Japan

Overall, Japan's short-term financing risk remains low, supported by a strong domestic investor base, a large net external asset position and the fact that public debt is overwhelmingly denominated in JPY and held domestically. Nevertheless, public finances remain a key vulnerability. General government debt is projected to remain above 230% of GDP over the forecast horizon, while fiscal deficits are expected to stay elevated as ageing-related spending, energy-support measures, defence expenditures and rising debt-servicing costs continue to weigh on the budget. While debt-servicing costs remain manageable, the Bank of Japan's gradual policy normalization and higher long-term interest rates could increase financing pressures over time. At the same time, Japan's strong external position and current-account surplus, expected to remain around 4% of GDP until 2028, provide an important buffer against external shocks.

In the long run, the Japanese economy’s vulnerabilities mostly stem from a declining, aging population – with gains in productivity not enough to compensate and a resistance to immigration. The working-age population (between age 15 and 64) has been declining in Japan since 1996. The old-age dependency ratio remained at 70% in 2024, the highest amongst major developed countries. The fertility rate in Japan declined to 1.1 in 2024, a record low. Climate change is another long-term risk for Japan, which, as an archipelago, is vulnerable to rising sea levels and more intense weather events.

Japan’s business environment is relatively well-positioned in our assessment of 185 economies, rated in the best range in the majority of sub-components, although it seems to be slightly deteriorating. The 2026 Heritage Foundation’s Index of Economic Freedom survey assigns Japan rank 30 out of around 185 economies, reflecting particularly good scores with regards to property rights, judicial effectiveness, government integrity and monetary freedom, while there remains room for improvement regarding government spending and fiscal health. Meanwhile, the World Bank Institute’s annual Worldwide Governance Indicators surveys suggest that the regulatory and legal frameworks are business friendly and the level of corruption is low. Our proprietary Environmental Sustainability Index puts Japan at rank 167 out of 217 economies, reflecting strengths in water stress and CO2 emissions per GDP, but weaknesses remain in the recycling rate and renewable electricity output, while energy use per GDP has recently been deteriorating.

Japan's political stability has improved markedly after a period of turbulence. Prime Minister Takaichi Sanae was elected LDP president in October 2025 following Shigeru Ishiba's resignation after losing the majority in both houses of parliament. Initially leading a minority coalition with Nippon Ishin no Kai, Takaichi called a snap election in February 2026 that resulted in a historic landslide where the LDP won 316 seats, securing a two-thirds supermajority in the House of Representatives. With a strong personal mandate and a fragmented opposition, the government is well positioned to advance its legislative program and we do not expect early elections.