Japanese economic policy is entering a more sensitive phase as government spending expands, borrowing costs rise, and the Bank of Japan approaches a new hike in interest rates, at a time when Fitch Ratings is monitoring whether the government of Prime Minister Sanae Takaichi is able to maintain a convincing balance between supporting growth and fiscal discipline.
Jeremy Zook, senior director of sovereign ratings for the Asia-Pacific region at Fitch, said that the agency will scrutinize the components of the upcoming budget to assess the extent of the balance between the “responsible” and “proactive” aspects of the government’s fiscal policy.
Japan's budget requests for the next fiscal year are heading to record levels, driven by a new framework that more closely integrates the core budget with spending that was previously relegated to supplementary budgets, in addition to the rising cost of debt service as government bond yields rise.
This point is particularly important, because Japan is entering a phase in which very low interest rates are no longer guaranteed. Government bond yields have risen in recent months to their highest levels in decades, which means that any new fiscal expansion will become more expensive, and that markets will more closely monitor the government's ability to finance its investments without causing a deterioration in debt conditions.
Zook explained that the most important indicator for Fitch will be the path of the primary balance of the budget, that is, the difference between revenues and expenditures before calculating debt interest. This indicator is a direct test of whether the government is able to finance its current spending from revenues or whether it will continue to rely on debt.
Despite these risks, Fitch does not currently expect a rapid deterioration in Japan's sovereign rating. The agency believes that the debt-to-GDP ratio may continue to decline over the next five years, benefiting from stronger nominal growth and increased tax revenues, before stabilizing later.
Conditional success
But the success of this scenario depends largely on the ability of Takaichi's investment program to actually raise the economy's productive capacity, not just increase government spending.
The government aims to direct public and private investments to strategic sectors, such as artificial intelligence, semiconductors, economic security, and energy.
Zook said that international experiences with industrial policies were mixed, noting that allowing the private sector to play the largest role in determining the direction of investments may be the most important factor in ensuring the success of this policy.
Fitch continues to evaluate the government program, including whether the list of priority investment areas, numbering 17 sectors, needs more focus rather than distributing resources widely.
Fitch rates Japan's sovereign debt at "A" with a stable outlook, which is lower than the "A+" ratings from Standard & Poor's and "A1" from Moody's. Zook said that the risks remain balanced, with no clear tendency towards raising or lowering the rating.
Risk warning
But the fiscal challenge cannot be separated from the ongoing shift in monetary policy. Kazuyuki Masu, a member of the Board of Directors of the Bank of Japan, warned that the bank may be forced to raise interest rates at a rapid pace if inflation accelerates, as financial conditions remain easy.
Masu said that core inflation was “very close” to the Bank of Japan’s 2 percent target, and that real interest rates should not remain in the negative range for a long time. However, he pointed out that the current data do not suggest a sharp and rapid overshoot of inflation, which reduces the chances of a significant increase of 50 basis points at the next meeting.
Markets widely expect the interest rate to be raised to 1.25 percent at the bank’s meeting on September 17-18, after the bank raised interest to 1 percent in June, the highest level in 31 years.
This step is becoming increasingly important. Because the Bank of Japan is facing pressure from two opposite directions. On the one hand, rising oil and food and a weak yen could entrench inflation above target levels, and on the other hand, rapid tightening could put pressure on consumption, investment and growth, making the timing and speed of future increases a very sensitive issue.
Maso pointed out that the bank's estimates place the nominal neutral interest rate in a range between 1.1 and 2.5 percent, which means that the current rate is still at or below the lower part of this range.
He considered that keeping interest rates at very low levels for a long period was “unnatural,” calling for gradual continuation of normalization.
Here, monetary policy directly intersects with the financial file. Every increase in interest rates raises the cost of government borrowing, increases debt service, and puts pressure on the budget, which at the same time seeks to finance large investments and promote growth. Therefore, the upcoming budget will be more than just an annual spending plan; Rather, it will become a test of Tokyo's ability to manage a new phase of the Japanese economy. Fiscal policy can no longer rely on cheap financing, and the Bank of Japan is no longer willing to maintain very low interest rates.
For investors and rating agencies, the key question will be whether Takaichi's government can transform investment spending into productivity growth that raises revenues and reduces the debt burden, or whether higher interest rates will quickly reveal the limits of fiscal expansion.
If the government succeeds in achieving this balance, the credit rating may remain stable and debt conditions remain under control. However, if spending increases without a clear improvement in growth and revenues, the cost of borrowing may become a major pressure point on the Japanese economy in the coming years.
Indicators of trade calm between China and the United States are accelerating ahead of the expected meeting between US President Donald Trump and his Chinese counterpart Xi Jinping later in September, with Beijing announcing that it seeks to reach “as soon as possible” an agreement to mutually reduce customs duties on goods worth $30 billion, in conjunction with intensifying its purchases of American soybeans.
The developments combine two parallel paths: The first is a negotiation aimed at reducing duties on non-sensitive goods and rebuilding a more stable mechanism for managing bilateral trade, and the second is practical, represented by China’s return to purchasing large quantities of American agricultural goods, in a step that could help improve the atmosphere of the summit and mitigate some of the effects of the trade war between the two largest economies in the world.
Huang Ling, a spokeswoman for the Chinese Ministry of Commerce, said that negotiators are working to implement mutual reductions in tariffs on $30 billion worth of goods “as soon as possible,” without providing additional details about the sectors or goods that may be included in the agreement.
This comes before the expected meeting between Trump and Xi in Washington on September 24, which will be the third direct meeting between them within a year. The two governments describe communication channels at the leadership level as an essential tool to prevent trade and technology disputes from turning into a broader confrontation.
Chinese Foreign Ministry spokesman Gu Jiaqun said that “leader diplomacy” plays an indispensable strategic role in directing relations between the two countries.
Trump and Xi had agreed during their previous meeting in Beijing in May to establish a US-China Trade Council to manage trade files, along with a parallel investment council, after a truce that ended a phase of sharp escalation of mutual customs duties.
An important aspect of the ongoing negotiations is focused on identifying a group of “non-sensitive” goods on which each party can reduce duties in a balanced manner. Analysts believe that such targeted reductions are more realistic than a broad trade agreement, especially since many of the main points of disagreement between the two countries relate to advanced technology, industrial support, investment, and national security.
• Trade is at the forefront: Barclays Bank indicated in a research note that trade will be at the top of the summit’s agenda, pointing out that the current truce regarding fees expires on November 10. But he warned that the chances of reaching a comprehensive agreement are still limited, suggesting a selective reduction in fees rather than a broad settlement.
In a practical sign of improving conditions, China bought about one million metric tons of American soybeans within one week, according to four traders who spoke to Reuters. These purchases bring China's total purchase of US soybeans to nearly half of the annual commitment of 25 million tons, which Washington said Beijing had pledged to buy annually until 2028.
A trader based in Asia said that the Chinese state-owned company Sinogreen has intensified its purchases in recent days, adding that the pace of purchases has increased ahead of Xi's upcoming visit to the United States. These deals have significance beyond the grain market; Agriculture has always been one of the most sensitive sectors in the trade relationship between Washington and Beijing, given the political weight of American farmers, especially in the agricultural states that constitute an important electoral base for the American administration.
Increased Chinese purchases would give the White House a tangible indication of progress, while helping Beijing demonstrate its willingness to make measurable economic concessions ahead of the summit. But the purchases also have purely commercial motives. Soybean stocks in Brazil, the world's largest exporter, have declined, prompting China to diversify supply sources at a time when the feed and oil industries need stable flows of oilseeds.
The US Department of Agriculture announced sales of 340,000 tons of soybeans to China, in addition to 100,000 tons to unannounced destinations, in partial confirmation of the return of Chinese demand for American supplies. China still imposes additional 10 percent tariffs on US goods, including agricultural products, following the previous round of reciprocal tariffs. This means that any reduction in duties on soybeans may open the door to the return of private Chinese seed crushing companies to the American market, after the duties limited their competitiveness compared to government buyers.
Washington had announced after the May meeting that China had agreed to purchase US agricultural commodities other than soybeans worth $17 billion annually until 2028, in parallel with its annual commitment to purchase 25 million tons of soybeans.
The coincidence of these purchases with talk about reducing fees indicates that the two parties are trying to build a negotiating ground before the summit through limited, but implementable, agreements, instead of trying to resolve all the dispute files at once. From an economic perspective, any mutual reduction in tariffs could provide breathing room for businesses in both countries after years of high trade costs and policy uncertainty. It may also help reduce the prices of some imported goods, and give American and Chinese companies greater clarity in planning supply chains.
• Existing obstacles: However, major obstacles still remain. Disagreements over semiconductors, artificial intelligence, industrial support, Chinese investment in the United States, and restrictions on advanced technology are all still far from being resolved, which limits the chances of the current calm turning into a complete reset of economic relations. Therefore, the success of the September summit is likely to depend on the ability of the two parties to achieve tangible progress on less sensitive issues, such as reducing duties on selected commodities and stabilizing agricultural obligations, while postponing the more complex strategic issues to later rounds. In this context, soybean purchases and talk of reducing duties on a $30 billion trade appear to be an early test of the seriousness of both parties. If the current signals turn into announced agreements, US-Chinese trade relations may enter a relatively more stable phase. However, if it remains within the framework of political messages, markets and companies will remain at risk of a return to escalation as the end of the customs truce approaches in November.
The Turkish Central Bank kept the key interest rate at 37 percent on Thursday, in line with expectations, keeping it unchanged for the fifth meeting in a row, as it continues to monitor the repercussions of the war in Iran on inflation rates.
In a poll conducted by Reuters, 16 out of 17 economists expected to keep the interest rate at 37 percent, while one expert expected to reduce it by 100 basis points.
The central bank also kept overnight lending and borrowing interest rates unchanged, at 40 percent and 35.5 percent, respectively. The bank uses the “interest rate band”, or interest corridor, to adjust the cost of funding in the market when necessary, without changing the key interest rate.
Last month, the Central Bank resumed one-week repo auctions, which had been suspended since March, with the aim of controlling the inflationary impact of the war in Iran. The overnight interest rate, which has remained at approximately 40 percent since the suspension began, fell by 300 basis points.
The sharp rise in energy prices resulting from the war has destabilized import-dependent economies, such as the Turkish economy, at a time when the inflation rate reached 31.51 percent last month.
In its latest report on inflation, the central bank raised its expectations for the inflation rate by the end of 2026 to 28 percent, compared to 26 percent in a previous estimate, while the government expects inflation to reach 28.4 percent by the end of this year.
Economists still expect monetary policy to continue to ease through the remainder of the year, but are closely monitoring new tensions in the region and their potential impact on inflation.
