Fitch: Japan's New Political Dynamics May Challenge Positive Fiscal Trends

Fitch Ratings stated that the re-election of Shigeru Ishiba, leader of the Liberal Democratic Party (LDP), as Japan's Prime Minister at the head of a minority government signifies significant changes in the country's political dynamics. “Our fundamental assumption is that Japan's credit metrics will not be significantly affected in the context of the positive trends of recent years, but that looser fiscal policy may pose risks to the country’s rating over time,” Fitch expressed. “Our core view is that the new political balance will lead to only marginal changes in Japan's fiscal approach, with the government still expected to pursue gradual fiscal consolidation and remain cautious about major policy shifts that could lead to volatility in the bond market during a period of normalizing monetary policy.”

Fitch highlighted Japan's strong bureaucracy and institutions, including the Ministry of Finance, and expressed confidence in an established institutional commitment to fiscal consolidation and prudent policy-making. "However, there is a risk that the new political dynamics could lead to looser fiscal policies," they added.

The rating agency also noted that expectations for fiscal consolidation could be influenced by external developments, such as the potential for higher tariffs on Japanese exports by the next U.S. administration or the need for Japan to accelerate its own defense capabilities. “The Japanese yen has weakened since mid-September, which may partly reflect recent political developments in the U.S. and Japan. Both increased public spending and a weaker yen are inflationary, and could speed up the Bank of Japan's tightening of monetary policy,” Fitch assessed.

Fitch remarked, "We see upside risks to our forecast that BOJ policy rates will rise to 0.75% by the end of 2025 and to 1% by the end of 2026. The continuation of higher interest rates will increase the government's interest costs over time; however, stronger domestic inflationary dynamics may provide counterbalancing support for debt sustainability."