(Adds details, political source)
* No new debt issuance involved in extra budget
* Govt eyes new borrowing, tax hikes to pay for reconstruction
* PM cites extra budget passage as one condition for resignation
* Opposition shows no sign of compromise on deficit-bond bill
By Tetsushi Kajimoto
TOKYO, July 25 Japan's parliament approved on Monday a 2 trillion yen ($25 billion) extra budget for disaster relief after the March earthquake, paving the way for bigger reconstruction spending likely to involve new borrowing and tax hikes.
Prime Minister Naoto Kan, under fire for his handling of the nuclear crisis triggered by the massive March 11 earthquake and tsunami, has cited the passage of the extra budget and two other key bills as conditions for keeping a promise to resign.
Kan has kept the timing of his departure vague, frustrating his critics in the opposition and his own party. Political wrangling over the fate of the unpopular premier is threatening to further delay compilation of a future reconstruction budget expected to exceed 10 trillion yen.
Investors are counting on huge reconstruction spending to help the world's third-largest economy pull out of a post-disaster slump and resume moderate growth later this year and early in 2012.
Tokyo plans additional spending of 13 trillion yen to help pay for Japan's biggest rebuilding project since the period just after the World War Two. It has already set aside 6 trillion in the extra budget just passed in parliament and one approved in May.
To raise the money, the government is considering issuing reconstruction bonds, with maturity of around five years, while scaling back other spending plans, the source told Reuters.
Optimists in Kan's ruling Democratic Party of Japan, who want the unpopular leader to go, are hoping the two remaining bills will be passed by mid-August.
That would clear the way for Kan to resign and for a party leadership race to replace him as the country's sixth prime minister since 2006.
But it remained unclear if combative opposition would cooperate in passing those other bills -- one on deficit-bond issuance needed to fund a $1 trillion budget for the fiscal year to March 2012, and the other on renewable energy.
An opposition lawmaker told Reuters it would not make a political issue out of the renewable energy bill --- which could be enacted next week -- but opposition parties were driving a hard bargain on the deficit-bond bill.
The opposition demands that the ruling Democrats review their spending plans including child-care payouts as a condition for the deficit-bond bill, and discussions are already under way.
"But taking such steps alone would not guarantee the passage of the deficit-bond bill, as our decision on the matter will depend on a political situation at the time," the lawmaker said.
With public debt already twice the size of the $5 trillion economy, the heavily-indebted government has so far funded the two extra budgets without new borrowing while tapping fiscal reserves and reallocating spending.
The second supplementary budget features steps to cope with the radiation crisis at Fukushima Daiichi plant, operated by Tokyo Electric Power Co , and help indebted individuals and businesses in the quake-hit areas secure new loans.
It includes 7 billion yen set aside for a planned organisation to handle compensation to victims once a relevant bill is passed by parliament.
The government set up a framework in the extra budget to issue 2 trillion yen in special-purpose bonds to help finance the planned organisation, and it earmarked 20 billion yen in the extra budget for interest payments. It also created government guarantees worth 2 trillion yen for the new organisation.
($1 = 78.355 Japanese Yen) (Additional reporting by Linda Sieg; Editing by Tomasz Janowski)