Japan’s New Prime Minister Faces Economic Challenges Ahead

Japan is entering a critical phase in its economic policy with the leadership of Prime Minister Sanae Takaichi, the first woman to hold the role. Takaichi has committed to stimulating the country’s economic growth through what she terms a “responsible proactive fiscal policy.” This strategy aims to balance targeted spending in strategic sectors while ensuring fiscal sustainability amid Japan’s significant public debt.

Japan’s economy has experienced lackluster performance in recent years. Following a post-COVID recovery, the annual real GDP growth has hovered around 0.8% from 2022 to 2024. Although there has been a modest recovery this year, driven by rising real incomes, increased consumption, fiscal stimulus, and a depreciated currency benefiting exports, growth is projected to reach only 1.1% in 2025, slightly above the pre-pandemic average of 0.9%.

Significant Economic Headwinds

Despite these slight improvements, several headwinds threaten to derail Japan’s economic momentum. According to QNB, stagnating consumption poses a considerable challenge. Consumption accounts for roughly 60% of Japan’s economy, making it a crucial determinant of overall economic performance. Despite some improvement this year compared to 2024, recent trends indicate stagnation.

The erosion of household purchasing power due to high inflation rates has contributed significantly to this stagnation. Following several months of gains at the end of last year, real earnings for workers have decreased throughout this year, a trend expected to persist. Compounding the issues, the Bank of Japan has begun normalizing its monetary policy, raising the benchmark rate from an ultra-low -0.1% to 0.5%. This increase raises the cost of credit for households and reduces the government’s fiscal maneuverability due to higher debt servicing costs.

Export Challenges and Policy Responses

Additionally, Japan’s export sector faces diminishing external support. The country’s trade dynamics shifted after the U.S. and Japan reached a trade agreement in July, instituting a baseline 15% tariff on nearly all Japanese imports entering the U.S. This new tariff burden contrasts starkly with the previous average of 1.5% and poses a significant challenge for Japan, which relies on the U.S. as its second-largest export market, accounting for around 20% of its annual foreign sales.

The expected slowdown in global trade, amid heightened trade-policy uncertainties and geopolitical fragmentation, further complicates Japan’s economic outlook. Exports constitute 20% of Japan’s GDP and are a vital driver of industrial production. The weakening prospects for exports, therefore, represent a major obstacle for Japan’s economic performance.

In response to these challenges, Prime Minister Takaichi has announced a substantial stimulus package amounting to JPN21.3 trillion. This initiative marks her first major economic maneuver and signals a proactive approach to bolster growth. Nevertheless, analysts express skepticism regarding the potential effectiveness of this stimulus in significantly altering growth trends.

Looking ahead, Japan’s economic growth is projected to decelerate to 0.6% annually over 2026-2027, down from the 1.1% growth expected for this year. With substantial economic headwinds looming, the new government faces an uphill battle in its efforts to revive sustainable growth.