UPDATE 1-Japan 08/09 draft budget projects 0.2 pct increase

(For highlights of the budget click on [ID:nT16996]. For details on government bond issuance click on [ID:nT172048])

(Adds details)

By Yuzo Saeki

TOKYO, Dec 20 (Reuters) - Japan plans to increase social security spending for its ageing society while cutting new debt issuance in the next fiscal year, according to a Ministry of Finance budget blueprint released on Thursday.

The first budget to be compiled by the administration of Prime Minister Yasuo Fukuda projected a 0.2 percent spending increase over this year, pointing to a retreat from fiscal reform efforts as politicians seek more spending against the background of a possible snap election.

"Through this budget, it's hard to see the direction of reforms of overall revenues and expenditures,"said Hidenori Suezawa, chief fixed income strategist at Daiwa Securities SMBC.

The total size of the budget for fiscal 2008/09, starting next April 1, will be 83.06 trillion yen ($733.3 billion), up from this year's initial budget of 82.91 trillion yen.

Japan has compiled austere state budgets in the past few years to rein in its huge public debt.

Still, the country's outstanding public debt is expected to rise to around 776 trillion yen by the end of next fiscal year, roughly 147 percent of the country's gross domestic product -- the worst among the world's leading nations.

Its key fiscal consolidation target is to shift the primary balance -- revenue excluding debt issuance minus spending excluding debt service -- into surplus for both central and local governments by the fiscal year starting in April 2011.

But the MOF's budget proposals showed the primary deficit for the central government alone will widen for the first time in five years to 5.18 trillion yen in fiscal 2008/09.

RISING SOCIAL SECURITY COSTS

The ministry has been under pressure from ruling Liberal Democratic Party lawmakers who want to boost government spending to win back the support of voters after the party took a drubbing in an upper house election in July.

The budget will go through final tweaks this week before it is submitted next month to parliament, where it is likely to face another political problem.

With opposition parties holding a majority in the upper house, parliament may not be able to approve the government's budget proposals before the new fiscal year starts on April 1.

In that case, the government may be forced to run on a stop-gap budget for the first time in 14 years.

Even if the budget is approved by April, it could be revised to reflect demands from the opposition bloc, with the likely result of a further increase in spending, analysts say.

The MOF's draft budget showed general expenditure, covering steps ranging from defence and public works to social welfare and education, will rise 0.7 percent from the current fiscal year to 47.28 trillion yen, because of an increase in social security payouts. Social welfare, which accounts for 46 percent of general expenditure, will rise 3.0 percent as Japan's ageing population requires more spending on pensions and medical services.

The new budget sets aside 7.44 trillion yen for pension payments, up 5.8 percent from the current fiscal year. The government is also increasing tax grants to municipal governments by 4.6 percent to 15.61 trillion yen to respond to calls from lawmakers to increase spending to reinvigorate regional economies.

The MOF, however, managed to reduce new debt issuance by 0.3 percent to 25.34 trillion yen, largely thanks to an increase in non-tax revenues such as transfer of surplus funds in the foreign exchange special account to the general budget account.

The MOF will have last-minute negotiations with other ministries over the next few days before compiling a final draft.

That draft, expected to contain only small changes from the proposals unveiled on Thursday, is expected to be approved by the cabinet on Dec. 24 and will be submitted to parliament in January. (Editing by Mike Miller)