Japan is exploring ways to enhance the management of its $1.3 trillion foreign exchange reserves, a move that has raised market concerns about a potential large-scale sell-off of US Treasury bonds.

A draft of Japan's economic growth strategy indicates the government will examine methods to improve the management of its foreign reserves and boost asset returns, aiming to bolster strained national finances.

A senior economist at Mizuho Research Institute, Saisuke Sakai, stated directly that "effectively utilizing the foreign reserves would mean selling US Treasuries." He questioned the feasibility of such a move for US-Japan relations, especially with US long-term interest rates on the rise. This comment has heightened market anxiety, as Japan is the largest foreign holder of US government debt.

This draft document is central to the policy agenda of Prime Minister Sanae Takaichi. She has previously noted that the foreign reserves have performed "extremely well," benefiting from a weak yen. Some officials interpret this as a signal of her intent to use related surpluses to fund a controversial plan to suspend the food consumption tax.

However, sources familiar with the matter suggest a significant shift in the reserve asset allocation is "unrealistic," as the primary purpose of the reserves is to provide ammunition for currency market intervention.

Draft Language is Vague, Lacks Specifics on Asset Changes

According to the draft document, the Japanese government says it will "study the merits of improving management and utilizing assets held by public sector entities, including the Foreign Exchange Fund Special Account, more effectively." The draft does not explicitly propose concrete plans to alter the composition of the reserve assets.

Currently, Japan's foreign reserves, accumulated through past dollar-buying interventions, are believed to be heavily invested in US Treasuries. Reserve surpluses, including interest income from these bonds, are traditionally transferred to the general account to support the national budget.

Akira Moroga, chief market strategist at Aozora Bank, warned that a strategy focused on higher returns "could undermine the safety of the reserves and be perceived negatively by the markets." He emphasized that the fundamental purpose of foreign reserves is to support national credit, so they should primarily be held in highly reliable, liquid assets rather than riskier investments.

Large-Scale Intervention Drains Reserves, Highlighting Policy Strain

The discussion on improving reserve management reflects the pressure Japanese authorities face in maintaining the size of these reserves.

In late April, as the yen weakened past 160 per dollar, Tokyo authorities resumed large-scale currency market intervention, spending approximately $73 billion to buy yen. This caused the reserve balance to drop by a record 5.6% in May, exposing the limitations of sustained, large-scale interventions.

Some ruling and opposition party lawmakers have proposed consolidating foreign reserves, central bank-held ETFs, and pension assets into a sovereign wealth fund to pursue higher returns. Yet, a source with knowledge of the situation noted that "there is considerable difficulty in pursuing returns in a way that runs counter to the purpose of the foreign reserves."

Ambitious Growth Strategy Coincides with Persistent Fiscal Pressure

The newly unveiled economic growth strategy under Prime Minister Takaichi aims to mobilize a cumulative total of over 370 trillion yen (approximately $2.29 trillion) in combined public and private investment across 17 strategic areas, including artificial intelligence and semiconductors, by the 2040 fiscal year.

Government estimates suggest this initiative could boost Japan's potential economic growth rate by up to 1.4 percentage points over the next 15 years. However, the document does not specify the breakdown between public and private investment shares.

Simultaneously, the plan adds pressure to Japan's already precarious fiscal situation. The government is considering establishing a multi-year budget framework to provide stable funding for critical investments in economic security, with some of this spending potentially financed through transitional bonds.