Japan Reportedly Plans to Double Defense Spending to 3.5% of GDP, Ministry of Defense Denies, Yet Japanese Bond Yields Hit 30-Year High

On Tuesday, the 25th, local time, news broke that Japan is considering significantly raising its medium-term defense spending target, causing renewed turmoil in the already pressured Japanese government bond market. Concerns over Japan’s fiscal sustainability soared, with the benchmark JGB yield—indicative of long-term interest rates—hitting a new thirty-year high. Amid Prime Minister Sanae Takaichi’s simultaneous push for tax cuts and military expansion, the challenges in Japan’s debt management are drawing heightened vigilance from investors.

According to a Bloomberg report, sources revealed that Japanese defense officials have signaled a strong intention to ramp up defense spending in talks with the United States. One proposal is to follow South Korea’s commitment to raise defense expenditure to 3.5% of GDP within a decade; another, more modest target, is 3%.

Following the reports, defense ministry press secretary Kimihito Aguin swiftly denied the information at a press conference, stating that Japan has not signaled to the U.S. any intention to boost spending as high as 3.5%, and emphasized that defense buildup is "based on Japan’s independent judgement" and "should not be driven by a preset expenditure figure."

Despite official denials, market reactions to the news were swift and intense. Japan’s benchmark 10-year government bond yield on Tuesday reached a new high since 1996, closing at 3.04%—double its level from a year ago—while the yen fell to 155.24 per U.S. dollar, a more than one-week low. Meanwhile, the defense sector rallied against the market trend; IHI Corp and Kawasaki Heavy Industries closed up by 1.8% and 0.9% respectively, after both stocks had once fallen over 2% earlier in the session.

Pressure from Additional Bond Issuance: Defense Spending May Double Current Levels

If the target of defense spending accounting for 3.5% of GDP becomes reality, the supply of Japanese government bonds will face an unprecedented shock.

According to reports, Defense Minister Shinjiro Koizumi stated in April this year that the current fiscal year’s defense and related spending is 10.6 trillion yen (about $68.8 billion), which, based on 2022 nominal GDP, is about 1.9%; using the Cabinet Office’s forecast for this year’s nominal GDP, the actual ratio is only 1.5%. On the same basis, a 3.5% target corresponds to a budget of about 24 trillion yen—more than twice the current level.

The Ministry of Defense has already submitted a record 8.9 trillion yen budget request for the next fiscal year, a 0.9% increase over this year. However, many projects in this request lack specific spending amounts, suggesting the final budget may be much larger. In addition, the continued depreciation of the yen is eroding Japan’s real purchasing power for overseas arms imports, further fueling potential spending needs.

Fiscal Contradiction: Tax Cuts and Military Expansion Advance Side by Side, Funding Sources Unclear

The fiscal dilemma facing the Takaichi government is that their military expansion plan and tax cut promises are being pursued simultaneously, with both requiring large sums of funding.

This week, the Takaichi cabinet approved a temporary reduction in food consumption tax, lowering the sales tax on food and beverages from 8% to 1% for two years, effective next April, involving about 5 trillion yen (approximately $32.3 billion). The government claims it will not issue new debt for this purpose, but the specific funding plan has been postponed until the end of the year.

Finance Minister Satsuki Katayama stated on Tuesday that the government will "comprehensively review spending and revenue" and determine a fiscal spending level "that corresponds to steadily reducing the debt-to-GDP ratio" while "closely monitoring tax revenues." She also mentioned plans to emulate the U.S. Department of Government Efficiency (DOGE) by intensifying efforts to cut redundant subsidies and spending. However, given that only three potential cutbacks have been identified in voluntary departmental reviews, these statements do little to alleviate market concerns.

Meanwhile, Sanae Takaichi also announced a public-private joint investment growth plan worth over 370 trillion yen targeting 2040, further intensifying concerns over Japan’s fiscal capacity.

Bond Market Pricing Logic: BOJ Normalization and Fiscal Risk Combine

The continued rise in JGB yields reflects the market’s pricing in of multiple overlapping risks. The 10-year yield breached 3% for the first time earlier this month—its highest since 1996—driven by inflation pressures, expectations of fiscal expansion, and the market’s anticipation that the Bank of Japan may accelerate rate hikes.

Iwai Cosmo Securities analyst Daisuke Aiba commented, "The bond market’s response already reflects fiscal concerns. Investors find it difficult to view such news positively. Furthermore, whether Japan can actually expand its defense capabilities beyond the current limited range is also in question."

Robert Ward, Chair of Japan Studies at the International Institute for Strategic Studies, believes that Japanese policymakers and bureaucrats have already laid the groundwork for a sharp increase in defense spending, with timing being the only uncertainty. He stated, "Whether it’s five or ten years, given the importance of the U.S.-Japan alliance, I don’t think there’s any other choice."

Official Denial: The Dilemma of Policy Signaling and Market Communication

There is a clear gap between the Ministry of Defense’s denial and what sources have revealed.

According to Bloomberg, some Japanese officials said they were not ready to make a formal commitment and would deny the target if it was made public. Defense Minister Shinjiro Koizumi has also publicly insisted that spending levels should be determined by military needs, not monetary targets.

This strategic statement reflects the Japanese government’s dilemma between bond market pressure and allied expectations. Last month, U.S. Deputy Assistant Secretary of Defense for Policy Elbridge Colby explicitly stated, "We are eager for Japan to increase its investment," but generally, the U.S. has refrained from publicly pressuring Japan.

Notably, the ruling Liberal Democratic Party under Takaichi pointed out in an internal document this June that 3.5% has become the global standard for defense spending, but made no specific suggestions for how to secure matching funds. Japan’s new five-year defense plan is expected to be released by year’s end, at which point markets will receive a clearer policy signal.