TOKYO (Reuters) - Prime Minister Naoto Kan has widened his lead over powerbroker Ichiro Ozawa ahead in a party leadership vote, Kyodo news agency said on Friday, days before the contest that could set Japan's fiscal priorities.
Whoever wins the September 14 vote faces the task of keeping a split Democratic Party of Japan (DPJ) from unraveling while struggling with a strong yen, a fragile economy, huge public debt and a divided parliament that threatens more policy deadlock.
Markets are bracing for a shift toward a more stimulative fiscal policy if Ozawa, 68, wins.
But it remains unclear whether the political strategist, whose future is clouded by a funding scandal, could survive a possible opposition campaign to stall parliamentary business.
Ozawa is unpopular with most voters, put off by his image as a wheeler dealer. Critics question whether what they see as his economic policies would help escape decades of stagnation.
"Strong arm policies may be welcomed by the markets short-term, but in the longer term the preservation of the old economic and political set-up may only serve to strengthen the sense of hopelessness," said Masamichi Adachi, a senior economist at JP Morgan Securities Japan.
Kyodo news agency said Kan, who took office three months ago as Japan's fifth premier in three years, had locked up 585 points out of a total 1,222 compared to 475 points for Ozawa. The points are based on votes by DPJ members of parliament, local lawmakers and party rank-and-file.
The winner of the party election, held every two years, is expected to become prime minister because of the DPJ's majority in parliament's lower house.
Kan vows to cap new bond issuance for the fiscal year from next April at this year's level of around 44 trillion yen ($524.7 billion) to curb public debt, already about twice the size of the $5 trillion economy.
Ozawa, once a protege of Kakuei Tanaka -- a former premier and the architect of Japan's political regime of pork-barrel and party factions -- has said he would consider issuing new debt to fund stimulus steps if the economy worsens.
A win by Ozawa would likely give a short-term boost to stocks while weakening government bonds and the yen, a Reuters poll showed on Friday.
But more than two-thirds of respondents said Ozawa would be neutral or negative for the economy, long-term. About half said a Kan victory would be neutral for stocks, bonds and the yen.
Kozo Watanabe, a DPJ elder backing Kan in the race, said an Ozawa victory would erode public trust in politics given polls showing most voters back Kan, but cautioned against exaggerating policy differences.
"Whoever becomes prime minister, the budget and fiscal situation won't change," he told Reuters in an interview.
Japan's economy grew just 0.4 percent in April-June, better than initial estimates but cold comfort as authorities grapple with deflation and a yen near a 15-year high against the dollar.
Kan's government unveiled new measures on Friday, but analysts doubted they would have much impact.
Japanese officials have been trying to talk down the yen, even threatening intervention, with little success. Ozawa has said he would take all possible steps to stop its rise.
Ozawa would also likely step up pressure on the Bank of Japan (BOJ) to buy more government bonds to keep his spending plans from pushing up long-term interest rates.
The Democrats took office for the first time last year and promised major changes after more than 50 years of dominance by the conservative Liberal Democratic Party. They have since floundered and were thrashed in a July upper house election.
Even if Kan wins the party vote, a robust showing by Ozawa could cast doubt on efforts to reduce debt. An Ozawa victory would also leave unanswered questions.
Admirers say his political skills would help win opposition backing to get bills through parliament, but his scandal-tainted image could make rival parties wary of joining hands.
A judicial panel of ordinary citizens is expected to decide in October whether Ozawa must face indictment over a funding scandal in which three of his aides have already been charged.
Additional reporting by Yoko Nishikawa, Yoshiyasu Shida, Leika Kihara, Stanley White, Nathan Layne and Chisa Fujioka; Editing by Ron Popeski