Fitch says Japan can keep deficits manageable despite election tax cut pledge

A sharp selloff in Japanese government bonds that pushed the 10-year yield to a 27-year high has not yet altered Fitch Ratings' baseline view that Tokyo will keep budget deficits "within manageable levels," the agency said in an emailed comment on Jan. 21. The statement came after Prime Minister Sanae Takaichi's campaign pledge to suspend a food levy for two years, a move that markets treated as a potentially expansionary fiscal shock ahead of an imminent lower house election.

Jeremy Zook, director of Asia-Pacific sovereign ratings at Fitch, said the agency will "continue to assess the impact of new fiscal announcements, including the latest proposal to suspend the consumption tax for food products," but that it believes "these announcements are sufficiently captured in our current fiscal forecasts." He warned that "fiscal expansion materially exceeding our current expectations remains a risk, but for now we assume the government to continue to keep deficits within manageable levels following the elections, particularly given recent bond market pressure."

Fitch affirmed Japan's sovereign rating at A with a stable outlook earlier in the week, and said recent stronger nominal growth has supported a reduction in the fiscal deficit, giving Tokyo some headroom to absorb election-related uncertainty. The agency also reiterated a key vulnerability: Japan's public debt-to-GDP ratio exceeds 230 percent, the highest among developed economies, a structural constraint that leaves little margin for sustained, large-scale fiscal loosening.

Markets moved first and fast. The pledge to suspend the food levy accelerated a selloff in Japanese government bonds, lifting the benchmark 10-year yield to a multi-decade peak as investors reassessed the likelihood of near-term fiscal expansion. The surge in yields has immediate implications for government financing costs and for the Bank of Japan's policy calculus, increasing pressure on Tokyo to signal a credible plan to offset the cost of any tax relief.

For investors and policymakers, Fitch's statement strikes a balance between caution and conditional reassurance. By keeping its A rating and stable outlook for now, the agency signals that its baseline economic and fiscal projections—which incorporate recent growth improvements—are robust enough to withstand the election-driven noise. At the same time, its explicit caveat about materially larger fiscal expansion underscores a clear trigger for downward pressure on credit assessments: persistent policy promises that translate into higher structural deficits.

The timing of the election intensifies the policy trade-offs. Short-term political incentives favor visible fiscal giveaways, such as a two-year tax suspension, while long-term fiscal sustainability requires either higher growth, continued primary surplus improvement, or offsetting revenue measures. With public debt above 230 percent of GDP, even temporary revenue losses could complicate an already delicate debt servicing profile if they persist or are broadened.

Looking ahead, the crucial variables will be the final design of any food tax suspension, the magnitude of revenue loss, and whether the government pairs relief with explicit offsetting measures. Market moves this week suggest investors will reward credible, time-bound policies and penalize open-ended fiscal loosening. Fitch's stance implies that moderate, contained election promises are tolerable within current forecasts, but any fiscal expansion materially beyond those forecasts would raise clear risks to Japan's credit metrics and to market stability.