Japan PM wins party vote but faces more challenges

TOKYO (Reuters) - Japanese Prime Minister Naoto Kan will keep his job after an unexpectedly decisive victory in a ruling party vote on Tuesday, but must now unify his party and forge deals with the opposition in a divided parliament.

Kan, 63, who has pledged to curb spending and borrowing, is struggling with a strong yen, a fragile recovery and public debt that is twice the size of Japan's $5 trillion economy.

Markets had been braced for a shift towards aggressive spending if Kan lost to Ichiro Ozawa, a scandal-tainted powerbroker who had said he would consider issuing more debt if the economy worsened.

The Democratic Party of Japan (DPJ) has floundered since sweeping to power a year ago, and its coalition with a tiny partner lost their upper house majority in a July election under Kan. He took over from unpopular Yukio Hatoyama in June as Japan's fifth leader in three years.

"Kan won by quite a big margin. But he still needs to come up with ways to pass legislation through parliament, such as by teaming up with an opposition party," said Koichi Haji, chief economist at NLI Research Institute.

"The outlook doesn't look good for Kan."

The yen briefly rose to another 15-year high of 83.09 per dollar after Kan won, but then traded back to about 83.30. Kan's government has repeatedly expressed concern about the yen's rise and its impact on the export-dependent economy, but so far has refrained from intervening in the market.

Ten-year Japanese government bond futures rose after Kan's win soothed worries about a shift to expansionary fiscal policy.

OZAWA'S NEXT MOVE

Ozawa, 68, had promised to stick to election campaign promises to give consumers more cash and pry control over policy away from bureaucrats to refocus budget spending.

He had also pledged to do everything to curb the yen's rise, even if that meant a solo intervention, and could have pressured the Bank of Japan to buy government bonds to fund his spending plans.

"Whoever won, there would be much difficulty binding the party together again, and in that sense Kan has to adopt some of the agenda raised by Ozawa or his supporters," said Yuuki Sakurai, CEO and President, Fukuoka Capital Management.

The DPJ last year ousted the Liberal Democratic Party (LDP), ending more than 50 years of nearly non-stop rule by the conservative party, but it has stumbled and the upper house election loss under Kan upset Ozawa and his followers.

Kan won just over half of the votes cast in the leadership contest by DPJ parliamentarians, but trounced Ozawa in voting among the party rank-and-file.

"This outcome is better than Ozawa's win, but it doesn't mean people are really supporting Kan," said university student Saburo Takahashi. "It's just choosing the better one of the two, but I don't think many people will expect Kan to push for big changes."

While Ozawa has been known as "Destroyer" for breaking up parties he led, he is not expected to leave the party right away.

Still, Kan will need to reach out to members of Ozawa's camp to unify the party and even then, Ozawa may remain a threat.

"I guess the next occasion is when Kan's support rates go down and then there will be an opportunity for Ozawa to play another trick," said Koichi Nakano, a professor at Sophia University. "I don't think he will be finished until he is dead and buried. At the end of the day, he is a destroyer."

Confronted with runaway debt, Kan has called for debate on raising the 5 percent sales tax to fund the growing social welfare costs of a fast-ageing population but it is unclear if opposition parties will help him pass bills in the divided parliament.

(Additional reporting by Yoko Nishikawa, Yoko Kubota, Kiyoshi Takenaka and Antoni Slodkowski; Editing by Tomasz Janowski)

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