Why Japan’s new fiscal era matters for advanced economies and Asean

THE Bank of Japan (BOJ) appears increasingly likely to raise interest rates again, even as the government advances a 370 trillion yen (US$2.3 trillion) multi-year investment programme focused on economic security, artificial intelligence and next-generation industries.

Together, these developments capture Japan’s core challenge: restoring growth amid higher interest rates and record public debt. In doing so, Japan is becoming the first major economy to confront the fiscal and financial pressures that many advanced economies are likely to face over the coming decade.

For more than three decades, Japan appeared to defy the conventional rules of public finance. Government debt climbed to unprecedented levels, yet interest rates remained near zero, inflation stayed subdued and markets continued absorbing government bonds.

High domestic savings, a loyal domestic investor base and extensive BOJ bond purchases allowed the government to finance itself on exceptionally favourable terms.

Breakdown of old buffers

Those buffers are now weakening. Inflation has returned. The BOJ has ended negative interest rates, begun raising policy rates, and is gradually reducing its bond purchases. At the same time, an ageing population is eroding Japan’s domestic savings base.

As the central bank steps back from government bond markets, private investors will play a larger financing role – making market confidence, transparency and central bank independence increasingly important.

Japan is becoming more exposed to the same market disciplines that shape borrowing costs elsewhere.

This shift does not signal an imminent fiscal crisis but the gradual return of market discipline after decades of ultra-low rates and central bank purchases. As financing conditions normalise, investors will increasingly focus on the credibility and quality of fiscal policy, not simply the size of public debt.

The effects are already visible. A wide interest rate gap with the US encouraged investors to borrow cheaply in yen and invest in higher-yielding overseas assets through the carry trade.

While the weaker yen has supported exporters, it has also increased the cost of imported food, fuel and raw materials, squeezing household incomes and keeping inflation elevated.

From fiscal stimulus to industrial productivity

Japan is therefore entering a deeper policy transition. The original Abenomics programme relied on monetary easing, fiscal stimulus and structural reform to end deflation.

Today’s challenge is different. Public investment is increasingly directed towards economic security, AI, semiconductors and advanced manufacturing to mobilise private investment and raise productivity.

Equally important, the government has reaffirmed that monetary policy remains the responsibility of the BOJ. Preserving the bank’s independence provides an important institutional anchor for financial stability.

This is Japan’s deeper fiscal turning point. For years, exceptionally low interest rates blurred the distinction between borrowing to finance future growth and borrowing to fund current obligations.

As spending on pensions, healthcare, defence, debt service and industrial policy rises, fiscal space is becoming more constrained.

The central question is no longer simply how much debt Japan carries, but whether public borrowing generates stronger productivity and sustainable long-term growth.

Japan nevertheless retains formidable strengths in robotics, precision engineering, advanced materials and semiconductor equipment.

Support for Rapidus reflects a broader strategy to rebuild an innovation ecosystem around advanced manufacturing and AI. Its success will ultimately depend less on public funding than on its ability to attract private investment, stimulate competition and deliver lasting productivity gains.

Implications for advanced economies and Asean

Why does this matter beyond Japan? Because many of the forces reshaping Japan’s economy are spreading elsewhere.

Ageing populations, geopolitical tensions, higher defence spending, climate investment and the race to build AI capabilities are placing increasing demands on public finances across advanced economies.

Japan is simply confronting these pressures first, offering policymakers elsewhere an early guide to how highly indebted societies can adjust to a world of higher interest rates and more demanding financial markets.

The implications extend directly to Asean and particularly to Singapore. Japan’s monetary normalisation could gradually encourage some Japanese savings to return home after decades of overseas investment, influencing regional bond markets, funding costs and exchange rates.

Simultaneously, as Japanese firms expand investment in advanced manufacturing, semiconductors and digital infrastructure, regional supply chains will likely deepen and technology partnerships will strengthen.

Japan has consistently ranked among Asean’s top five sources of foreign domestic investment. Singapore’s sophisticated financial markets, strong legal framework and regional connectivity leave it well-placed to support these investments and strengthen its role as Asia’s principal financial gateway.

Confronting a new fiscal era

Japan’s experience suggests that the era of exceptionally cheap global capital is giving way to one shaped by higher interest rates, strategic industrial policy and competition for long-term savings.

Fiscal sustainability will increasingly depend on controlling debt, while ensuring public investment raises productivity and resilience.

This is more than a national story. It is the first major test of how highly indebted economies adapt to a world of positive interest rates, tighter fiscal constraints and strategic public investment.

Japan is confronting this challenge first – offering an early glimpse of the new fiscal era that many advanced economies will soon have to navigate.

The writer is a distinguished fellow at the Centre for Social and Economic Progress and former director at the International Monetary Fund