By Linda Sieg and Yoko Nishikawa
TOKYO (Reuters) - Finance Minister Naoto Kan, a fiscal conservative with an image as a challenger to the status quo, was elected as Japan's next premier on Friday, as the ruling party tries to repair its fortunes ahead of a national election.
Kan, 63, will become Japan's fifth prime minister in three years, taking the helm as the country struggles to rein in a huge public debt, engineer growth in an ageing society, and manage ties with security ally Washington and a rising China.
The Democratic Party of Japan picked Kan by an overwhelming majority to succeed unpopular Prime Minister Yukio Hatoyama, who quit this week ahead of an upper house poll expected in July that the ruling bloc needs to win to avoid policy deadlock. He was later voted in by parliament's powerful lower house.
"With all of you, I would first would like to compile firm policies or plans to rebuild Japan ... ahead of the upper house election," Kan said in his acceptance speech before leaving the stage and pumping his fist in the air.
Kan's rise to the top job could spell bolder steps ahead to rein in a public debt that is already twice the size of the economy, although he faces opposition from many in his party ahead of the election.
Hatoyama, his voter ratings in tatters, resigned on Wednesday just eight months after the Democrats swept to power pledging to cut waste, wrest control of policy from bureaucrats, and give consumers more cash so as to stimulate domestic demand.
His abrupt departure has raised concerns among investors that the government will delay efforts to thrash out plans, due out this month, to cut public debt and craft a growth strategy.
BATTLING DEFLATION, FISCAL REFORM
Financial market players generally welcomed Kan as Japan's next leader. His selection improves the ruling bloc's prospects at the polls, though many wondered how much would change.
"If Hatoyama had remained the party would have had a big loss at the election and the political situation would have been chaotic," said Hiroyuki Nakai, chief strategist at Tokai Tokyo Research.
"But with Kan in charge now, the sense of stagnation in politics and the economy is receding somewhat, even though much will depend on the makeup of the cabinet."
Kan, a former health minister who got his start in politics as a grassroots activist, has forged an image as a fiscal conservative and occasional central bank critic since assuming the finance post in January.
He was among the few cabinet ministers to urge early debate on raising Japan's 5 percent sales tax, a step economists say is vital to fund the huge social welfare costs of a greying society.
Kan was likely to pick a fiscal reformer, Deputy Finance Minister Yoshihiko Noda, as his finance minister, a move that would be welcome for bond markets worried about too much debt.
Kan said in a statement that he would work with the Bank of Japan to beat the deflation bedevilling Japan's economy.
As finance minister, Kan has pressured the central bank to do more in the battle against deflation, although for now the government and BOJ seem to be on the same page.
He also said he would keep Japan's policy to cut greenhouse gas emissions by 25 percent by 2020 from 1990 levels.
Financial markets will be watching the new leader's comments on currencies as well.
"(Kan's) appearance of being in favour of a weaker yen is being viewed positively by the stock market. For the Nikkei to move much over 10,000, we need currencies to move towards a weaker yen," said Kenichi Hirano, operating officer at Tachibana Securities.
GRASSROOTS ACTIVIST, OZAWA FACTOR
Unlike many recent premiers, Kan does not hail from a political dynasty. That could appeal to voters weary of leaders born with silver spoons in their mouths who proved inept at governing.
He got his start in politics as a grassroots student activist, later joining small political parties before helping to found the then-opposition Democratic Party in 1996.
Kan defeated his only rival, 50-year-old Shinji Tarutoko, a little-known lawmaker who had won backing from some supporters of party powerbroker Ichiro Ozawa.
Ozawa, seen as pulling the strings in Hatoyama's government, also quit his key post as party secretary-general this week in an effort to improve the party's image, tarnished by funding scandals that embroiled Ozawa, Hatoyama and other lawmakers.
Kan, who helped found the DPJ in 1996 and is hardly a fresh face, has made clear he wants to sideline the 68-year-old Ozawa, whose image as an old-style wheeler dealer has undermined the Democrats' pitch as purveyors of change.
But while the wily Ozawa may withdraw into the shadows, sceptics question whether his influence will entirely fade.
That matters because Ozawa, known as a master campaign strategist, is reluctant to promise bold fiscal reform steps such as raising the sales tax ahead of the upper house poll.
Kan, who is likely to be sworn in by the emperor early next week, will form his new cabinet on Tuesday, a DPJ official said.
The current session of parliament will likely be extended to enact key bills and the upper house election held on July 25, Japanese media said.
The Democrats swept to power in a historic election last year and will run the government whatever the outcome of the July upper house poll, but the ruling bloc needs to win a majority in that chamber to ensure that legislation is enacted smoothly.
Media surveys showed Hatoyama's resignation had given the faltering party a boost, but analysts have said the Democrats and their tiny ally, the conservative People's New Party, may have to find new partners, including small parties recently formed by defectors from the ousted Liberal Democrats.
Kan, who media said would retain policy maven Katsuya Okada as foreign minister, faces a tough task keeping ties with the United States on track, since a deal clinched by Hatoyama with Washington to shift a U.S. airbase within the southern Japan island of Okinawa is staunchly opposed by local residents.
Kan became Japan's most popular politician for a time when as health minister in 1996, he forced bureaucrats to expose a scandal over HIV-tainted blood products.
(Additional reporting by Yoko Kubota; Editing by Michael Watson)
