Takaichi’s hunt for new cash to fund spending harbors risks

Prime Minister Sanae Takaichi is on the hunt for new tools to help implement her ambitious economic agenda, but shifting the rules to unlock more cash to fund it could bring fresh risks.

At stake is Takaichi’s fiscal credibility. She faces a year-end deadline to explain how she intends to pay for initiatives ranging from a two-year sales tax cut on food to a defense buildup and a sweeping investment plan that’s supposed to boost Japan’s economy for years to come.

If she succeeds, Takaichi could manage to cap new government bond issuance, reassuring investors worried about Japan’s already enormous debt burden, while also reinforcing her popularity with voters. Yet some of the cash-gathering methods under consideration would stretch existing safeguards, while others could leave taxpayers shouldering greater risk.

“It’s not like there’s some magic money pot they can keep dipping into,” said Takeshi Makita, chief senior economist at the Japan Research Institute. “The reality is they’ve made too many big promises and are now struggling to find the money to pay for them.”

Here’s where Takaichi is looking — and the risks involved.

Rainy-day FX funds

Years of yen weakness and high overseas interest rates have helped swell surpluses in Japan’s Foreign Exchange Fund Special Account, which holds the bulk of the country’s foreign reserves and which is used to finance currency intervention. Private-sector members of a government advisory panel last month proposed tapping into those surpluses more aggressively to help fund spending.

Under Finance Ministry guidelines, the government generally retains at least 30% of the surplus in the fund as a buffer against future currency risk, while transferring much of the remainder to the general account, where it can be used for a variety of purposes. In fiscal 2025, the account generated about ¥5.1 trillion ($32.3 billion) of surplus. Some ¥3.1 trillion, or about 60%, was allocated to the following year’s general account.

Relying more heavily on foreign reserves, however, would carry risks.

Profits in the account could fall if overseas interest rates decline or the yen strengthens. Also, there could be scenarios where the country needs to keep drawing from the fund to finance intervention meant to address market volatility.

That means income from the account is less predictable than tax revenue. Larger transfers may be possible for several years, but it can’t be assumed that they’ll remain at current levels indefinitely.

JRI’s Makita said that transferring more of the fund to general coffers holds little risk right now, but he warned against making it a permanent fixture given future uncertainty. More specifically, he expects surpluses to shrink as the U.S.-Japan interest-rate gap narrows and the government takes action to limit further yen weakness.

Two-step loans

A centerpiece of Takaichi’s economic strategy is a plan to bring in ¥370 trillion in public and private investment across 17 strategic sectors, including artificial intelligence and semiconductors, through fiscal 2040. As questions arise over whether the private sector can actually help deliver investments of that scale, the industry ministry has proposed measures to encourage banks to lend more.

One proposal would expand “two-step loans,” under which the state-backed Japan Finance Corporation provides funding to financial institutions that then lend to businesses. The ministry wants to broaden participation to megabanks and regional lenders through the introduction of such loans designed to finance crisis-response investments, making financing more accessible to smaller companies.

Another would allow the government to absorb part of lenders’ losses if borrowers default — protection previously reserved largely for emergencies such as natural disasters and the pandemic.

Government guarantees against the lender’s potential losses could pose fiscal risks, as any shortfall in covering those losses could ultimately be financed through the general account, cautioned Takero Doi, a professor at Keio University. Still, he played down concerns about moral hazards, saying that private banks could combine government-backed two-step loans with their own lending, potentially increasing the amount of financing while also preserving banks’ incentives to assess credit risks carefully.

BOJ coffers

The Bank of Japan announced at its October policy meeting that starting next year it will accelerate sales of its exchange-traded fund holdings to ¥860 billion a year from the current pace of ¥330 billion. That’s expected to increase the central bank’s surplus remits to the government, potentially providing an extra ¥800 billion annually, according to Bloomberg Economics.

On Friday, Takaichi said the government should use the additional proceeds to finance investments in sectors that are critical for Japan’s economic security. While the ETF sales could be a solid source of funding for the government for years to come, those asset values would be affected by market movements. The central bank said it can slow its sales depending on the market environment.

Cutting waste

Japan’s version of the U.S. Department of Government Efficiency, established last year, is currently poring over existing subsidies, tax breaks and public funds to see what could be cut. The country has roughly 200 public funds which hold around ¥7 trillion.

But reclaiming that money may prove politically fraught.

Many subsidies and tax preferences have long benefited influential industries, and moving too aggressively to eliminate them could trigger resistance from interest groups and ruling-party lawmakers with close ties to those sectors.

Takaichi is known to have weaker support from her party’s establishment compared with previous premiers, and cutting back on tax breaks and programs that households and businesses have come to rely on could risk alienating the same voters Takaichi seeks to keep on her side.

“Of course, Takaichi may read the room and avoid cuts that would make her unpopular,” said Keio’s Doi, who’s also a member of the Fiscal System Council.

How much Takaichi can ultimately extract from these and other sources of funding would determine whether she can keep new government bond issuance in check.

Takaichi pointed to bond issuance of around ¥40 trillion in the previous fiscal year and pledged a similar approach for the upcoming budget, effectively giving investors a benchmark to judge her fiscal plans.

“I’d like to see some concrete results as soon as possible, particularly in terms of how much these efforts will actually help curb government bond issuance,” said Doi.

The government may be able to find substantial sums outside the bond market. The harder question is, how long those sources will be available, and whether tapping them might have lasting repercussions.