UPDATE 2-Japan Democrats take power, tough challenges loom

Sun Aug 30, 2009 7:20pm EDT

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(For more on Japan's election, click [ID:nPOLJP])

* Opposition Democrats to take power after historic win

* Hatoyama must tackle struggling economy, record joblessness

* Japan Democrats face pressure to deliver on promises (Adds Hatoyama quote in paragraph 4)

By Linda Sieg

TOKYO, Aug 31 (Reuters) - Japan's next leader Yukio Hatoyama, fresh from a historic election win, faced the task on Monday of forming a government to tackle challenges such as reviving the economy and steering a new course with close ally Washington.

Sunday's victory by the Democratic Party of Japan (DPJ) ends a half-century of almost unbroken rule by the Liberal Democratic Party (LDP) and breaks a deadlock in parliament, ushering in a government that has promised to focus spending on consumers, cut wasteful budget outlays and reduce the power of bureaucrats.

But the untested Democrats, who will face an upper house election in less than a year, will have to move quickly to keep support among voters worried about a record jobless rate and a rapidly ageing society that is inflating social security costs.

"It's taken a long time, but we have at last reached the starting line," Hatoyama told a news conference at his home in Tokyo on Monday. "This is by no means the destination. At long last we are able to move politics, to create a new kind of politics that will fulfill the expectations of the people."

Official figures have not yet been released, but media forecasts show the Democrats with about 308 seats in the 480-seat lower house, compared with only 119 for the LDP.

Hatoyama was expected to quickly set up a transition team to prepare to take power but said he would not name his cabinet until the new parliament voted him in as prime minister.

Financial markets are expected to welcome the end to a political deadlock that has stymied policies as Japan struggled with its worst recession since World War Two. The Democrats and its small allies won control of the upper house in 2007. [ID:nT334535]

Analysts say the decade-old Democrats' spending plans might give a short-term lift to the economy, just now emerging from recession, but worry that its programmes will boost a public debt already equal to about 170 percent of GDP. [JP/] [ID:nT27156]

The party has vowed not to raise the 5 percent sales tax for four years while it focuses on cutting wasteful spending.

"The problem is how much the Democrats can truly deliver in the first 100 days. If they can come up with a cabinet line-up swiftly, that will ease market concerns over their ability to govern," said Koichi Haji, chief economist at NLI Research Institute.

The Democratic Party victory ended a three-way partnership between the LDP, big business and bureaucrats that turned Japan into an economic juggernaut after the country's defeat in World War Two. That strategy foundered when Japan's "bubble" economy burst in the late 1980s and growth has stagnated since.

PRESSURE ON DEMOCRATS TO DELIVER

Support for the LDP, which has ruled for all but 10 months since its founding in 1955, has been on a downtrend for years, but charismatic leader Junichiro Koizumi managed to lead the party to a huge election win in 2005 with promises of market-friendly reforms.

Those reforms came under fire even within the LDP for worsening social and income gaps and were further attacked after the global financial crisis tipped Japan into recession.

In an essay published this month in the New York Times, Hatoyama railed at what he called the "unrestrained market fundamentalism" of U.S.-led globalisation but at his news conference sought to allay any concerns raised by those comments.

"We are not saying that the (free) market principles are all bad ... But the current economic situation is one where there need to be corrections in areas where reform went too far," Hatoyama said.

A series of scandals, policy flip-flops and a perceived inability to address deep-rooted problems such as creaking pension and health care systems eroded the LDP mandate.

Voters, having taken a gamble on change, will want to see proof quickly that the Democrats can do a better job.

"It's going to be crucial how they spend the first year in office, so in that sense they have to get focused very quickly to get things accomplished," said Sophia University professor Koichi Nakano. "Otherwise, the goodwill may dissipate very quickly and they may face a hostile upper house within a year."

Hatoyama will want to have his cabinet up and running in time to attend a U.N. General Assembly meeting and a G20 leaders summit in Pittsburgh in September.

The Democrats want to forge a diplomatic stance more independent of the United States, raising fears about possible friction in the alliance. They have also vowed to improve ties with Asian neighbours, often frayed by bitter wartime memories.

"(Hatoyama) is basically articulating the idea that the U.S.-led Pax Americana era has come* to an end," said Sheila Smith at the Council on Foreign Relations in New York.

"My sense of the DPJ is that they have wanted a little distance between Tokyo and Washington."

Budgetary matters will claim much of the government's attention in its early days. Party leaders have said they might freeze or redirect some of the 14 trillion yen ($149.5 billion) in stimulus spending planned for the year to March 31, 2010.

They may have to craft an extra budget for the current fiscal year to cover an expected tax revenue shortfall, and Japanese media said the party wants to have an outline of the budget for 2010/2011 by sometime in October. (Additional reporting by Yoko Kubota and Yoko Nishikawa in Tokyo and Paul Eckert in Washington, Editing by Dean Yates and Chris Gallagher)

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