Japan Approves Record Budget, Boosts Defense and Social Spending

The Cabinet on December 26 approved a draft general account budget for fiscal 2026 totaling ¥122.31 trillion, clearing the first formal step toward parliamentary approval for a budget that begins in April 2026. The amount tops the initial FY2025 budget of ¥115.1978 trillion and follows earlier press estimates near ¥115.54 trillion; the government used the ¥122.31 trillion figure as its official proposal.

The package steers a distinctly expansionary fiscal course while responding to demographic pressures and rising regional security risks. Social security spending is a central driver of the budget increase, reflecting Japan’s rapidly aging population and recent inflationary pressure on welfare costs. The Cabinet Office assumed a baseline real GDP growth of 1.3 percent for fiscal 2026, up from an estimated 1.1 percent in the current year, to underpin revenue projections.

Defense spending rises sharply, exceeding ¥9 trillion for FY2026 and up roughly 9.4 percent from FY2025. The increase continues what officials describe as the fourth year of a five year program to move toward a 2 percent of GDP defense target, and some policy makers framed the appropriation as accelerating that timeline. The defense package prioritizes strike back capability and coastal defense through long range cruise missiles, unmanned systems and drones, and expanded research and development. The draft allocates more than $1 billion to co develop a next generation fighter with Britain and Italy, aiming for deployment in 2035, and includes plans for AI operated drones to operate alongside manned aircraft. The budget also sets aside nearly $64 million to support Japan’s defense industry and arms exports, an effort tied to growing foreign sales such as Australia’s decision in August to select Mitsubishi Heavy Industries for Mogami class frigate upgrades.

Beyond security, the draft budgets ¥6.11 trillion for infrastructure maintenance, covering water and sewerage systems and related facilities, and ¥2.30 trillion for agriculture and fisheries measures intended in part to stabilize rice supplies amid recent price rises. Debt servicing costs are projected to exceed ¥30 trillion for the first time, lifted by higher interest costs as the Bank of Japan shifts away from large scale monetary easing toward policy normalization.

Those debt dynamics frame the most acute market concern. The government signaled it will take measures intended to limit new long term bond issuance, a response to investor unease over rising deficits and mounting debt service. Details of those measures were not fully disclosed in the Cabinet release. Market participants and budget analysts will scrutinize whether reduced new issuance can coexist with large fiscal deficits and accelerating military procurement without pushing yields materially higher.

Prime Minister Sanae Takaichi, who took office in October, presented the budget as a blend of proactive growth support and fiscal responsibility while prioritizing national security. The draft now moves to the Diet for deliberation and final appropriation, where debates over defense expansion, the trajectory of social spending, and the long term sustainability of public finances are likely to dominate political and market attention in the coming months.