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 leadership vote 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 toward aggressive spending if Kan lost the party leadership contest to Ichiro Ozawa, a scandal-tainted powerbroker who had said he would consider issuing more debt if the economy worsened.

Kan was favoured by most ordinary voters but Ozawa's strong support among lawmakers made the outcome of the vote far from certain.

The Democratic Party of Japan (DPJ) has floundered since sweeping to power a year ago. Its coalition with a tiny partner lost their upper house majority in a July election a month after Kan took over and floated a possible rise in the 5 percent sales tax to fix tattered state finances.

Kan has also disappointed many with his lack of a convincing message for how to engineer growth, despite hopes that the former grass-roots activist was a pragmatist who could get things done.

"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 a fresh 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 and Nikkei stock futures fell after Kan's victory made a shift to aggressive spending unlikely.

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. His supporters had painted him as a decisive leader and skilled operator who could break through Japan's political and economic stalemate.

Ozawa had also pledged to act boldly 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 spending.

"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.

Credit rating agency S&P said Japan's credit quality was sinking slowly but was not in danger of an immediate downgrade.

"There is no reason to be optimistic simply because of the continuation of the policy of the previous government, because the DPJ government has a tendency to take populist measures," S&P director Takahira Ogawa told Reuters Insider TV in an interview.

The DPJ last year ousted the conservative Liberal Democratic Party, ending more than 50 years of its nearly non-stop rule. But once in power, it has struggled to maintain unity.

Kan won just over half of the votes cast by DPJ members of parliament in the leadership contest, but trounced Ozawa among the party rank-and-file and prevailed with 721 out of 1,212 total points.

"This outcome is better than Ozawa winning, but it doesn't mean people are really supporting Kan," said university student Saburo Takahashi. "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.

Kan was tightlipped about a possible cabinet reshuffle, telling a news conference merely that he would leave for a U.N. General Assembly meeting in a week and planned to discuss that and other matters with former DPJ leaders Wednesday.

"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 Sophia University professor Koichi Nakano.

"I don't think he will be finished until he is dead and buried. At the end of the day, he is a destroyer."

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