TOKYO (Reuters) – Japanese ministries’ budget demands for the next fiscal year will likely top 110 trillion yen ($753 billion), the Nikkei business daily reported on Friday, with rising interest rates expected to boost debt servicing costs.

The annual budget requests, to be submitted to the finance ministry by the end of August, highlight the difficulty of streamlining spending for the industrial world’s most heavily-indebted government.

Under persistent pressure to reflate the world’s third-largest economy, the finance ministry will scrutinise the budget requests before it compiles the draft annual state budget in December. This fiscal year’s budget stood at 114 trillion yen.

Debt-servicing costs and defence spending will increase 10% each from this year’s initial budget, while social security outlay, estimated at 33.7 trillion yen, will rise due to the snowballing costs of supporting Japan’s fast-ageing society.

It would be the third straight year that budget requests exceed 110 trillion yen and may top a record 111.6 trillion yen requested for fiscal 2022.

For the past decade, the government has taken advantage of low borrowing costs helped by the central bank’s ultra-loose monetary policy, put in place to achieve its elusive 2% inflation target.

However, the Bank of Japan’s policy adjustment last month brought home the reality that the government cannot count on the central bank to effectively monetise its massive borrowing indefinitely.

“Rises in assumed rates mean prices must be rising and so will nominal GDP and tax revenue. It’s only natural for debt-servicing costs to rise under such circumstances,” said Takuya Hoshino, senior economist at Dai-ichi Life Research Institute.

“We need to change our mindset in the era of inflation.”

The finance ministry will raise its assumed long-term interest rate to 1.5% for the fiscal 2024/25 year from a record-low 1.1% this fiscal year, bringing the debt-servicing costs to 28.14 trillion yen, which would mark a rise of nearly 3 trillion yen from this year’s amount.

The BOJ guides short-term interest rates at -0.1%, buying huge amounts of government bonds to cap the 10-year yield around 0% as part of efforts to fire up inflation to its 2% target.

Last month, the BOJ said it would allow the 10-year bond yield to move up to 1%, having previously raised the cap to 0.5% last December from 0.25%.

The 10-year bond yield has risen to its highest in nearly a decade, and further rises in interest rates could put upward pressure on debt-servicing costs.

The defence spending budget request is expected to hit a record 7.7 trillion yen, up by nearly 1 trillion yen from this year, due to Prime Minister Fumio Kishida’s plan to boost military outlay to cope with threats from an assertive China and unpredictable North Korea.

The budget may be inflated further as some items are requested without an amount being specified.

($1 = 146.0100 yen)

(Reporting by Tetsushi Kajimoto; Editing by Diane Craft and Jacqueline Wong)

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