growth in the services sector, very rigid hierarchical labour laws and regulations, and very slow adoption of digitalization. One can also argue that a cultural resistance to, or intolerance of, failure also serves to inhibit innovation. While Takaichi has touted AI deployment to fill labour shortages and labour skills gaps, this would implicitly either create an even greater reliance on China — which looks highly unlikely given rising tensions between the two countries — or pivot to a reliance on the US, which the latest trade deal implies, above all in terms of strategic investments. It also begs the question of how the evident resistance to digitalization, let alone encouraging widespread AI deployment, can and will be incentivized.
THE IMMEDIATE CHALLENGE IS HOW TO DEAL WITH ELEVATED INFLATION
LD PARLIAMENT NMENT WOULD M YEARS OF
L AUSTERITY D PATTERN OF NT IN THE FUTURE RM.
But the immediate challenge is how to deal with elevated inflation after decades of deflation and ultra-easy monetary policy, and in no small part due to the protracted period of weakness of the JPY, which has, above all, contributed to food and energy inflation. While nearly all political parties have touted cutting the sales tax on food, there are, as yet, no credible and detailed plans on how to finance the fiscal ‘hole’ that this would create, which comes on top of having to deal with rising debt service payments on that mountain of government debt. Given that any sales tax cut would almost certainly have to be temporary, there is the additional challenge of finding an alternative after the suspension comes to an end, as Takaichi and Finance Minister Katayama have acknowledged with some sketchy proposals to replace it with some form of tax credits. While the landslide election victory does give them a ‘honeymoon period’ to come up with a fiscally viable plan, public concern about cost-of-living pressures will demand relatively rapid action, and not just rhetoric.
One solution to the fiscal challenges that both Takaichi and Katayama have touted is changing the way that Japan’s vast FX reserves (USD 1.178 trillion) are used. Under the current rules, 70% of the profits from the special account that manages the FX reserves can be transferred to the general
government account. The surplus on that account was JPY 5.36 trillion (USD 34.5 billion) in the 2024 fiscal year, with 30% retained as protection against potential future losses, which could be very substantial. Aside from the obvious risk of relying on a potentially very volatile source of revenues, the fact is that even if 100% of the surplus (i.e., interest income) were transferred, it would not go very far, given that the current fiscal shortfall is estimated at JPY 5.0 trillion. One suggestion from opposition party Komeito is to fold the BoJ’s QE ETF holdings and FX reserves into a sovereign wealth fund in order to generate higher returns, which could then be deployed for government spending. But this also implies substantial sales of US Treasuries, which would doubtless face fierce US opposition, given that Japan remains the largest holder of USTs — particularly if the proceeds were primarily (as seems likely) used for domestic spending rather than investments in the US. A more innovative solution might consider leveraging those holdings, though this also would not be without risk, and by effectively hypothecating some of its FX reserves, it would also reduce its capacity to defend the JPY.
What is clear is that just because political stability has returned to Japan, the serious fiscal and structural challenges that it faces require radical changes — made all the more difficult by an increasingly fragmented world. Per se, a very close eye needs to be kept on how Takaichi & Co deal with these.
Marc Ostwald E:
marc.ostwald@admisi.com T: +44(0) 20 7716 8534
31 | ADMISI - The Ghost In The Machine | Q1 Edition 2026
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