Will Prime Minister Takaichi's landslide victory resolve or amplify Japan's debt crisis?

A historical victory

Japanese voters demonstrated unwavering support for Prime Minister Sanae Takaichi in the snap election held on 8 February. Her Liberal Democratic Party (LDP) secured 316 seats in the 465-member Lower House. Combined with coalition partner Japan Innovation Party's (Ishin) 36 seats, the ruling bloc's overall position strengthened from 232 to 352 seats.

This comfortably surpasses the critical two-thirds threshold (310 seats) required to override the Upper House, granting Takaichi the authority to pass legislation without opposition support and initiate constitutional amendments – a goal the LDP has pursued since 1955. With no national election required until 2028, she possesses a clear runway for her ambitious agenda.

2026 Japan Lower House election results

The three-pillars: relief, defence and growth

Takaichi's administration centres on three interconnected priorities. First, addressing cost-of-living pressures through a two-year suspension of the 8% consumption tax on food. The tax break is projected to cost approximately 5 trillion yen ($32 billion) annually – nearly equivalent to Japan's entire education budget. This builds upon a 21.3 trillion-yen stimulus package already approved in November.

Second, strategic investment across 17 strategic sectors including artificial intelligence (AI) and semiconductors, shipbuilding, and quantum computing to establish technological sovereignty. Japan will collaborate with the US in developing these areas as part of a trade agreement to invest $550 billion in the US.

Third, a substantial defence buildup. The fiscal year (FY) 2026 budget allocates approximately 9 trillion yen for defence spending, on track to achieve the 2% of gross domestic product (GDP) target. The spending focuses on counterstrike capabilities, long-range missiles, and AI-operated systems.

To execute this vision, the administration requires parliamentary approval for its FY2026 budget, which totals a record 122.3 trillion yen, up 7.1 trillion from FY2025.

The Takaichi trade

Financial markets delivered split verdicts on the election outcome. The Nikkei 225 and TOPIX both advanced to all-time highs, with the Nikkei surging past 57,000. The decisive victory provides greater certainty to investors regarding the stability of Japan's political environment.

Since Takaichi secured the LDP presidential election on 4 October 2025, the Nikkei has returned 26%, significantly outpacing the S&P 500 (+4%) and the Hang Seng Index (+1%). Infrastructure companies, semiconductor manufacturers, electrical equipment providers and defence contractors led gains during this period as clear policy beneficiaries.

Bond markets, however, present a contrasting narrative. Long-dated Japanese government bond (JGB) yields rose immediately following the landslide victory. Although much of this movement has since reversed as the upcoming expenditure has been largely priced in by the market. Since Takaichi became LDP president, yields on 40-year JGBs surged to a record high above 4%, whilst the 10-year JGB yield rose above Chinese government yields for the first time in history. The Ministry of Finance raised its interest payment rate assumption from 2.0% to 3.0%. Debt-servicing costs are projected to rise to a record 31.3 trillion yen in FY2026, accounting for approximately one-quarter of the FY2026 budget.

The yen exhibited a similar response to the Lower House election, weakening to 157.7 against the US dollar initially before recovering to current levels.

Yield curve has steepened since October 2025

The fiscal arithmetic challenge

Japan enters FY2026 with sobering fundamentals: nominal GDP of 665 trillion yen (as of June 2025) and government debt of 1,342 trillion yen (as of December 2025). According to International Monetary Fund (IMF) October 2025 data, its government debt-to-GDP ratio stands at 230%, the highest amongst developed economies.

With real GDP expected to expand by 0.7% according to the IMF, nominal GDP growth (which includes inflation) remains below the Ministry's interest rate assumption. This means that for Takaichi to deliver her commitment to reduce the debt ratio further, the government must transform the current deficit into a surplus of at least 4 trillion yen.

An anticipated increase in tax revenue will help fund approximately 1.3 trillion of the shortfall, but how can the administration finance the remainder? More importantly, the draft FY2026 budget has not yet accounted for the revenue loss of 5 trillion yen from food tax suspension.

Should Takaichi rely on economic growth to support this expenditure, real GDP growth would need to nearly double from 0.7% to 1.3%, or inflation would need to surge to 2.6% – which would magnify the precise problem voters elected Takaichi to resolve.

Gross debt position as a percentage of GDP

The Bank of Japan dilemma

The Bank of Japan (BoJ) faces an impossible dilemma. Inflation has exceeded the 2% threshold for 44 consecutive months, yet the central bank has raised interest rates by only 75 basis points, stating it requires evidence demonstrating resilience in the domestic economy.

Markets are growing increasingly impatient with the BoJ's extremely cautious stance and harbour concerns that Takaichi's advocacy for lower interest rates could pressure the central bank's independence. This has resulted in sharp depreciation of the yen, creating three significant issues for Japan:

• Volatile currency movements discourage foreign investment in Japan
• A weaker yen translates into higher imported prices and creates public frustration with elevated living costs
• It damages relations with the US, which may perceive a weaker yen as an unfair trade advantage

It is critical for the BoJ to demonstrate that its monetary stance is determined by economic conditions, not political considerations, to provide a stable environment for the Japanese economy to grow and flourish.

Narrow path, high stakes

Markets will scrutinise closely any indications of fiscal slippage. The current trajectory – with 3% interest rates, 2.7% nominal growth, and insufficient budget surpluses – is mathematically unsustainable. Takaichi's strategy requires real GDP growth to accelerate from 0.7% to at least 1.3% – a challenging prospect given Japan's structural headwinds of ageing demographics, productivity stagnation, and a shrinking workforce.

However, Japan does possess crucial advantages: debt overwhelmingly held domestically in yen, a persistent current account surplus providing a steady pool of domestic savings, and low reliance on foreign capital. These factors have protected Japan from external funding crises that destabilised Greece or rattled the UK under Liz Truss, keeping yields lower than fundamentals might otherwise dictate.

Yet these buffers have limits. The world's most indebted developed economy is attempting its most expansionary fiscal policy in decades whilst navigating the end of ultra-low rates. Bond vigilantes are calculating whether the numbers add up. Thus far, they remain sceptical, and the mathematics suggests they are right to be.

• The figures stated in this article are as of 10 February 2026 unless otherwise stated. Past performance is not a reliable indicator of future performance.