Japan's Fiscal Outlook Unchanged Despite LDP's Election Victory

Japan's ruling Liberal Democratic Party (LDP), led by Prime Minister Sanae Takaichi, secured a significant victory in the recent elections, obtaining a two-thirds supermajority in the lower house. Despite this political shift, fiscal projections remain unchanged, with expectations of a primary fiscal deficit of 2% to 3% of GDP for fiscal years 2026 through 2028, and a decline anticipated from fiscal year 2029.

The 10-year Japanese government bond (JGB) yield is projected to reach 2.3% by the end of 2026 and 2.5% by the end of 2027. Market pressures are expected to influence Prime Minister Takaichi's fiscal policies, as she requires cooperation from influential party members who prioritize fiscal discipline.

Takaichi's proposal to eliminate the 8% consumption tax on food for two years is anticipated to take at least two years to implement, despite her desire for prompt action. She has also committed to identifying alternative revenue sources to offset the projected decline in tax revenue.

The LDP's supermajority may reduce the risk of populism-driven fiscal deterioration, as reflected in the stability of JGB yields post-election. However, there remains a significant risk that global investors may question the credibility of the government's plan to balance proactive fiscal policy with fiscal discipline.