Japan fiscal reform in question after PM resigns

By Yoko Nishikawa

TOKYO (Reuters) - Japanese Prime Minister Yasuo Fukuda's sudden resignation may derail the nation's fiscal reform efforts if a new leader prioritizes stimulating an economy on the verge of recession, economists said.

Fukuda has been keen to rein in Japan's huge public debt of around 1- times GDP, the highest among major industrialized nations while Taro Aso, a veteran lawmaker and frontrunner to take over the leadership, has been more vocal about spending more to boost the world's No.2 economy.

"Aso has been advocating larger fiscal spending lately, so fiscal discipline may suffer a set-back after Fukuda's resignation," said Takahide Kiuchi, chief economist at Nomura Securities.

Japan's economy is on the verge of a recession, if not already in one, as high oil and food prices bite. GDP contracted in the second quarter at its sharpest rate in seven years as global growth slowed.

The government last Friday issued a package of tax cuts and other steps to ease the pain to businesses and consumers from rising oil and food prices.

But partly thanks to Fukuda's caution, it avoided any return to the massive public spending projects Japan resorted to in the 1990s in a mostly unsuccessful attempt to pump up the economy.

It was unclear what kind of impact the change in Japan's prime minister will have on the Bank of Japan's monetary policy.

The central bank's long-held desire to boost Japan's low interest rates back to more normal levels was already on hold due to the stalled growth and few saw any room for any cuts.

On fiscal reform, the government currently aims to get the primary balance -- the budget balance excluding debt servicing costs -- into the black in fiscal 2011/12 as part of efforts to cut Japan's huge fiscal deficit.

But Aso, the secretary-general of the ruling Liberal Democratic Party, said in August that such a target may need to be reconsidered in such tough times.

Aso also urged the government to expand tax incentives on stock investments last month.

"I think Aso will be the leading candidate to succeed Fukuda. As Aso favors larger government spending, it will be positive for stocks and negative for bonds," said Hidenori Suezawa, chief bond strategist at Daiwa Securities SMBC.

The LDP's next leader will enjoy a large majority in parliament's lower house and will lead Japan's government.

But most politicians will likely be preoccupied with a looming general election that must be held by September next year, leaving little time for detailed policy work -- including deciding who should fill two vacancies on the BOJ's rate-setting policy board.

(Editing by Rodney Joyce)