Spring 2026 White Paper
Japan is now in a new stage of its economy, the key characteristic of which is the clash between two forces that have previously acted in unison. For thirty years, fiscal expansion and monetary easing have supported each other in Japan: the government took on debt while the Bank of Japan took in that debt and as a result the cost to both sides was effectively nil. That situation, however, has come to an end. Since February 2026, Japan has experienced a highly unconstrained expansionary government alongside a central bank that is actively withdrawing monetary easing at the same time. The purpose of this report is to claim that it will be the way in which these two forces interact, rather than either force alone, that will decide Japan's economic course over the next five years, and that the country is carrying out this experiment from a position of exceptional external vulnerability.
The political change came about as a result of the snap election held on February 8, 2026. Prime Minister Sanae Takaichi took the Liberal Democratic Party's vote share in the Lower House from 465 seats to 316, an increase of 118, which was the largest single-party result since the end of the war and gave the government a two-thirds majority (Johnstone). For the first time in years, the usual limitations affecting Japanese fiscal policy, the need to negotiate with coalition partners, the influence of the Upper House, and the threat of a soon-to-happen election all have disappeared. The administration has taken advantage of this freedom by presenting a record budget of ¥122.31 trillion for fiscal year 2026, setting a record for defense spending, providing industrial subsidies for semiconductors and AI, and introducing a reduction in the consumption tax on food which will come into effect in April 2027.
The economic situation is that the cost of debt is no longer zero. The Bank of Japan abolished its yield curve control in March 2024, increased its policy rate to 0.75 percent in December 2025 and then to 1.00 percent on June 16, 2026 (Japan Times, “Bank of Japan Takes Rates to 1%”), and it is generally expected to make another move in September 2026. The ten-year JGB yield has risen from about 0.8 percent before the exit to nearly 2.9 percent by September 2026 (Trading Economics). Since the majority of Japan's existing debt was issued at fixed low rates, the financial damage is not avoided but is postponed. From fiscal year 2027 onwards, refunding and the issuance of new bonds will constitute the main part of the total stock, and Japan's debt burden will for the first time in a generation become genuinely subject to market pricing.
There are three underlying structural pressures. The first of these is demographic: the number of people of working age has fallen by 16 percent since its peak in 1995, fertility levels are at a record low, and the labor market is now reliant on foreign workers even though the political system is unwilling to refer to them as immigrants. The second relates to energy: the level of self-sufficiency in terms of primary energy is 15.3 percent, the second lowest in the OECD, and dependence on imports of crude oil from the Middle East has reached 95.9 percent in fiscal year 2024, almost all of it passing through the Strait of Hormuz. On 28 February 2026, the United States and Israel launched an attack on Iran, which in turn led to Iranian retaliation and the effective closure of the strait, through which roughly 20 percent of the world's oil and LNG supply passes (Center for Strategic and International Studies). The third is geopolitical in nature: export controls imposed by China on Japanese companies linked to defense, in response to Takaichi's remarks about Taiwan in November 2025, have placed Japan's access to rare earths and other dual-use inputs directly under the control of a strategic rival.
The implications go well beyond Japan. Since Japanese interest rates have remained low for so long, it is now the largest foreign holder of U.S. Treasury securities, with holdings amounting to over $1 trillion; when domestic yields rise towards 3 percent, the calculation that previously encouraged Japanese savings to go abroad turns around. If even a portion of that capital is brought back into the country, it will increase borrowing costs in the United States, lead to tighter global financial conditions, and reduce the amount of money flowing into emerging markets. Japan's process of monetary normalization is therefore not just a domestic issue; it is part of a gradual winding down of one of the biggest sources of cheap capital in the global financial system.
For investors, the key factors are how quickly the BOJ will be tightening, the JGB long-term bonds, and the yen. As for policymakers, the issue is whether Japan can fund its expansionary agenda via the fiscal 2027 rollover period without suffering a disorderly repricing. For the Indo-Pacific region, Japan's concurrent move into semiconductors, AI, arms exports, and regional energy financing marks the biggest expansion of Japanese economic statecraft since the 1980s, and this is taking place because Tokyo now views economic dependence as a security issue.
The February 2026 snap election brought about a change in Japan's political and macroeconomic situation. Prime Minister Sanae Takaichi saw the Liberal Democratic Party (LDP) achieve a historic win by obtaining 316 of the 465 seats in the Lower House. Since the LDP has a two-thirds supermajority by itself and its coalition partner, the Japan Innovation Party (Ishin), provides an additional 36 seats to make the governing group total 352, a majority that enables the parties to overcome rejections of legislation in the House of Councillors (Nippon.com). This level of support gives Takaichi an extraordinary amount of political freedom when it comes to shaping economic policy and greatly decreases their need for centrist compromises.
As a result, Japan is moving towards a very expansionary economic period that is financed by debt, representing a version of “Abenomics” with a strong emphasis on government intervention. Yet this change creates a conflict at the macroeconomic level since Takaichi's focus on fast economic growth, military expansion, and gaining domestic popularity through wide-ranging cost-of-living subsidies directly clashes with the existing state of inflation, the falling value of the yen, and the Bank of Japan's (BOJ) own initiatives to tighten monetary policy. For ordinary Japanese people, this change brings about immediate relief from the government at the point of purchase, but it could jeopardize the country's long-term fiscal stability.
The interest rate at the current level. In January 2026 the BOJ kept it at 0.75 percent by an 8-1 majority, Takata being the board member who disagreed and advocated a rise on the grounds that the price stability target had been achieved to a large extent and that risks to prices had become biased towards higher levels (Bank of Japan, “January 23”). It remained at that level again in March, the vote once more being 8-1 with Takata dissenting this time in favor of a hike, policymakers at the time cautions that escalating tensions in the Middle East were casting a shadow over the outlook (Trading Economics). At the meeting on April 28 the rate was left at 0.75 percent, although the vote had become closer with Nakagawa and Tamura joining Takata in voting against the decision to hold it (Bank of Japan, “April 28”). On June 16, 2026 the BOJ increased the policy rate to 1.00 percent by a 7-1 vote, Asada being the one who dissented and wished to keep it unchanged; the yen rose slightly to 160.22 against the dollar as a result of the decision (Lee). On July 31 the board maintained the rate at 1.00 percent by eight votes to one (Edge for Economic Consultancy). Overnight index swap data indicated that there was about a 97 percent chance of a 25-basis-point increase to 1.25 percent at the meeting on September 17–18 (Tech Times). The Bank of Japan's own estimate of the neutral rate is in the range 1.0 to 2.5 percent. The sell-side consensus (from BofA, Nomura, Goldman and EFG) set the terminal rate at 1.25 to 1.5 percent and stated that June or July 2026 would be the next probable period for a rate hike, a prediction which the June increase confirmed.
The policy of yield curve control. The Bank of Japan formally discontinued its yield curve control (YCC) in March 2024. The yield on 10-year Japanese government bonds rose from about 0.8 percent before the exit to 2.49 percent on 13 April 2026 and has since increased, reaching a range of 2.88 to 2.93 percent in the second week of September 2026 as the yen climbed to a level near its seven-month high (Trading Economics). The 30-year yield hit a record high of 3.91 percent on 20 January 2026 due to speculation about the election. The 10-year and 30-year yields together show the effect of three overlapping factors: the weakness of the yen, the fiscal supply outlook under an expansionary government, and the risk of stagflation resulting from the ongoing conflict in the Middle East.
The 2024 Shuntō wage negotiations resulted in a total wage increase of 5.10 percent, while the 2025 round yielded 5.25 percent, the highest figure in 34 years, with agreements reached with SMEs exceeding 5 percent. Rengo's preliminary figure for the 2026 Shuntō, released on March 23, 2026, was 5.26 percent in total and 3.85 percent for base pay, marking a third year in a row in which the total wage increase was above 5 percent (Rengo). Even though there were nominal wage gains, real wages stayed negative for most of 2025 because the CPI rose faster than earnings. Vanguard and BOJ staff had forecasted that the point at which real wages would turn positive would occur in mid-2026 as inflation eased, although the energy price shock caused by the closure of the Strait of Hormuz has delayed that crossover.
| Institution | USD/JPY Forecast (End-2026) | Rationale |
|---|---|---|
| JPMorgan (Tanase) | ~164 | Fiscal-dominance premium; limited BOJ tightening |
| Nomura | ~140 | Carry-trade unwind; US–Japan spread compression |
| Goldman Sachs | ~150–155 | Gradual normalization; US softening |
| ABN AMRO | Appreciating vs. USD | Rate differential narrowing in H1 2026 |
| Sell-side consensus | ~150–157 | — |
In practice the yen moved along the weaker part of that range until mid-2026, being traded at a rate of around 160 to the dollar at the time of the June increase (Lee). Japan's foreign reserves fell by a record amount of $80 billion in August as a result of yen intervention (CNBC). Since then the currency has recovered due to the winding down of carry trades, expectations of capital being repatriated, and increasing US political pressure on Japan to support the yen by adopting a tighter monetary policy (Trading Economics). This shows how sensitive the yen has become to the BOJ's tightening path rather than to trade flows.
The impact of a rise in interest rates. Japan's debt level, measured as a percentage of its GDP, is about 230 to 235 percent (for general government on the basis used by the International Monetary Fund), making it the highest among the other G7 countries (International Monetary Fund). Higher interest rates aggravate this situation since the costs of servicing the public debt go up as rates rise. For every 100 basis points by which long-term rates increase, annual interest payments rise by approximately ¥3.6 trillion (Ministry of Finance).
The strategy which the government depends on most is to replace bonds as they come to maturity by issuing new ones. In fiscal 2025 alone, total bond issuance was expected to amount to ¥172 trillion, and it will be necessary for the market to take it in smoothly in order to prevent fiscal turmoil. The key weakness in the situation is the timing. Interest payments in Japan at first come from the bonds which have already been issued at fixed rates, but from fiscal 2027 onwards those financed by newly issued and refunding bonds will become dominant, so that Japan's debt burden will increasingly be affected by changes in the market.
The Ministry of Finance's own forecasts show this worry: the amount paid in interest is expected to increase from ¥10.5 trillion in the first fiscal year of 2025 to ¥25.8 trillion by fiscal year 2034, the forecasts being based on the shaky premise that the yields on 10-year JGBs will stay at 2.5 percent from fiscal year 2028 through to 2034 (Ministry of Finance); meanwhile, the yields have already gone beyond that assumption.
In terms of finance, the Takaichi government is carrying out an aggressive economic program which relies on borrowing and is not restricted by conventional limits on spending. On April 7, 2026 the Diet approved a record budget of ¥122.31 trillion for the year ending March, making it the first time in eleven years that the annual spending plan had not been enacted before the start of the fiscal year on April 1, and the amount allocated to defense-related purposes reached a record ¥9.04 trillion (Japan Today, “Diet Enacts”). The main areas for spending are focused on national security and on promoting strategic industrial development, with specific investments being made in AI and in the manufacture of semiconductors.
At home, the government is trying to protect the public from the effects of inflation by giving out cash, providing energy subsidies, and reducing the consumption tax on food. Takaichi had promised a complete two-year halt to the 8 percent food levy, a move which was expected to reduce government revenue by about ¥5 trillion, or roughly $30 billion, each year (Katsumura), equivalent to around 0.8 percent of GDP. The measure which her Cabinet approved on August 5, 2026, is more limited in scope: it involves lowering the rate from 8 percent to 1 percent for a two-year period starting in April 2027, a decision that caused a split with senior figures in her own party who expressed public opposition (Japan Times, “Takaichi's Cabinet”). No alternative source of revenue has yet been found, and critics have warned that the two-year measure is in effect a tax increase on a timer (Sekiguchi). In order to fund its wider expansionary policy, the government intends to issue ¥29.58 trillion in new bonds, highlighting Japan's heavy dependence on borrowing at a time when its fiscal position is the worst among the G7 countries (Xinhua), new borrowing covering approximately 40 percent of recent supplementary budgets. Overall government debt remains close to 230 to 240 percent of GDP, making the administration very susceptible to rising bond yields and the growing cost of servicing the debt.
Since the breakdown of its asset price bubble in the early 1990s, corporate hiring in Japan has fallen considerably, this being a clear indication of the country's severe demographic problems. Because of a drop in fertility rates and a growing aging population, Japan is leading the way in experiencing labor shortages. The working-age population has been steadily decreasing since 1990, falling by 16 percent from its peak of 87.3 million in 1995, and in the early 2000s record-low fertility rates were achieved due to employment insecurity, high housing costs and high childcare costs, with further historic lows in the 2020s as marriages were put off during the COVID-19 pandemic. From 1990 to 2022, Japan's real GDP increased at an annual rate of 0.8 percent, which was the second lowest in the Group of Seven (Canada, France, Germany, Italy, Japan, the United Kingdom and the United States); at the same time, its working-age population declined by 0.46 percent each year.
This is mainly a consequence of Japan's cultural norms. Unlike the nuclear family pattern common in the United States, Japan has retained traditional, gender-based values under which women take on the main role of carer. It is for this reason that Japan's lowest ever birth rates have led to a strong imbalance in the labor market in a society that is rapidly aging. Approximately 20 million Japanese workers in their 40s and 50s are stuck in low-paid jobs, and this generation is characterized by limited savings and a low rate of home ownership. This situation arises from a combination of insufficient public pensions and a corporate system that compels workers to take up lower-paying positions after the mandatory retirement age, thus pointing to two economic areas in which more effective solutions could be developed. Women's involvement in the labor market has in the past been shown by an M-shaped curve, which indicated that they left the workforce during their childbearing years. Nevertheless, in recent years their participation rate has risen considerably, reaching about 78 percent in June 2025, an increase of nearly 20 percentage points on the roughly 60 percent level seen in the early 2000s.
A further area that requires greater attention is Japan's immigration policies. In order to strengthen its workforce and decrease its dependence on older workers, Japan is offering short-term visas, raising the maximum period of residence from three to five years, and dropping the need for re-entry permits. The country also gives immigrants access to healthcare and provides them with routes to obtain permanent residence status. Yet newcomers generally encounter cultural, linguistic, and social difficulties and are given little help in adjusting to Japanese customs.
In 2026 there are opposing trends in Japan's priorities for labor reform. Even though the number of people of working age in Japan is shrinking rapidly, particularly in the rural parts of the country, Prime Minister Takaichi is trying to undo the measures aimed at preventing burnout and is seeking to restore the culture of working overtime. The shrinking workforce in Japan, as mentioned above, affects different parts of the country to varying degrees. The number of farmworkers has been halved since 2000 and the percentage of farmworkers who are 65 years of age or over has risen from 53 percent to 71 percent by 2023 (Ministry of Agriculture, Forestry and Fisheries). Takaichi's government is altering the programs that enable foreign workers to enter Japan, particularly in the agricultural sector, by introducing more generous schemes, widening the eligibility criteria and setting up stepping-stone arrangements into the Specified Skilled Worker system, which allows foreign workers to address labor shortfalls. It is still not clear what effect these policy changes will have, since they will not come into force until 2027, but early forecasts from the USDA's Foreign Agricultural Service, together with Japan's long-standing anti-immigrant rhetoric, might suggest that there will be only limited change (United States Department of Agriculture).
The urban landscape and the reforms aimed at the knowledge economy are very different from the above policy. Japan has in the past faced high levels of worker burnout as a result of its strict culture regarding overtime, a situation which has even given rise to the problem of karoshi, that is, death due to overwork. The situation regarding overtime in Japan is complex and varies from case to case. As a basic rule, many salaried employees are paid in advance for the overtime they are expected to carry out, which creates a financial incentive and a sense of obligation to spend that time. In 2014 the cabinet under Shinzo Abe passed the Act on Promotion of Preventive Measures against Karoshi, thereby treating the problem as one of national policy by requiring government research, launching awareness campaigns and providing consultation services, although the act itself did not impose limits on working hours. It was not until the 2018 Work-style Reform Law (Hatarakikata Kaikaku) that binding limits on overtime were introduced, setting a general cap of 45 hours per month and 360 hours per year, with a special clause allowing for up to 100 hours in a month and 720 hours a year. Several sectors, such as construction, commercial drivers and physicians, were given extended grace periods and had more lenient industry-specific limits, so the actual caps were weaker than those stated on paper (Ministry of Health, Labor and Welfare).
The 2018 package also extended the scope of hours-exempt pay. The discretionary labor system in Japan—this system enables employers in certain occupations to count a set number of hours as having been worked no matter how much time is actually spent, existed before the reform and is mainly applicable to jobs like design, research, and consulting. The 2018 law also introduced the “highly professional” status, which completely removes any regulation on working hours for a small group of high-earning specialists. Although the intended aim of both arrangements is to shift the evaluation from hours to output and thus discourage overtime, there is an alternative interpretation that they will result in workers not being paid for the overtime they carry out. The extent of coverage has so far been very limited, applying to only about 2 percent of Japanese workers. Takaichi plans to increase the number of workers who are eligible and to relax the criteria. This could result in greater overwork.
Since the number of workers in Japan is declining considerably, Takaichi's government is promoting the employment of foreign workers in rural areas while withdrawing agricultural worker protections. Given the shrinking workforce and the low birthrate, it appears that pressures in Japan will keep on rising under the present and forthcoming policy situation.
In order to counter the demographic collapse and the serious shortage of workers, Japan has become ever more dependent on foreign labor, the number of people who are foreign residents reaching a record 4 million by early 2026 (Immigration Services Agency). Even so, there has been an increase in xenophobic feelings among the general public. During her campaign Prime Minister Takaichi took advantage of this by promoting strict immigration controls, managing to absorb the platforms of the right-wing opposition and presenting unregulated immigration as a danger to national unity.
In practice, her administration introduced a policy framework in January 2026 called Comprehensive Measures for Accepting Foreign Nationals and Orderly Coexistence, this being a replacement for the guidelines which had originally been adopted in December 2018 when a major amendment to the Immigration Control and Refugee Recognition Act led to Japan opening the door to lower-skilled foreign labor through the Specified Skills program (Kajita). The policy seeks to meet the economic need to admit up to 1,231,900 foreign workers over the five-year period ending in fiscal 2028 via the specified skilled worker and skill development programs (Journal News), while at the same time enforcing strict social compliance measures. The framework is intended to make it more difficult to obtain permanent residency or naturalization, although it gives no clear indication of whether the aim is to achieve eventual settlement or instead to crack down on entry (Kajita). The policy makes no use of formal ‘immigration’ or routes leading to permanent settlement, and instead concentrates on temporary labor. As a result, foreign workers have to go through greater bureaucratic difficulties, for example facing strict Japanese language requirements when applying for permanent residency and longer continuous residence requirements, which leaves a large part of this vital workforce in insecure, non-regular employment.
While Takaichi is in office, Japan is actively expanding three major industries, semiconductors, artificial intelligence, and green technology, which are essential to modernising the country's economy and at the same time reducing its dependence on other countries. Moreover, Japan's new investment allows it to increase its influence in East Asia and function as a counterbalance to China's economic power.
Japan currently relies heavily on imports when it comes to semiconductors, the main supply countries being China, Malaysia and the Philippines. Nevertheless, the semiconductor industry remains one of the most important globally, thanks to the rising demand from artificial intelligence, cloud computing and advances in the automotive sector. The global semiconductor market is expected to see tremendous growth over the next ten years, which is why national investment in the area is so significant. Seeing this, Japan has taken action to restore its domestic capabilities, having approved more than ¥600 billion for Rapidus, a domestic chipmaker concentrating on next-generation 2-nanometer semiconductor technology with the aim of achieving mass production by 2027. Japan already has strong points which provide a solid basis for this initiative. It is the world's second biggest producer of semiconductor manufacturing equipment and holds a dominant position in key materials such as photoresists and silicon wafers. Japan's semiconductor strategy is also closely linked to international cooperation, especially with Taiwan. Although Taiwan is leading in chip manufacturing, Japan excels in materials and equipment, so the two economies are highly complementary. This is shown by Taiwan Semiconductor Manufacturing Company (TSMC)'s decision to build a large fabrication plant in Kumamoto, a move that has been backed by Japanese government subsidies. These kinds of collaborations not only improve the supply chains but also help to promote regional stability by bringing the economic interests of the major players in East Asia into line.
Japan is also making use of its industrial strengths and international collaborations in order to enhance its capabilities in the field of artificial intelligence. A prominent example is Microsoft's decision to invest $10 billion in Japan from 2026 to 2029 in order to expand its artificial intelligence infrastructure, strengthen cooperation in the area of cybersecurity, and train workers, building on the $2.9 billion that it had already invested two years before (W.Media). This investment is directed towards developing cloud and AI capabilities through partnerships with local companies such as Sakura Internet and SoftBank, which provide graphics processing units and other computing resources in order to increase AI capacity within Japan, as well as including a plan to train one million engineers and developers in AI-related skills by 2030 (Storyboard18). A significant aspect of this investment is its focus on “sovereign AI”, which means that data is stored and processed within the country rather than overseas. Microsoft has said that by working with local partners businesses and government agencies will be able to keep their sensitive data at home while still being able to use Azure cloud services, thus improving both data sovereignty and technological capability (Storyboard18). Since geopolitical tensions are increasing, countries are becoming more careful about data security and their dependence on foreign powers. Japan's approach shows a change in the way nations handle sensitive information and digital infrastructure and may therefore act as a model for other regions, offering a possible blueprint for future partnerships with European and other Asian countries.
At the same time, Japan's increasing involvement in the energy and green technology sectors offers an opportunity for the country to boost its soft power in East Asia. In April 2026 Takaichi committed $10 billion in financial assistance to the economies of Southeast Asia, providing a sum of ¥1.6 trillion as part of an initiative called “Power Asia” in order to strengthen those regions' energy supply chains and help them to obtain crude and petroleum products; the initiative was announced following an online summit with the ASEAN members within the Asia Zero Emission Community framework (Agence France-Presse). Although the Partnership on Wide Energy and Resource Resilience Asia does address the immediate vulnerabilities in fossil fuel supply chains, it fails to meet the region's wider energy transition objectives and could end up increasing Southeast Asia's reliance on fossil fuels at a time when this is precisely the wrong thing to do (Nguyen). The initiative is important as an example of Japanese economic diplomacy, even though its contents are more in the nature of emergency financing for fossil fuels than of clean energy exports. Only if Japan combines this type of crisis financing with real investment in solar, hydro, geothermal and grid modernization can it establish itself as a reliable energy partner rather than as a lender of last resort, thereby improving its international image while setting up new economic relationships with countries that are attempting to move towards low-carbon economies. In this way, green technology can function both as a means of enhancing domestic resilience and as a way of strengthening Japan's position on the global stage.
In summary, Japan's investments in semiconductors, artificial intelligence, and energy show a deliberate strategy aimed at achieving economic independence, strengthening its alliances, and staying competitive in the global race for technology. By concentrating on industries which support future innovation, Japan is not only boosting its own economy but also altering its position within the international system.
The share of thermal power in Japan's electricity generation in fiscal year 2023 was 68.6 percent, that of renewable energy 22.9 percent and that of nuclear power 8.5 percent (Agency for Natural Resources and Energy). The level of self-sufficiency in respect of primary energy is 15.3 percent, the second lowest in the OECD. Fossil fuels provide 80.7 percent of primary energy.
Japan imports about 85 percent of its primary energy, this comprising almost all of its crude oil, LNG and coal. The proportion of its crude oil imports coming from the Middle East reached 95.9 percent in fiscal year 2024, the highest level since 1965, having been 82.5 percent in fiscal year 2015. Both the UAE and Saudi Arabia provide roughly 40 percent of the crude oil. Almost all of it passes through the Strait of Hormuz. This strait is the only sea route by which oil, natural gas and other cargo can leave the Persian Gulf, including 93 percent of Japan's oil imports, and as a result of its de facto closure the Japanese government began to release 80 million barrels of oil on March 16, 2026, the amount being equivalent to 45 days of domestic demand (Center for Strategic and International Studies).
In the case of the major economies that import energy, Japan is in one of the most structurally vulnerable positions globally when it comes to its dependence on oil and its exposure to the Strait of Hormuz. As Ember has analysed, 87 percent of the total energy used in Japan comes from imported fossil fuels, a proportion which is higher than that of South Korea (81 percent), much greater than India's (35 percent), and more than four times China's (20 percent) (Ember). The other sources of energy and the extent of their dependence on the Strait of Hormuz are set out below.
| Country | Energy Self-Sufficiency | Fossil Fuel Import Dep. | Oil Import Dep. | Middle East / Hormuz Oil Exposure | LNG via Hormuz |
|---|---|---|---|---|---|
| Japan | 15.3% | ~87% [1] | ~99% [1] | 95.9% of crude (FY2024) — highest since 1965 [3], UAE & Saudi Arabia ~40% each [2] | ~20% of total energy |
| South Korea | ~8% | ~81% [1] | ~100% | >60% of crude imports from Middle East | ~17% of total energy [1] |
| Taiwan | ~5% | ~95% [1] | ~99% | Virtually all crude imported; 39.3% coal + 42.4% LNG in power mix [1] | ~24% — highest globally [1] |
| China | ~85% | ~20% | ~72% | Largest volume globally but offset by domestic coal & diversified pipeline routes [2] | Moderate |
| India | ~40% | ~35% [1] | ~85–87% | 40–50% pre-crisis; diversified to ~70% outside Hormuz (Mar 2026) [4] | ~65% of LNG imports [5] |
7th Strategic Energy Plan. Japan revised several items from the previous plan written in 2021. The 7th Strategic Energy Plan was approved by Cabinet in February 2025, with the supporting METI/ANRE mix figures revised that April, and made the following changes (Ministry of Economy, Trade and Industry):
Emissions reduction targets are -46 percent by FY2030 (vs. FY2013), -60 percent by FY2035, -73 percent by FY2040, and net zero by 2050.
Are these values realistic? To achieve the goals outlined, Japan would have to increase renewables by 13 to 15 percentage points and cut fossil fuels by 26 percentage points within five years to meet the FY2030 target alone. Given that the FY2023 mix still ran 68.6 percent thermal, that nuclear restarts remain slow and locally contested, and that the Hormuz disruption has pushed the system toward whatever fuel is physically available rather than whatever is cleanest, the FY2030 target should be treated as aspirational rather than as a planning assumption. The FY2035 and FY2040 targets depend almost entirely on new reactor construction and grid buildout that has not yet begun at the required scale.
In April 2026, Japan made significant changes to its policies regarding the manufacture of arms. On April 18, 2026, when the “Mogami Memorandum” was signed on the JS Kumano in Melbourne, Tokyo agreed to provide the Royal Australian Navy with 11 next-generation Mogami-class frigates under a deal worth up to A$20 billion, the first three of which were to be completely built by Mitsubishi Heavy Industries in Nagasaki and delivered by December 2029 (Asia Times). A few days later, on April 21, Japan announced that it was reversing a major policy decision and was ending its long-standing ban on the export of lethal weapons, altering its arms export principles at a meeting of the National Security Council and removing the rules that had previously restricted transfers to non-lethal uses such as rescue and surveillance; Takaichi described the change as a way of enhancing the defensive capabilities of partner countries and thus securing Japan's own security, while stressing that the country's commitment to a peaceful path would not be altered (Panda).
The immediate impact on industry as a result of these changes is expected to be limited. Japan's defense industrial base is narrow, production volumes are small, and the Mogami agreement in fact did not depend on Tokyo altering its export controls, because there was already room for transfers related to joint development and production (Australian Strategic Policy Institute). The importance lies in what the reform enables in the longer term: it provides a repeatable model for exporting entire lethal systems to partners like Australia, New Zealand, Indonesia, and the Philippines, at a time when US allies are being cautious about Washington's unpredictability. If this model proves viable, defense will become a real export sector rather than remaining just a domestic procurement exercise, and the ¥9.04 trillion defense budget will begin to double as a result of industrial policy.
Green energy has a similar role in the growth strategy for the same reason. At home, the aim is to achieve energy transformation in order to address the fact that a 15.3 percent level of self-sufficiency was revealed by the Hormuz closure to be a national security risk. Outside the country, the motivation is to create new markets: the GX 2040 Vision, the POWERR Asia financing, and the AZEC framework are all efforts to ensure that Japanese technology, standards, and capital become the preferred option for energy systems in Southeast Asia before Chinese alternatives take over that position. The two reasons will lead in the same direction only if Japan actually develops its domestic capacity rather than exporting financial support for the fuels it also needs. This is the fundamental tension in the current growth strategy.
Regionally, two main forces are influencing Japan's situation in East Asia: Japan-China relations and the continued integration of East Asian production networks.
There have been key tensions with China regarding defense and controls on key dual-use items and materials. The dispute began with Takaichi's parliamentary remarks on November 7, 2025 concerning a potential Taiwan contingency; after demanding that she retract the comments, China prohibited exports of dual-use items destined for Japanese military end users in January 2026 (The Economy). On February 24, 2026, the Ministry of Commerce added 20 Japanese entities, including the shipbuilding and aerospace affiliates of Mitsubishi Heavy Industries, to its export control list, the first time Japanese firms had been added since the list's January 2025 debut (Xiao et al.). Another 20 Japanese equipment and materials companies were placed on a “watch list,” subjecting their purchases of Chinese dual-use goods to stricter end-user and end-use reviews (Caixin Global). The campaign continued into June 2026, when China blacklisted four Japanese government defense research institutes, including the National Institute for Defense Studies, and imposed tighter restrictions on dozens of other Japanese entities (CNBC, “China Widens Japan Export Curbs”).
These dynamics also significantly impact trade beyond China and Japan. The controls prohibit foreign organizations and individuals from providing Chinese-origin dual-use items to the listed entities, effectively cutting those companies off from the seven rare earths and associated materials on China's dual-use control list, including dysprosium and yttrium, which play small but vital roles in cars, planes, weapons, and consumer electronics. China maintains an export control list of roughly 1,100 dual-use items and technologies, and manufacturers must secure a license to ship them overseas wherever the end user may be (NBC News).
Market reaction in Tokyo was mixed, with Subaru shares falling 3.5 percent while Mitsubishi Materials shares rose 3.8 percent and Mitsubishi Heavy shares were down 3.1 percent (NBC News).
Experts estimate that three months of export restrictions from China may inflict economic damage of approximately ¥660 billion ($4.2 billion) on Japan, while a yearlong restriction may lead to losses of ¥2.6 trillion ($16 billion). Japan remains reliant on Chinese rare earths, which accounted for 58 percent of supply in 2024 (Caixin Global), down from 90 percent, and it remains highly dependent on such materials for missile guidance systems.
In response to China's restrictions, Japan has secured alternative sources of heavy rare earth materials from Australian miner Lynas Rare Earths Ltd., with JARE purchasing 50 percent of materials and the remainder available to other Japanese companies. While China has not directly commented on Lynas, the deal helps lessen China's influence over rare earth pricing, providing insulation.
China's restrictions also impact the Southeast Asian region, as China prohibits suppliers from supplying Japanese subsidiaries or supply chains on the blacklist. Though Southeast Asian economies may fill roles in alternative supply chains meant to reduce reliance on China, they face the risk of depending on critical Chinese inputs.
One promising example is Shin-Etsu Chemical in Vietnam, which operates rare earth refining and magnet manufacturing facilities. However, its capacity has not expanded since the site's completion in 2018, and the operation still relies on feedstock that originates in Chinese-dominated supply chains. Vietnam has also imposed a ban on unprocessed rare earth exports in 2026. Going forward, regional reliance on China risks limiting growth of the advanced manufacturing sector and state autonomy.
Malaysia also offers potential opportunities for future growth, as its current expansion of processing capacity with investment in heavy rare-earth refining strengthens its ability to support midstream capabilities and heavy rare earth-related products, key areas where Japan experiences the most prominent gaps.
Japan has a central position in the world's financial markets since it is the largest foreign holder of U.S. Treasury securities, having invested more than $1 trillion in U.S. debt (U.S. Department of the Treasury). For many years, the low interest rates in Japan have caused banks, pension funds, and insurance companies to invest overseas, particularly in Treasuries, because these provided higher and safer returns than Japanese bonds. This situation is advantageous for the United States since the strong demand from Japan for Treasuries helps to maintain lower borrowing costs in the U.S. and contributes to stability in global financial markets. The trade surplus that Japan enjoys with the United States also supports this process, as the dollars earned from exports are usually reinvested in American debt.
However, as Japan moves away from its ultra-low interest rates, Japanese investors might start to shift their capital back into the domestic markets since returns there are becoming more attractive. This trend is already apparent: the rise in the yen in September 2026 was caused by the termination of carry trades and by expectations of capital being repatriated (Trading Economics). The shift in policy could have major consequences for both the US and Japanese economies. When Japan brings its investments back home, the total demand for US Treasuries decreases. In order to keep the Treasuries appealing, yields have to go up, which in turn raises the cost of US government borrowing and leads to higher borrowing costs throughout the American economy.
The effects might be felt all around the world; higher US yields together with decreased overseas investment by Japan could lead to tighter global financial conditions, greater market volatility, and a reduction in capital flows into emerging markets which depend heavily on foreign investment.
Addressing demographic headwinds in Japan requires a comprehensive combination of efforts across the policy and social domains. These include changes that further promote participation by women and seniors in the labor market, increased incentives to improve the fertility rate, and the promotion of a culture of acceptance and assimilation for foreign workers. In particular, increasing opportunities and working hours for full-time work for women, along with increasing opportunities for foreign workers, who contributed over 50 percent of labor force growth from 2023 to 2024, would be effective. Other productive policies, some of which Japan has already implemented, are paid parental leave, childcare coverage, and tax exemptions; these efforts should be continued moving forward.
One area that requires further improvement is Japan's parental leave system. Despite being one of the most generous in the world, offering up to 52 weeks at roughly 60 percent of wages on average across the leave period, it still lacks significant uptake, particularly from men (Organisation for Economic Co-operation and Development). This links back to Japan's culture: the intense corporate culture, fear of career penalties, and deep-rooted gender stereotypes compel men to continue working. Despite the establishment of legal rights, men still fear demotion or social harassment. It will therefore take overturning these cultural pressures and creating stronger incentives within the workforce culture to encourage paternity leave. Only then can these policies actually bear fruit and aid in progressing women's ability to participate in the workforce, coupled with policies that reduce educational and opportunity costs for mothers raising children. By contrast, there is only limited evidence that cash transfers on their own meaningfully raise fertility, and financial incentives alone appear insufficient to increase birth rates. Moving forward, Japan should shift more of its focus onto non-monetary incentives.
In addition, to achieve an annual growth rate of 1.24 percent, the government's economic growth target, Japan needs 6.74 million foreign workers by 2040, about four times what it had in 2020 (Japan International Cooperation Agency). A necessary step in this process is not only providing improved educational opportunities for immigrants to mitigate the assimilation challenges identified earlier, but also implementing anti-discrimination laws. Japan remains the only G7 country without comprehensive anti-discrimination legislation or an independent national human rights institution. By repairing this and potentially enabling immigrants to become naturalized citizens, Japan can attract more workers.
It is also important to note opposition from the far-right party Sanseito, which has drawn attention for its xenophobic campaign and “Japanese First” agenda, and which increased its Lower House tally to 15 seats from two in the February 2026 election (Malay Mail). Despite foreign tourism boosting revenue, local governments have struggled to cope with the impact of overtourism on their residents' livelihoods. As a result, polls from November and December 2025 found that over half of respondents believe Japan needs fewer visitors and immigrants, with 66 percent supporting Prime Minister Takaichi's tougher stance. This highlights that even as Japan heads toward a more controlled immigration model, it should adopt ways for temporary workers to gain language proficiency and familiarity with Japanese etiquette to ease concerns about social disruption.
As for the industry, Japan should keep on investing in important areas such as semiconductors, artificial intelligence, and green technology and at the same time enhance its partnerships with other countries. These industries are at the heart of future economic growth and technological competitiveness. By working closely with partners who have complementary strengths, Japan will be able to secure its supply chains, accelerate innovation, and decrease its dependence on any one country.
Japan should also increase its soft power in East Asia by serving as a consistent and reliable partner to the countries adjacent to it. By offering support during times of instability, for example, when it comes to energy or supply chains, it is possible to build up long-term trust and cooperation. Through this method, Japan will be able to strengthen its relations in the region, boost demand for its industries, and slowly offset China's influence without engaging in direct conflict.
Regarding domestic financial markets, Japan should regard foreign direct investment as a means of reinforcing its existing strengths rather than as something it has to rely on for growth. It already possesses strong domestic savings and financial institutions which offer a great deal of capital. In areas such as green technology and artificial intelligence, the most valuable aspect of foreign investment is the technology, expertise, and partnerships that it provides, not merely the funding.
Interest rate policy must be handled with care if it is to prevent a slowdown in these sectors. Although higher rates will raise borrowing costs and make it more difficult for companies to invest, particularly in emerging industries, they do not necessarily lead to a reduction in foreign investment and might even draw in some capital. The greatest risk involves raising rates too rapidly and thus slowing down growth at a time when these industries are still expanding. Taking a gradual approach will help keep investment going while at the same time permitting policy adjustments.
Because geopolitical tensions are continually changing, especially in the Middle East, those in charge of policy should focus on narrowing the gaps in their knowledge and enhancing visibility within the supply chains for essential materials. Both governments and companies would stand to gain significantly by keeping a close eye on their dependencies involving politically unstable areas and by securing alternative arrangements in the event of disruptions to energy markets and trade routes. The damage caused by the closure of the Hormuz Strait and by China's export controls did not result from the disruptions themselves but was due to the fact that companies had very little knowledge of their second- and third-tier exposures prior to those disruptions occurring. Making it mandatory to map out supply chains for critical inputs and requiring the public disclosure of dependence on chokepoints would turn an uncertain risk into one that can be managed.
In response to China's controls, Japan and its partners should also keep on diversifying their sources of rare earth materials and put money into processing capacity in other countries in order to decrease their excessive dependence on China. These measures taken together would serve to strengthen the resilience of Japan's economy in the face of uncertainty in the region and at the same time preserve its long-term industrial and national autonomy.
Japan served thirty years as the world's best example of the situation that arises when a wealthy economy runs out of growth; it is now becoming an example of a different and less common scenario: what occurs when such an economy decides to get out of difficulty by spending, with no political force capable of obstructing it, at the very moment when its cost of capital starts to rise.
The various parts of this report deal with different manifestations of the same issue. In financial terms, the government has promised to maintain high spending levels, to reduce the tax on food, and to expand its defense spending while at the same time the Bank of Japan is withdrawing the monetary easing which had previously made these commitments affordable. As regards demographic matters, Japan requires a large number of foreign workers, even though it has been unwilling to refer to this as immigration, and has therefore established a legal system intended for importing labor without importing residents. Industrially, it is making heavy investments in semiconductors, AI, arms and clean energy in order to lessen its dependence on other countries, even though it remains more dependent than almost any other similar economy on a single maritime chokepoint and a single supplier of critical minerals. In all these cases the strategy is consistent within itself but is at odds with the circumstances in which it has to function.
The situation is still not a crisis and might not develop into one. Most of Japan's debt is held by domestic investors, its institutions are trusted, wage growth has gone above 5 percent for three successive Shuntō periods, and real wages are now closer to becoming positive than they have been at any time since inflation started. A government with a four-year term and a supermajority does in fact have the chance to introduce structural changes which fragile coalitions would not have been able to make. The reason for adopting the present strategy is that Japan has failed to make adequate investments over the course of a generation and that the costs of continuing to stagnate are greater than the costs of borrowing.
However, the timing is harsh and three dates are more important than the rest. The first of these is in fiscal 2027, by which time refunding and bonds issued anew will make up the majority of the total debt and Japan's borrowing costs will start to reflect market prices rather than the old fixed rates. The second is in April 2027, when the consumption tax on food drops to 1 percent without any identified replacement revenue and at the same time the revised foreign worker programs come into effect. The third is when the BOJ's policy rate reaches the lower end of its own neutral rate estimate, at which point a decision has to be made as to whether normalization should continue into genuinely restrictive territory given that there is a highly indebted sovereign on the other side of the trade.
To outside observers, the number of indicators that are worth keeping an eye on is less than the report's scope implies. The longer end of the JGB curve is the simplest single indicator of whether the markets accept the fiscal policy path. The rate at which Japanese capital is being repatriated is the clearest indication of the impact on US Treasuries and on financing in emerging markets. The increase in the number of Specified Skilled Worker visas following the 2027 reforms will indicate whether Japan's demographic strategy can succeed given the political restrictions it has placed upon itself. And the proportion of crude oil arriving outside the Strait of Hormuz will show whether the energy vulnerability described in the 7th Strategic Energy Plan is being dealt with or is being dealt with only on paper.
The fact that Japan's case is instructive is because it is a foretaste of what is to come; the problems of an aging population, high public debt, dependence on energy imports, and supply chains vulnerable to a strategic rival are not specific to Japan since they too will be faced by much of the developed world in the next twenty years. Japan is merely the first country to be carrying out this experiment in the open, and without the monetary buffer that had made the previous thirty years tolerable. Whatever outcome the Takaichi strategy has, it will be carefully observed and not only in Tokyo.
