Japan's largest budget proposal in history: "Reduce the issuance of ultra-long bonds" to soothe the bond market, while increasing funding for chips and AI by three times

The Japanese Cabinet approved a record budget of 122.3 trillion yen (USD 785 billion) on Friday, aiming to implement an active fiscal policy while alleviating concerns in the bond market by reducing the issuance of ultra-long-term bonds and controlling the scale of new debt issuance.

According to a Reuters report on Friday, Finance Minister Katsunobu Kato stated that although the budget size is at a historical high, it is not excessively large relative to the size of the economy, with the initial budget size to nominal GDP ratio remaining unchanged for three consecutive years. The government successfully kept the new bond issuance below 30 trillion yen, achieving a long-standing goal of the Ministry of Finance.

The budget significantly increases investment in cutting-edge technologies, with the Ministry of Economy, Trade and Industry's spending on chips and artificial intelligence rising to approximately 1.23 trillion yen, nearly tripling from the previous year. This includes 150 billion yen in support for the state-owned chip company Rapidus Corp. and 387.3 billion yen in AI development funding.

Concerns in the bond market regarding the Kato government's expansionary fiscal policy have pushed up Japanese government bond yields, forcing the government to demonstrate fiscal discipline in budget preparation. The issuance of ultra-long-term bonds will be reduced to 17.4 trillion yen, the lowest level in 17 years.

Debt Management: Significant Reduction in Ultra-Long Bond Issuance to Soothe the Market

In response to the recent pressure of rising government bond yields, the Ministry of Finance has reduced the issuance of ultra-long-term government bonds in the new fiscal year's budget by nearly one-fifth to 17.4 trillion yen, the lowest level in 17 years.

Market concerns that the Kato government's expansionary fiscal policy may exacerbate the debt burden have driven up government bond yields. Japan already has the heaviest debt burden among developed countries, with debt exceeding twice the total economic output, making it highly sensitive to rising borrowing costs.

To address market concerns, the Ministry of Finance will hold hearings with market participants around June each year starting from the next fiscal year to gather feedback and make adjustments as necessary. In June of this year, a sell-off in the bond market forced the Ministry of Finance to unusually revise its issuance plan, reducing the issuance of ultra-long-term bonds from 24.6 trillion yen to 21.4 trillion yen.

The total issuance of government bonds in the new fiscal year (including ultra-long-term bonds) will be 180.7 trillion yen, nearly a 5% decrease from the total for this fiscal year (including supplementary budgets). The Ministry of Finance will maintain the issuance of benchmark 10-year government bonds while increasing the combined issuance of 2-year and 5-year bonds by 2.4 trillion yen.

Technology Investment: Surge in Chip and AI Spending Drives Industrial Upgrade

The budget for the Ministry of Economy, Trade and Industry has increased by approximately 50% to 3.07 trillion yen compared to the previous year, primarily due to a significant increase in spending on chips and AI. The budget support for the chip and AI sectors will surge from about 300 billion yen last year to 1.23 trillion yen, nearly quadrupling.

In the semiconductor sector, the government has allocated 150 billion yen for the state-owned chip company Rapidus Corp., bringing the government's total investment in the company to 250 billion yen. In terms of AI, 387.3 billion yen will be used to develop domestic foundational AI models, strengthen data infrastructure, and research "physical AI" technologies The significant increase in technology investment comes at a time when the United States and China are in fierce competition in the field of cutting-edge technology, and Japan is trying to enhance its capabilities in these critical areas. The government also plans to fund chips and AI mainly through the regular budget rather than temporary supplementary budgets starting from the next fiscal year to ensure more stable financial support.

The budget proposal also reserves 5 billion yen to ensure the supply of critical minerals, including rare earths, and allocates 122 billion yen for decarbonization projects, including the development of next-generation nuclear power plants.

Fiscal Discipline: Debt Dependency Hits 26-Year Low

Despite the total budget reaching a historic high, the issuance of new government bonds has only slightly increased from 28.6 trillion yen this year to 29.6 trillion yen. The debt dependency ratio will drop to 24.2%, the lowest level since 1998.

Tax revenue is expected to grow by 7.6% to a record 83.7 trillion yen, helping to fund the increased spending. However, the growth in tax revenue cannot fully offset the impact of soaring debt repayment costs and increased social security and defense spending.

As the Bank of Japan exits its ultra-loose monetary policy, debt repayment costs will surge by 10.8% to 31.3 trillion yen, assuming an interest rate set at 3.0%, the highest level in 29 years. This highlights Japan's enormous debt burden's high sensitivity to rising interest rates.

According to Bloomberg, Finance Minister Shunichi Suzuki emphasized that the new budget reflects the current economic conditions and price trends, and the budget size is not too large compared to the size of the economy. The Tokyo Metropolitan Government plans to abandon its fiscal consolidation policy aimed at achieving annual fiscal balance and set new multi-year targets to allow for more flexible spending arrangements