RPT — BREAKINGVIEWS — Japanese PM’s reflationist label is hard to shake

(The author is a Reuters Breakingviews columnist. ) By Hudson Lockett HONG KONG, Oct 14 (Reuters Breakingviews) — Sanae Takaichi chafes at the word "reflationist". 3 trillion investment splurge and looser budgeting processes, will not intensify the inflation she vowed to tame on the campaign trail. They're probably wrong: the biggest risk to Japan's economy is that she succeeds.

Since the country's first female leader took charge 12 months ago it has become clear that her policy program, dubbed “Takaichinomics”, is based on a misunderstanding of what drives Japan's growth. As she readies to pass her first national budget since an electoral landslide in February, this mistake threatens not only to further lift prices but also to undermine the virtuous economic cycle which has delivered the Asian country from decades in the doldrums. Bond and currency markets have been rattled repeatedly by Takaichi’s attempts to shrug off the structural limitations imposed on her recent predecessors by Japan's looming debt and graying workforce.

But where the late Prime Minister Shinzo Abe used monetary and fiscal stimulus to rouse the economy from a deflationary stupor, the current incumbent wants sharply higher spending to turbo-charge growth at a time when prices are already rising. To her credit, there are signs she is partially changing course. After a year of tacitly pressuring the Bank of Japan to slow-roll rate rises in order to keep government funding costs down, Takaichi is now attempting to shed her reputation as a monetary reflationist.

The shift is in part due to the sliding yen, combined with a government bond selloff that has pushed up yields and invited public pressure from US Treasury Secretary Scott Bessent. Ayano Sato, one of two central bank board appointees who unnerved markets by voting against last month’s hike, even voiced tepid support for more rate rises in a recent Reuters interview. That’s potentially positive for the Japanese currency, which has weakened about 7% against the dollar since Takaichi took charge of the Liberal Democratic Party.

Yet the prime minister still refuses to fully explain how she plans to cover the revenue shortfall from scrapping food taxes for at least two years — her flagship measure for providing inflationary relief to households. 2%. Official reassurances that fiscal policy will be both “responsible and proactive” have failed to assuage investors worried by the implications of sharply higher spending for sovereign debt, which is near 200% of GDP. The 65-year-old believes large-scale government-led investment is the only prescription for the economic malady of lacklustre growth she diagnosed in February, after her party regained control of the legislature’s powerful lower house.

However, while the contribution to growth from increases in the capital stock may be lower than in the 1980s boom, average annual investment over the past decade still clocks in at 25% of Japanese GDP, per Capital Economics, the highest level among the Group of Seven rich economies. Additional government investment is more likely to intensify inflation. Previous administrations focused instead on improving labour mobility and bringing in overseas workers to offset Japan’s shrinking population. These efforts helped free up more productive workers to seek better-paying jobs, while also providing enough ready hands for private investment projects.

The upshot has been a return of wage-driven inflation which, though disquieting for households used to stable prices, helped spur Japan’s economic revival. By contrast, Takaichi has thrown up new barriers to long-term residency for imported labour while delaying her predecessor’s plans to raise Japan's minimum wage. In July she downplayed the role of inflation in driving growth in her first economic policy blueprint, blaming “chronically insufficient investment in the future” for kneecapping potential GDP. 3 trillion) public-private investment plan to more than double GDP growth by 2040, as well as removing limits on annual budget requests by government ministries.

Their latest submissions imply spending will jump by 14% to a record 143 trillion yen for the 2027 fiscal year. The sharp increase is supposed to partly reflect outlays previously left to supplementary budgets, which Takaichi wants to scrap. But emergency spending packages may endure given their utility for voter-pleasing initiatives, such as the June move to subsidise fuel costs. Rising interest rates further complicate the picture.

Increased borrowing costs not only raise the burden of funding the government but also servicing its existing debt, which is set to reach about 37 trillion yen next year. Ayako Fujita, Japan chief economist at JPMorgan, estimates the bond issuance necessary to cover both the prime minister's budget plans and interest payments will likely lead to an increase in Japan’s debt-to-GDP ratio during the 2027 fiscal year, ending four straight years of decline. That risks triggering a vicious cycle as investors dump longer-dated government bonds and push yields still higher. The bank estimates this could help push the closely watched ratio back above 200% by 2031.

Supporters of the prime minister’s policies shrug off inflation concerns and argue higher growth will expand the tax base to offset any revenue lost from tax cuts, while returns on government-led investments will help cover further outlays. Yet new plans to reboot Japan's version of the now-defunct US Department of Government Efficiency in order to scrounge for unused government funds suggest mounting pressure to cover spending. And as countries like China have learned the hard way, the investment success rate for state-backed projects is low.

A massive injection of government funding into Japan’s financial system may instead crowd out private investment as the shrinking labour force creates a bottleneck for viable projects. That could prompt domestic investors to seek returns overseas, undermining Tokyo’s efforts to repatriate capital and increasing downward pressure on the yen. Far from delivering a growth boost, Takaichi’s investment drive looks more likely to distort markets and undermine the factors behind Japan’s recent economic renaissance. The best-case scenario is for the prime minister’s audacious plan to either fail or be diverted.

Otherwise she may attract far worse labels than "reflationist". Follow Hudson Lockett on Bluesky and X. com)