Japan’s vast foreign exchange reserves are facing renewed attention after Prime Minister Sanae Takaichi signalled she is searching for funding sources to support a controversial plan to suspend a consumption tax following her landslide election victory.
The spotlight has turned to Japan’s $1.4 trillion reserve stockpile—far larger than the country’s annual budget—as Tokyo confronts the challenge of covering an estimated 5 trillion yen ($31.99 billion) yearly revenue gap. The prospect of tapping alternative funding sources has already unsettled financial markets.
After Sunday’s decisive win, Takaichi said her government would accelerate discussions on suspending the 8% food consumption tax for two years without issuing new debt, noting that details would need to be negotiated with other political parties.
Several government officials, speaking anonymously due to the sensitivity of the issue, suggested that Takaichi could consider drawing on surplus funds generated by Japan’s foreign exchange reserves. During the campaign, she pointed out that the reserves had benefited significantly from yen weakness and were “performing very well.”
Asked about the possibility, Finance Minister Satsuki Katayama said in a television interview that using part of the surplus was conceivable. However, she cautioned that such discussions overlap with foreign exchange intervention policy and that, in the national interest, not all details could be disclosed.
Concerns over fiscal sustainability resurfaced last month when Takaichi’s tax-cut proposals and expansionary spending plans triggered sharp moves in Japanese markets. Bond yields surged to record highs as investors questioned how additional spending would be financed in a country carrying the largest debt burden among developed economies.
FX reserves not meant to fund fiscal policy
In the last fiscal year, Japan recorded a record surplus of 5.4 trillion yen from its special account for foreign exchange reserves. The surplus largely reflected income from U.S. Treasuries accumulated during past dollar-buying interventions.
These assets, primarily invested in Treasuries, are funded through yen-denominated financing bills. Interest costs have been more than offset by returns, thanks to the wide interest rate gap between the United States and Japan.
There is precedent for diverting reserve surpluses to fund major policy initiatives. While fiscal rules require at least 30% of annual surplus to remain in the account as a buffer against losses, this threshold has occasionally been relaxed, allowing larger transfers to the general budget.
“Currency reserves have sometimes been used for political purposes,” one government official said.
Saisuke Sakai, senior economist at Mizuho Research & Technologies, stressed that foreign currency reserves are primarily a safeguard for currency stability. While income from the reserves is important, he warned it should not be treated as a permanent funding source because it fluctuates with market conditions and interest rates.
With any additional surplus unlikely to fully offset the expected revenue shortfall, the main opposition party has proposed more radical ideas. These include combining Japan’s foreign exchange reserves with the central bank’s ETF holdings to form a sovereign wealth fund aimed at achieving higher returns.
Opposition lawmaker Isamu Ueda argued that the scale of Japan’s reserves may be excessive relative to their core purpose of maintaining currency stability, suggesting a more proactive investment approach could be pursued without significantly increasing risk.
Government officials have largely dismissed the proposal as impractical, noting that large-scale sales of U.S. Treasuries could strain relations with Washington at a time when the U.S. bond market remains sensitive. Japan is currently the largest foreign holder of U.S. government debt.
Former vice finance minister for international affairs Hiroshi Watanabe also warned that reducing reserves could limit Japan’s ability to intervene in currency markets if the yen weakens further. Echoing this view, Fred Neumann, chief Asia economist at HSBC, said selling reserves for fiscal purposes rather than exchange-rate management would be risky, as it would shrink the buffer available for future intervention.
