Japan weighs raising defense spending to 3.5% of GDP as bond yields climb

Japan's cabinet under Prime Minister Takaichi Sanae, which has championed a "strong Japan" and "responsible expansionary fiscal policy," is reportedly considering raising defense spending to 3.5% of GDP. The potential increase is drawing concern that it could place a significant strain on financial markets and government finances, coming as the yen remains weak — prompting two rounds of US-Japan currency intervention this year — and government bond yields continue to climb.

Bloomberg reported Tuesday (local time) that Japanese defense officials had recently signaled to their American counterparts a willingness to substantially increase defense spending. Sources who spoke to Bloomberg cited one leading scenario under consideration: raising defense outlays to 3.5% of GDP over 10 years, roughly in line with the pace South Korea has committed to. The sources also said Japan could set a lower target of around 3%.

The Japanese government responded cautiously, saying no figures had been decided. Defense Ministry spokesperson Agui Kimihito said at a press briefing Tuesday (local time) that Japan's defense buildup "is pursued based on our own judgment, in accordance with the fundamental principle that we must defend our own territory ourselves," adding that it "is not a matter of starting from a predetermined spending figure. What matters is the substantive content of our defense capabilities."

Bloomberg nonetheless interpreted the scenario as entirely plausible, given Prime Minister Takaichi's stated ambition to build a stronger Japan and the Donald Trump administration's intense pressure on allies to boost defense spending. Takaichi had already accelerated defense outlays to 2% of GDP in the fiscal year that ended last March — two years ahead of the original schedule. Until 2022, Japan maintained an informal cap of 1% of GDP on defense spending, making the recent pace of increases a sharp departure, Bloomberg noted.

The ruling Liberal Democratic Party, led by Takaichi, had already signaled in June that it believed 3.5% of GDP had become a global benchmark for defense spending and that Japan should raise its ceiling accordingly. US pressure has added to the momentum. Last month, Elbridge Colby, US undersecretary of defense for policy, said he was "desperately hoping Japan will step up" on defense spending.

Robert Ward, Japan chair at the International Institute for Strategic Studies, said the groundwork for a major defense spending increase had been laid among Japanese policymakers and officials. "It's only a matter of when Japan will make the shift to 3.5%," he said. "Whether it takes five years or 10, given how important the US-Japan alliance is, I don't see an alternative."

News of Japan's deliberations rattled financial markets, which are already grappling with rising borrowing costs driven by climbing government bond yields.

The yield on Japan's 10-year government bond rose above 3% on Tuesday (local time), reaching its highest level since 1996. Markets widely expect the Bank of Japan to raise its policy rate by 0.25 percentage points on Friday, which could cause the government's borrowing costs to balloon further in the months ahead.

A persistently weak yen adds another layer of pressure on the Japanese government. The yen fell to 155.24 per dollar on Tuesday (local time). The currency's weakness not only raises the relative cost of borrowing but also threatens to undermine Japan's defense expansion plans — a weaker yen erodes the country's purchasing power for overseas weapons procurement.

Aiba Daisuke, an analyst at Iwai Cosmo Securities, said fiscal concerns make it difficult for investors to view the news positively. "There are also questions about whether Japan actually has the capacity to meaningfully expand its defense capabilities beyond the currently limited scope," he said.