(For more on Japan's election, click [ID:nPOLJP]) (Adds challenge on emissions target)
By Yoko Nishikawa
Aug 31 (Reuters) - Japan's Democratic Party faces a raft of challenges after crushing the ruling coalition in an election on Sunday, including growing social welfare costs in a rapidly ageing society and tattered public finances.
The victory ends more than 50 years of almost unbroken rule by the conservative Liberal Democratic Party (LDP) and breaks a policy deadlock caused by a divided parliament, where the opposition controls the upper house and can delay bills.
Following are major challenges for the next government.
Japan's economy returned to growth in the April-June quarter, pulling out of its longest recession since World War Two. But the nascent recovery was due to short-term stimulus efforts and economists say it could lose momentum later this year. [ID:nECONJP]
The outgoing LDP government had planned 27 trillion yen ($287 billion) in stimulus spending since the global financial crisis erupted last year. The Democrats have said the government is spending money on the wrong things, such as a museum of Japanese pop culture, adding it would cut wasteful spending from an extra budget for the year to next March.
Stimulus efforts from past economic woes have left a public debt equivalent to 170 percent of GDP, the highest among advanced nations, worrying financial markets about further debt issuance.
The Bank of Japan, with its key policy rate near zero percent, last month extended by three months the September deadline for its unconventional measures aimed at easing corporate funding strains. The focus now is on when the central bank will exit from those emergency measures.
AGEING POPULATION, SALES TAX DEBATE
One of Japan's biggest challenges is to revamp and pay for soaring health, social welfare and pension bills as a wave of post-war baby boomers retire.
For a graphic tracking Japanese demographics, click: here
Economists say funding these will mean raising the 5 percent consumption tax, but the topic is politically touchy. The Democrats say they will not hike the tax for at least four years.
Critics say five years of pro-market reforms under Junichiro Koizumi, the LDP prime minister from 2001 to 2006, have widened social, income and regional gaps. The Democrats have sought to distance themselves from those changes, which included postal privatisation and deregulation of the job market.
The global recession has given some impetus to calls for a return to stronger regulation. Companies worry that trend will be stronger under a Democratic Party government, given the party's support among labour unions. EMISSIONS AND ENVIRONMENT
The Democrats say they will target a 25 percent cut in emissions from Japan, the world's fifth-biggest greenhouse gas emitter, from 1990 levels by 2020. That is tougher than the outgoing government's 2020 aim of a cut of 8 percent below 1990 levels. [ID:nT183553]
But the Democrats also plan to eliminate highway tolls and abolish a decades-old surcharge of about 25 yen (27 U.S. cents) per litre on gasoline from April. Those plans have led green groups to question the party's resolve for greener lifestyles.
The Democrats face the tough task of balancing their push for a low-carbon society with the need to quickly implement policies that have mass appeal to consumers and industry ahead of an election to the less powerful upper house in 2010. [ID:nT220303]
Japan's new leader must address the challenge of China's rising regional clout, while keeping ties with its huge Asian neighbour and biggest trading partner on an even keel.
Sino-Japanese relations have improved recently after years of friction over Japan's military aggression in Asia before and during World War Two, but territorial and maritime disputes still simmer along with mutual mistrust over military ambitions. (Additional reporting by Chisa Fujioka, Editing by Dean Yates) ($1=94.23 YEN)