector. To address teacher shortages, a significant portion of the budget increase in 2025 was allocated to raising the post adjustment allowance for public school teachers. After adjusting for salary increases and inflation, the actual funding for basic university research, school renovations, and upgrades to experimental equipment has decreased significantly. Many national universities have announced tuition increases (such as the University of Tokyo), citing the central government's allocated "operating allowance" as insufficient to cover electricity and research costs under the dual pressures of inflation and interest payments.

C. Regional development imbalance: The MOF's local delivery tax (funds used to balance regional fiscal disparities) has been cut for three consecutive years. The MOF explicitly stated in its 2026 budget that, due to record-breaking national debt interest payments, it must reduce "non-essential subsidies" to local governments. This has forced many local governments to reduce basic public services. A city in Hokkaido was forced to close three elementary schools and reduce daytime care services for the elderly due to budget cuts. Due to soaring fuel costs and insufficient central government funding, some cities have been forced to reduce the frequency of snow removal on non-main roads. The Japanese government and ruling party have begun discussing the mandatory redistribution of some corporate taxes and fixed asset taxes from Tokyo to local governments, a move that indirectly demonstrates that the central government is no longer able to address regional imbalances through the existing local delivery tax system.

Structural reforms – international experience and lessons learned

Japan's experience offers important lessons for highly indebted economies worldwide. A 2023 report by the International Monetary Fund indicated that Japan's fiscal sustainability faces "high risks" and recommended a gradual adjustment of fiscal policy and the implementation of structural reforms. Rising Japanese government bond yields have revealed a deeper dilemma: How to balance debt sustainability with social welfare under the dual pressures of an aging population and economic stagnation. This challenge is not merely a fiscal issue, but a fundamental problem of social structure and the growth model. As the Japan Center for Economic Research has pointed out, only by finding a new balance between economic growth and social security reform can Japan avoid the long-term squeeze of fiscal difficulties on people's livelihoods and achieve sustainable development. This process will be difficult, but it is also an essential path for Japan's economic revitalization. Against the backdrop of increasing global economic uncertainty, Japan's experience will provide valuable reference for countries facing similar challenges, particularly in how to maintain a delicate balance between social welfare and fiscal sustainability in a highly indebted and aging society.