Japan’s New Leadership Faces Economic Challenges Head-On

Japan is entering a new chapter in its economic policy as Prime Minister Sanae Takaichi takes office, marking a historic moment as the first woman to lead the country. Takaichi aims to rejuvenate Japan’s economic growth through what she describes as a “responsible proactive fiscal policy.” This approach seeks to balance strategic spending with the need to maintain fiscal sustainability and control over Japan’s substantial public debt.

The challenge is formidable. Japan’s economy has struggled in recent years, with annual real GDP growth hovering around 0.8% from 2022 to 2024, according to QNB economic commentary. Despite a modest recovery in 2024, driven by rising real income and fiscal stimulus, the outlook for the next few years appears uncertain.

Stagnation and Structural Challenges

Consumption, which constitutes roughly 60% of Japan’s economy, remains stagnant and is a significant barrier to growth. Although there was an improvement in consumption this year, it has not been enough to offset broader economic challenges. High inflation has eroded household purchasing power, leading to a contraction in adjusted earnings throughout 2024—a trend expected to persist.

Compounding the issue, the Bank of Japan has been normalizing its monetary policy, raising the benchmark policy rate to 0.5% from a historically low negative 0.1%. This shift increases borrowing costs for households and constrains fiscal policy options due to the rising costs of servicing debt. The stagnation in consumption is likely to impede Japan’s economic growth prospects significantly.

Global Trade Dynamics and Future Strategies

Japan’s export sector also faces headwinds as external support weakens. After a period of uncertainty surrounding US trade policy, a new trade agreement was reached in July. This agreement imposes a baseline 15% tariff on nearly all Japanese imports entering the United States, a substantial increase from the average tariff of 1.5% recorded last year. Given that the US is Japan’s second-largest export market, accounting for approximately 20% of foreign sales, these new tariffs pose a significant barrier.

The expected slowdown in global trade, combined with ongoing geopolitical tensions, adds to the difficulties facing Japan. Exports represent around 20% of Japan’s GDP and are critical for industrial production. The diminishing prospects for exports further complicate the economic landscape.

In response to these challenges, Prime Minister Takaichi has proposed a stimulus package totaling JPY 21.3 trillion, marking her first major economic initiative and signaling a determined policy direction. Yet, experts remain skeptical about whether this package can effectively reverse the trends of decelerating growth.

Predictions suggest that Japanese economic growth may slow to 0.6% per year during 2026-2027, a decline from the 1.1% growth expected for this year. The new government’s ability to overcome these significant economic headwinds will be crucial as it attempts to navigate a complex and shifting global landscape.